Entrepreneurship: Recent Episodes
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Entrepreneurship includes works on the theory of the entrepreneur, e.g., in Mises, Kirzner, and Schumpeter, and the nature of profit.
Many people believe that the board game Monopoly, developed during the Great Depression, mimics a real-world capitalist economy. Monopoly is a game, not real life.
Original Article: "Is the Monopoly Board Game Like Real Markets?"
Economic calculation is not an either-or proposition. Even in so-called market economies like that of the USA, there is plenty of government intervention that distorts market processes.
Original Article: "Economic Calculation Is Nonbinary"
Too many economic commentators claim that monopolies are the cause of inflation. Austrian economic analysis shows that this is impossible.
Original Article: "Do Monopolies Cause Inflation?"
The fall of the Pac-12 is an unfortunate end to a proud collegiate institution. But its death isn’t the fault of uncurable greed but of the conference’s own inability to be competitive in the game.
Original Article: ""Greed" Didn't Kill the Pac-12. Entrepreneurial Failure Did"
Experienced entrepreneurs are Austrians.
Download the slides from this lecture at Mises.org/MU23_PPT_35.
Recorded at the Mises Institute in Auburn, Alabama, on 28 July 2023.
Entrepreneurship is a general feature of the market economy.
Download the slides from this lecture at Mises.org/MU22_PPT_09.
Recorded at the Mises Institute in Auburn, Alabama, on 24 July 2023.
Calls for black consumers to "Buy Black" can be interpreted as socially divisive, but they are also a way to encourage black entrepreneurs in a free market.
Original Article: "The "Buy Black" Movement: Divisive or a Boon to Black Entrepreneurs?"
Modern culture is biased against those that are rich even while depending upon the wealth that successful entrepreneurs have created.
Original Article: "Progressives Want to Eliminate Wealthy Entrepreneurs but Need the Wealth They Create"
Austrian economics is not dry theory. It helps us make sense of our world and shows that exchange and production have a place in our moral universe.
Original Article: "How to Teach Austrian Economics to the Neighbor Kids"
Politicians like Elizabeth Warren and Alexandria Ocasio-Cortez are demanding that successful entrepreneurs be taxed into oblivion. The real parasites are the politicians who destroy wealth instead of creating it.
Original Article: "Who Are the Wealth Destroyers, Politicians or Billionaires?"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Austrian economics recognizes change as a constant and provides guidance for adapting to it and managing it. Change is changing for business — it’s faster and more fundamental in the digital age. Austrian economics can help even more as a result of its practical and realist approach to adaptation and continuous adjustment.
Knowledge CapsuleChange is changing.Change is a constant. You can think of the market in constant flux, as Mises did, You can think in terms of VUCA — volatility, uncertainty, complexity, and ambiguity. You can think of it in terms of complexity or of absolute uncertainty. However you tune your mind and your business processes, there are always going to be more things that can happen than you can predict or prepare for.
There are some ways to think better about ceaseless change, however. One is to bucket the major themes or corridors of change, to organize your thinking and make some judgments about where and how to act and adapt. By recognizing these multiple types of change, businesses will be better prepared for adaptive action.
Our E4B guest Phil Simon has studied change in the workplace and recently published a new book titled The Nine — about nine tectonic forces that are reshaping business and the workplace where we conduct business. He advises businesses to be alert to the changing nature of change in the digital age.
People are changing.The people you hire today and the people already working at your firm are not the same people as they were just a couple of years ago. They’ve been through a new, different and challenging experience of working through the Covid-19 pandemic, and they’ve been working with new technologies, in new places (i.e., working remotely) and they’ve been questioning how they relate to work, to their colleagues, and to the firm. Don’t expect them to be unchanged in their mindsets, attitudes, and work practices. The nature of the employment relationship is different today — less formal, less rigid, less standardized. Phil Simon uses the term “empowered employees” — employers must be empathic in understanding their new mental model as it relates to work.
The workplace is changing.The workplace is no longer a physical space where people congregate to collaborate on work tasks, but a digital space of networked people, machines and software. New software and new machines are evolving all the time in this space, changing our relationship to it and to work. People are not going to go back to the office as the standard method of getting business done. If you want to have a physical space for people to meet in person, it must be reconfigured to support those business activities that can only be done in person, and not just as a standard structure of cubicles, offices and wiring. People must feel that there is more or better productivity to be enjoyed in the physical shared space than can be realized elsewhere.
The structure of work is changing.Phil’s book includes a section on fractions: the idea that firms no longer need full-time access to a necessary business skill — like finance and accounting — via contracting with individuals for 100% of their worktime. New organizational models are emerging that utilize fractional access to these skills as needed. There are fractional CFOs and CMOs and CTOs. There are highly qualified experts available via sharing platforms; they can be both the best at what they do and the best fit for your firm’s need, available for a percentage of their time, not all of it. This thinking about fractional talent and skill utilization is becoming a more integral part of organizational thinking.
Automation is universally available.Some level of automation is coming to every workplace. It’s approaching with greater speed and intensity today. It’s best to think of automation in terms of outcomes: what needs to get done and can it be done in a more automated fashion? What needs to be produced (Phil cites automated pizza making machines)? What processes are taking up people’s time (Phil cites automation in payment systems)? What jobs can be totally automated (e.g., driving trucks)? What departmental functions can be fully automated (like content moderation at Twitter)? All businesses should be reviewing all their activities at all these levels and asking where automation can eliminate waste, save time and release resources for greater productivity. Whether it’s as simple as calendaring software or as complex as robotic process automation, it’s right to examine every opportunity and find an automated solution.
A.I. Is going to help.The rapid adoption of ChatGPT has opened many eyes to the possibilities of getting smart assistance to change and improve the way work is done. ChatGPT can help develop content, make plans, find data, write code, make summaries of libraries of documents, and assist in many many more tasks — as exhibited by the many ChatGPT threads on twitter that are full of new ideas. The great breakthrough of ChatGPT lies in making available the vast majority of available knowledge on virtually all topics in a convenient, conversational way. Businesses are the results of their accumulated, shared and applied knowledge. ChatGPT and similar AI’s amplify knowledge and accelerate learning. Businesses that don’t utilize this availability will fall behind their competitors.
There will be new software environments.Software and platforms are two parts of the work environment that are changing fast. Whether we work on Zoom or Slack or Teams or Github or Salesforce, we continuously encounter new upgrades and functions as well as new alternatives. There is no alternative to earning the skills to utilize these tools to their greatest productive effect, and to keep our learning updated.
One economic function that is not improving amidst content change is trust. We can’t be sure, sometimes, about the other party we’re talking to or collaborating with, we can’t be sure of trusting data, we can’t be sure that our privacy and property rights are protected. Phil made the prediction that blockchain, as a secure record of all transactions and un-hackable repository of data and information, will play a bigger role in our business future as an arbiter of trust. For example, this may be where our individual health records might reside, which individuals would own, and which they could share and use for their own benefit in navigating the regulated opacity of the healthcare system.
Subjectivism and empathy will always play important roles.Phil made a reference to “unhealthy analytics”. His point was that we are now in a position to measure more and more human action and human behavior, but that measurement does not necessarily provide insight, and may even give rise to perverse incentives. For example, it’s possible to measure when employees checked in to the office and when they left, but it’s not equally possible to monitor their productivity or motivation. It’s possible to measure the number of hours they spend on Zoom, but a different problem to measure their remote contributions. Analytics have their place, but understanding and empathizing with employees, and carefully constructing their mental models in order to be able to appeal to them and stimulate them, remain subjective, emotionally-based skills which are still a critical component of management.
Steer into the skid.How do founders, owners, and managers deal with these changes? Phil’s expression is to steer into the skid. Reimagine work, embrace the powerful new technologies that are available, and be willing to experiment — perhaps in ways that others aren’t — to generate the active learning that moves organizations forward. It might be messy, and even feel chaotic, but it’s the right response to tectonic change. Expect some turbulence, while being open to infinite new possibilities.
Additional ResourcesThe Nine: The Tectonic Forces Reshaping the Workplace by Phil Simon: Mises.org/E4B_215_Book
PhilSimon.com — Expertise on workplace collaboration and technology
Phil Simon on LinkedIn: Mises.org/E4B_215_LinkedIn
Entrepreneurship is well-defined in economics, and well-recognized as the engine that drives economic growth. That means people enjoying greater well-being, including but not limited to material prosperity. But economic growth can be uneven. Some countries, some regions, and even some firms do not generate the same levels of economic growth as others. How do we understand this variability? We look for what holds entrepreneurship back.
Knowledge CapsuleEconomic development can be a self-reinforcing cycle of continuous improvement in people’s circumstances.Greater material prosperity is a valid and worthwhile goal for economic development. But, says Shawn Ritenour, economic development goes beyond that goal: it delivers a greater variety of goods and services that individuals and businesses can use as means to achieve their own diverse ends. The production of this greater variety requires entrepreneurship in the creation of new ideas and the pursuit of new value, and it generates new entrepreneurship by supplying a greater variety of resources to work with in those pursuits.
To generate this cycle, an enabling environment is required — one that acts as a catalyst for entrepreneurship.Economic development is a multifaceted process in which several forms of human action combine in a system for economic prosperity. It’s not instructive to try to isolate financial capital or capital goods or technology or even human capital, and culture and social institutions can’t be ignored. These sources of prosperity must work together in an orderly fashion to generate the necessary synthesis.
The vital role is that of the entrepreneur.The entrepreneur is the one who undertakes production, the one who combines resources to produce a product that meets customers’ needs and enables those customers in their own economic pursuits. Entrepreneurs kick off the cycle. Firms and organizations can act entrepreneurially, but it’s fundamental to understand that individuals — sometimes working in teams or committees — are the ones behind entrepreneurial decision-making. The entrepreneur is not necessarily a single person, but entrepreneurship is always a human action.
How do we get entrepreneurship started?Entrepreneurship requires customer knowledge, technical knowledge and financial capital. Customer knowledge includes the empathic understanding of what’s needed for customers to be able to better meet their own needs. In the context of economic development, this knowledge is probably widely available to private entrepreneurs, but it may not be available to governments, whose understanding is distorted by predispositions to develop specific industries or subsidize specific economic sectors, or towards a particular technology. For these reasons, there can be no “entrepreneurial state”. Individuals with their own ideas and their own private property will provide the energy o break economic inertia.
Technical knowledge defines a sufficient understanding of the technology and technological resources to deliver the desired new value to the customer. In under-developed economies, this technical knowledge may be thin, so reinforcing the technical knowledge of entrepreneurs is appropriate, through education, injections of new technology, training, mentoring, or other forms of knowledge transfer.
With the right understanding of customer needs and the command of the right technology, the entrepreneurs involved in the development state will always need financial capital, because production takes time to organize before cash flows in to the firm from customers. In development contexts, entrepreneurs often will not have savings of their own, and there may not be an appropriate institutional infrastructure of local banks and lenders and investors.
Therefore, customer knowledge, technical knowledge and financial capital combine to provide the foundation for entrepreneurial leadership and growth. They’re integrated: it’s important for the sources of financial capital to understand and appreciate the nature of the customer and technical knowledge that is being deployed. Typically, this takes the form of venture capital or private equity.
Education is another important element in the institutional environment for entrepreneurship.Entrepreneurship as a skill or capability can not be taught — it requires a special orientation that’s more developed in some individuals and firms than others. But principles, process and tools can be taught, and experienced entrepreneurs and businesspeople who have developed market savvy can share knowledge that they have acquired. Communicating the entrepreneurial mindset and methods in all stages of education will help to create and promote an entrepreneurial community that’s supportive of economic development.
One aspect of learning is to understand the entrepreneurial ethic of sacrifice, that it takes a lot of time and effort and expenditures and extended commitment before business success can be achieved. There’s more hard work than there is magic.
Institutional elements such as property rights and sound money are important components of entrepreneurial development.Property rights and sound money may sound like abstract concepts, but they are extremely influential in economic development processes. Property rights mean that entrepreneurs can assemble and go to market with their own resources in whatever way they prefer. Sound money means that entrepreneurs can anticipate a return from their productive activities that’s not eroded away by inflation, and they’re not led into miscalculation by monetary manipulation (e.g., unanticipated escalation of future borrowing costs).
Removing obstacles to entrepreneurship is the best economic development policy.Traditional approaches to economic development favor centrally planned initiatives, government spending, and policies in the form of subsidies or special incentives. They’re not typically market-based approaches. But the right approach is the opposite of policy-making. Instead of trying to design and add new structures, development should be focused on the removal of barriers — on identifying what’s getting in the way of nurturing a rich and robust entrepreneurial culture, and focusing on the removal of those obstacles. Leave the entrepreneurs to identify the specific products and services and businesses that can flourish, and to attract the investment capital that will support those businesses, without the need for “policy”.
Additional ResourcesThe Economics of Prosperity: Rethinking Economic Growth And Development by Shawn Ritenour: Mises.org/E4B_214_Book1
The Economics Of Prosperity (Edward Elgar): Mises.org/E4B_214_Book2
Shawn Ritenour at Mises.org/Ritenour
Shawn Ritenour at Grove City College: Mises.org/E4B_214_Profile
Market research is a tool for gathering data about customers and consumers that businesses hope will lead to insights about their behaviors and preferences that can be translated into innovation, better service and better business performance. As with any dynamic system, it has changed over time, and the effects of entropy have begun to show themselves in invalid techniques, invalid data, and invalid conclusions. And as with virtually all business systems, the coming of the digital age provides businesses with the opportunity to review, revise and improve exiting practice and existing thinking.
Knowledge CapsuleTraditional models of market research are losing validity.The Economics For Business approach to market research leans to the qualitative, such as one-on-one conversations with customers and detailed ethnography whereby businesses can observe customer behavior directly. The market research industry grew up favoring quantitative research at scale for its own reasons: that’s where the money is. Sharekh Shaikh points out that a $USD 70 billion industry was built largely on large scale panels — recruited audiences adding up to hundreds or thousands of individuals, to whom the market research industry could launch survey questions (“data gathering instruments”), generating large amounts of response data for quantitative analysis and numerical reporting.
Customers of these research reports use the output for decision support. Consideration of launching, or of purchasing and installing, a software suite or platform costing millions of dollars can be justified with the results of a survey costs tens of thousands of dollars or low six-figures.
One of the planks supporting the value proposition of market research panels is the difficulty of recruiting qualified respondents, such as CIO’s or CTO’s for an enterprise software survey. Panel operators’ revenues reflect their claims to solve this problem, but Sharekh Shaikh tells us that the reliability of their claim has eroded. Panels now may include inaccurately identified respondents (wrong title or role, for example, because the respondent has changed jobs or roles), or even fraud (responses provided by others than the supposed respondent, including bots). The data from the panels is no longer as valid as it once was, and its decision-support quality no longer as high.
This general decline in the quality and reliability of traditional research is taking place in many categories, not just tech — consumer package goods, entertainment, fashion, and any industry that uses these methods.
The digital revolution brings new opportunities for change, including in traditional market research.It’s unusual to think of digitization as increasing human contact, but in research it’s the case. Sharekh’s research platform, CleverX, has effectively removed the intermediary, the market research panel operator and market research respondent recruitment agency, from the equation, so that the firm requiring research can be connected directly with the respondent with the desired experience and user perspective.
Respondents sign up to a place on the platform by supplying their personal data, career profiles, qualifications, credentials and experience. Their incentives include their desire to participate in and contribute to industry developments, as well as the compensation offered. By learning the questions that are being asked, the professionals who sign up to be respondents can gain insight into the developments that are being pursued in their industry. Being a panel member is career and professional advancement.
The firm seeking to gather data can identify their respondents and assemble their own panel, using their own criteria and specified profiles, and building a direct relationship with their respondents and customers. Moreover, they can use any data collection tool they prefer, whether that is a technical tool such as Survey Monkey, or direct one-one-one conversations on Zoom or Microsoft Teams, digital focus groups, or any other format. By integrating with calendar software, research interviews with CXO’s can be organized and calendarized. These powerful toolsets result in higher quality research being completed up to 10X faster.
Digital technology also facilitates video interviewing, so that researchers can talk directly with respondents, and develop a relationship with them. The video interviewing can be asynchronous: given a query, respondents can video-record their responses whenever convenient, TikTok-style. AI can add enhancements such as sentiment analysis, body language and facial expression interpretation.
The distinction between quantitative and qualitative research disappears and we realize qualitative data at scale.
Market research can become continuous monitoring in the adaptive entrepreneurial system.The reality of markets today is high-speed continuous change. Market research as a tool has always been at a disadvantage in delivering snapshot that take time to process, by which time the market has moved on. Now, with digital techniques, continuous monitoring is possible. Sharekh mentioned several applications:
Customer understanding of digital developments: as platforms and systems evolve, customers may not be able to keep up with the technology, or may not be taking advantage of new feature. Digital research techniques can monitor and measure customer understanding dynamically, and point to gaps in their comprehension.Dynamic product development: as developers move a product towards market, digital research techniques can expose potential customers to the development path, and help developers to integrate real-time findings.Monitoring changing lifestyles and mental models: since digital research technologies can provide a continuing connection with customers, it can measure not only their responses to queries, but also their behaviors, attitudes and thinking in general. It’s possible to develop profiles and personas and segmentations into which innovative ideas can be inserted to simulate reactions and acceptance.CleverX represents exactly the kind of knowledge recombination that can result in revolutionary change across an entire industry.A core concept in entrepreneurship is the combining of existing knowledge in new ways for new solutions. Sharekh Shaikh combines his software engineering knowledge with knowledge of the market research space and knowledge of the dissatisfaction of end users with the available research tools. His newly-launched company, CleverX, is a fast-growing new entrant in the research space as a result of providing a totally new service: the facilitation of a direct connection between researcher and respondent with digital intermediation in place of previous-generation tools. The experience for the customer is better data, at faster speeds, gathered more conveniently and faster, and, consequently, of greater use in development and innovation processes.
Additional ResourcesCleverX.com
Sharekh Shaikh on LinkedIn: Mises.org/E4B_213_LinkedIn
Peter Drucker famously identified the only two value-generating functions of the firm as innovation and marketing. We propose to differentiate brand building (or branding) from marketing, especially in this digital age. Brands are the vehicle for framing, establishing, nurturing and enhancing relationships with customers. In the digital age, marketing has become mechanized and mathematicised; it’s about numbers more than about human values and emotional bonding. Graceann Bennett is a branding expert who has devoted her career and her research agenda to furthering the science of brand building.
Knowledge CapsuleBrands are assets that drive customer value and business revenue, and they’re more valuable than ever in the digital age.Our Economics For Business entrepreneurial method emphasizes the facilitation of value for customers — it is customers who create value through their experiences, and the role of entrepreneurship is to facilitate those valuable experiences. Brands are platforms for value facilitation and conduits for value delivery. In the economic system where assets are value drivers, brands are high-capacity intangible assets. They can be developed and nurtured through various types of economic investment, with a high return on that investment because of the closeness to the customer that they can embody. The investment can be creative and intellectual and is not necessarily limited by budgets and financial resources.
Brands hold emotional and relational value, often communicated through symbols and codes.Brands have meaning for customers, and the meaning is differentiated — customers prefer one brand over another. Brands fit into their lives and connect to them emotionally - they can trust brands, rely on brands, and even love brands. Brands express the essential humanism of economics - the entrepreneurial ethic of improving others’ lives. They represent an understanding of human yearnings. They help people who are striving to be the best version of themselves. They’re a great tool for entrepreneurs.
Brands often communicate via symbols and codes: advertising, logos, package design, social media, and sales presentations. These are important, but they’re not the essence of branding. That role is reserved for the emotional connections that brands make with customers, engendering trusted relationships.
In the digital age, marketing has lost the art of branding.Brand building is an art, an engagement with customers on a psychological and philosophical plane, enhanced by creativity, design, expressive language and visualization. In the digital age, marketing is headed in a different direction. Marketing has become mathematicised. Digital marketing is all about the numbers: audience reach and likes and engagement metrics defined as clicks and views. It’s the mechanics of the engagement funnel, of clicks leading to conversions. Graceann Bennett called this approach “the attention economy rather than the emotional economy”.
Even worse, marketers are antagonizing customers with an interrupt-and-annoy approach of increasingly invasive pop-ups and intrusions and uninvited invitations in e-mail and text. Annoyingly intrusive marketing can further decay into creepiness as consumers receive offers for goods and services algorithmically triggered by their search history and e-mail conversations or voice requests to Siri or Alexa that they might not have realized were quite as available to marketers as they are.
Branding creates customer relationships through emotion and psychology.The mathematical, mechanical approach is exactly the opposite of the human approach of brand building. Branding aspires to a relationship with customers, a creative relationship of innovation and renewal that continuously improve customers’ expectations of what’s possible and their anticipation of satisfactions to come from brand usage and branded services. Entrepreneurial brand owners seek to understand the needs and wants of customers, and what they find disappointing in current experiences, with a view to making their experiences and their lives better. A lot of this initiative takes place in the realm of psychology, getting inside customers’ minds to understand their preferences and why they hold them, and their choices and why they make them.
Brandowning firms examine themselves critically to ensure that they are authentic in serving customers’ emotional and psychic needs.Graceann Bennett employs Jungian archetype analysis to clarify and channel brand approaches to customer relationships, emphasizing what’s authentic in the brand’s character and orientation that aligns best with customer psychology. While the first stage of the entrepreneurial method is a deep understanding of the customer and their needs so as to define and scale a potential market, it’s also appropriate in the solutions design stage for the brand owner to look inward to define the persona for the brand. To establish trust and build a relationship, a brand must inspire confidence on the customer’s part, and to do so must establish authenticity: when claiming to deliver a benefit and facilitate a valuable experience, the brand claims must be consistent with the brand character, the brand heritage and the brand history. A brand can’t claim to be something it’s never been before, or claim a meaning and a purpose that it has never before exhibited. It can add features and polish and update its attributes, but it can’t depart entirely from its historical, observed orientation. Brand relaunches and repositionings risk losing connection with the customer if they are not credible.
Brands should search not for novelty in presenting themselves, but depth, clarity and simplicity in establishing brand character.Ethnography is the best research technique to develop empathic engagement between brands and customers.
Ethnography is mingling with customers, talking to them, listening intently, and observing their actions and behaviors. This kind of interactive contact with customers should be primary - the analysis of digital clicks and views and followers and even purchase behavior can’t deliver the same rich emotional and psychic consumer understanding and insight. In the digital age, we’ve abandoned the art of mingling, and that’s a difference between branding and marketing.
Additional ResourcesGraceannBennett.com
Playbook Studio: Playbook.Studio
Graceann Bennett on LinkedIn: Mises.org/E4B_212_LinkedIn
It’s time to re-imagine how entrepreneurs bring their innovative value propositions to market at the appropriate scale to meet the important needs of millions of people. The new way of thinking is for entrepreneurs to focus all their energy on designing, refining and strengthening the value proposition, and then plugging in to a network of resources assembled by others so that customers enjoy the full realization of the value experience the entrepreneurial has designed. Jeff Grogg of JPG Resources joined Economics For Business to describe how this works in the CPG food and beverage industry.
Knowledge CapsuleStarting From A New Value Proposition.The entrepreneurial journey — whether starting a new company or launching or improving a brand or launching and managing a new corporate innovation initiative or even a new division or internal venture — starts with a value innovation goal. An entrepreneurial team or an entrepreneurial organization conceives of a new experience for customers that they’ll value highly enough to warrant the firm’s investment in new capabilities. The team tests the market appeal and commercial power of the value proposition to greatest extent they can. They get ready to go to market at scale — to produce, package, ship, distribute, sell and take payments, and then to respond to marketplace results with more volume, or broader distribution, or maybe some tweaks to some aspects of the execution of the value proposition.
Traditionally, once the launch decision is made, the firm maps out the value chain and assembles the enabling resources — manufacturing capacity for products, service backrooms and infrastructure for services, supply chain components, business partnerships and their associated contracts, marketing and sales capabilities, distribution, warehousing and retail access.
What if this part — the resource assembly part — were already done? The risks and constraints of making a new business out of a new value proposition would be greatly reduced.
Jeff Grogg and his platform firm have built new business infrastructure so that entrepreneurs don’t need to.Jeff describes his company, JPG Resources, as a business builder. His focus is on food and beverage businesses in the CPG category. The company build businesses so that entrepreneurs don’t have to. To be clear, the entrepreneurial teams focus on the customer and customer empathy and understanding, identifying a unique value that meets meaningful needs for a large number of people. That’s the critical step in the generation of new economic value.
The next step is typically building the supply chain from formulation and recipe development for scale, to manufacturing and packaging, shipping and distribution, and designing the management processes and hiring the people and drawing up the contracts for smooth continuous scale operations. That’s extremely hard work, and fraught with risk. The phrase “starting a business” can sound intimidating for that reason.
JPG Resources can absorb and take on and solve all those challenges and potential problems, and free the entrepreneurs to concentrate on customer value design and the last mile of marketing and sales.
The new entrepreneurial production structure can apply at all scales.JPG Resources has helped pre-market start-ups with initial product development and culinary research, has provided infrastructure for growth for maturing companies, has helped mid-size companies expand beyond their current scope, and has helped big companies enter new areas beyond their existing comfort zones. The new “plug-in” production structure operates at all stages and all scales and all along the value chain.
JPG Resources can provide manufacturing or train manufacturers from start up through expansion. The can help with food science, create new processes, manage contracting, identify and mitigate risk factors and arrange insurance. They can organize supply chain redundancy (efficient redundancy through back-ups, not wasteful redundancy through duplicates) and build resilience for clients. A virtual supply chain is superior to — and more flexible than - the self-assembled version.
The new entrepreneurial production structure is a network without boundaries.The very term “supply chain” reflects linear thinking — links joined together in sequence. Systems thinking is non-linear. The JPG Resources infrastructure is an ecosystem using connective logic, connecting the necessary components, people, knowledge and flows for the desired outcome, and reconnecting as needed when the environment or the market changes. The network is not bounded — there are always external or partner services that are currently outside the network that can be brought in through new connections. All are conceptually aligned, and all the relationships and contracts are win-win. The experience of JPG Resources in designing, assembling and integrating supply chains and production networks means that they’ve seen both sides of contractual relationships and service partnerships under all conceivable circumstances and can make sure all the agreements work - and expand the value space - for all parties.
The new entrepreneurial production structure is an acceleration and strengthening of knowledge-building proficiency.In episode #199, we identified knowledge-building proficiency as the key to value creation capacity. By partnering with infrastructure building firms like JPG Resources (and Gembah from episode #210), entrepreneurs can benefit from sharing the knowledge that these forms have already accumulated over multiple projects and product and business launches and growth initiatives. Jeff’s company is only too happy to share this knowledge, and doing so can help entrepreneurs avoid what he calls “self-harm” — making mistakes that could be avoided with the relevant prior knowledge.
Experience is harder to share. Jeff’s staff have hundreds of thousands of hours of experience, and, while entrepreneurs can’t live what they’ve lived, they can certainly benefit from experiential learning.
The error avoidance inherent in knowledge and experience sharing can be invaluable to entrepreneurs.
Individual freedom and choice still apply, in a more flexible capital structure.Entrepreneurs can choose as much or as little of the available pre-built infrastructure as they choose. They can focus on their own strengths and supplement where they know they need to. They can make their own connections in the ecosystem and their own adjustments as circumstances dictate.
The new entrepreneurial infrastructure does not imply a reduction in entrepreneurial initiative, but a boost, an acceleration, an expansion of value creation potential. It enables the entrepreneur to concentrate on value facilitation rather than on building a supply chain.
The capital structure for value creation in the economy as a whole becomes more flexible, flows more freely and can throw off the shackles of bureaucracy and regulatory compliance. The entrepreneur can pass on the burdens of HR and finance and legal and many more functions that are peripheral to — and sometimes impediments to - value creation and concentrate on the value task alone.
This suite of organizational and capital innovation points to a structure of more firms, better firms, and faster and more significant value creation, with fewer economic resources devoted to value-extracting bureaucracy.
Additional ResourcesJPGResources.com
Jeff Grogg on LinkedIn: Mises.org/E4B_211_LinkedIn
In our technocratic age, it is easy to dismiss the latest technological developments as an avenue toward freedom, but some of them still bode well for markets.
Original Article: "Artificial Intelligence Can Serve Entrepreneurs and Markets"
This Audio Mises Wire is generously sponsored by Christopher Condon.
In 1991, India's political leaders moved away from socialism, embracing markets and improving the economy. But Indian elites continue to push socialism to the detriment of the people.
Original Article: "Capitalism Has Improved Life in India, but the Spirit of Collectivism Still Dominates"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Entrepreneurship and innovation are the keys to economic growth and higher standards of living. The USA has long enjoyed leadership status on these dimensions — people see the USA as the land of entrepreneurs and the source of new ideas and advances in business. Is the reputation still deserved? Or is it being eclipsed as part of the general decline in standards and capabilities that we observe? Lipton Matthews is a global economic and geo-political analyst who brings deep knowledge and expertise to address our concerns.
Knowledge CapsuleBorrowing a framework from the Global Innovation Index published by the World Intellectual Property Organization, we can examine the state of entrepreneurship and innovation in the US relative to both other countries and its own history, under the headings of institutions, human capital and research, infrastructure, market sophistication and business sophistication.
Institutions: The private sector institutions of the USA continue to excel for entrepreneurship and innovation.When we think of American institutions for the encouragement of entrepreneurship and innovation, we must examine private sector institutions, not those of government. Ordinary people in civil society build the institutions that promote innovation. Private scientific research is robust in responding to market signals of consumer and business needs. Financial institutions such as venture capital and angel investors support innovative development. Policymakers mistakenly believe they can conjure up a creative economy by fiat, but they’re wrong. It’s private institutions that support and cultivate innovation. Even if the public sector tries to encroach, the private sector maintains its innovative edge.
Professor Sam Gregg warned us recently that the United States of today more closely resembles a European social democracy than many Americans are willing to admit, but Lipton Matthews is confident that America is still winning the entrepreneurship contests because the forces of democratic socialism can’t overpower the higher-energy force of the private sector drive for creative innovation in return for market reward.
Human capital and research: The ability to execute overcomes any shortcomings in education.If we look through the declinist lens, it’s easy to become gravely concerned about the state of education at all levels in the US, which directly impacts the development and deployment of what economists refer to as human capital. Do we under-allocate resources to teaching schoolkids business and entrepreneurship skills and tools, and at the college level, do we turn out too many English and philosophy grads compared to market needs, and not enough engineers and STEM grads?
Lipton Matthews cautions us against worrying about the wrong things. The educational qualifications of the products of American schools and universities matters less than their executional and implementational capabilities. America is a nation of do-ers, and that type of expertise is embedded and innate, from the time of the founding fathers and early immigrants who built the America economy. We prize innovators more than inventors — the ones who successfully turn ideas into marketable products and services. Entrepreneurship is action, and American business capitalizes the talent for execution, combining scientific learning with creative action to generate innovation. Executional capacity comes more from a market orientation than from formal learning.
A concern about the research component of the Global Innovation Index’s “human capital and research” classification is, perhaps, more justified. Government-directed research dominates formal research budgets — directed to fields such as climate change — for universities in the US, and the historical evidence is clear that this pool of research is inappropriate for the support of entrepreneurship, despite European aspirations to an entrepreneurial state. Brilliant scholars and researchers who could be entrepreneurs and innovators are diverted into unproductive activities.
It’s difficult to quantify private sector R&D we must hope that it is sufficient to counter-balance the state’s diversion of research funds. In fact, Lipton Matthews points out, we must expect the state and innovators to be in competition. The former prefers control and stability versus the latter’s pursuit of disruption and change.
Infrastructure: Think local and regional, not national.We are frequently presented with stories about the crumbling of US infrastructure. That’s the wrong level of focus, according to Lipton Matthews. First we should compare US infrastructure to other countries, where the quality of engineers and engineering may be lower, and so roads, bridges and communications networks are inherently superior in the US. Second, we should focus on infrastructure in our localities and regions. Local communities can manage infrastructure well in support of local businesses. Some towns and cities will have better-managed and better-maintained infrastructure than other parts of their state, and businesses will be attracted there.
Market sophistication: capital flowing to best entrepreneurial uses.Lipton Matthews interprets the Global Innovation Index’s category of market sophistication to refer to the financing of startups, scale-ups and innovative entrepreneurial businesses. American deployment of venture capital and the widespread networked access to investment funds are examples of market sophistication in practice. Ordinary people can invest in startups and innovation, and entrepreneurs at every stage of their journey can arrange access to investors.
While these investment funding networks may not be perfect, and while we may encounter some challenges in moving capital to the bottom of the pyramid, nevertheless, the private financial sector in the US is effective in directing funds towards innovation. While there may be some erosion of purpose, from long term funding of innovation to making money via short term trading in-and-out of markets, this does not detract from America’s lead in market sophistication.
Business sophistication: The ability of business to absorb new knowledge and use it to innovate.Bart Madden called knowledge-building proficiency the central differentiating function of the successful firm. Our businesses are learning machines, continuously generating new knowledge via R&D, marketplace experiments, interactions with customers and feedback from all business activities. While it’s possible that Americans might be eclipsed by some other countries in the race to produce patents, this is not a relevant measure. Marketplace innovation is the test of business sophistication, not patent registration. Knowledge accumulation must be accompanied by knowledge application.
America’s entrepreneurial nation of doers not only engages in eternal learning but in the adaptive entrepreneurial method of act-learn-improve. The rest of the world has not fully caught up.
SummaryIn Lipton’s eyes, America was oriented for entrepreneurial success by the founding fathers and early immigrants, and will continue to innovate and grow as a result of entrepreneurship. Only if we get in our own way through excessive statism, regulation and government intervention that misdirects our energy and resources will we break the well-established historical track record.
Additional ResourcesGlobal Innovation Index: Mises.org/E4B_209_Index
"For Now, Entrepreneurship And Innovation Still Hold A High Place In The USA" by Lipton Matthews: Mises.org/E4B_209_Article
What can economics tell us about designing fulfilling jobs and productive workplaces? Quite a lot if we apply the economics of subjective value and empathy. Melissa Swift is the author of Work Here Now: Think Like A Human And Build A Powerhouse Workplace. She discusses her research on the Economics For Business podcast.
Knowledge CapsulePoorly designed jobs and workplaces are dangerous, dull, annoying, frustrating and/or confusing.The results of academic research have confirmed how alienated many workers are from their jobs, and the trends in these findings are worsening, not improving. During the pandemic, many of us had the opportunity to stand back and survey this situation, and realize that it’s a problem that we need to address.
We can do better by applying Austrian economics principles of subjective value and empathy.The economics of subjective value should point employers in the direction of asking how employees feel about their jobs and the sense of purpose and meaning they derive from them. Why do these considerations not arise, or why are they insufficiently acknowledged? Melissa Swift sees what she calls a wall between how human beings operate and how the world of work operates. We think in discrete terms about “work” on one hand, and “people” on another, and don’t integrate them well.
Managers have demonstrated a penchant for intensifying work (doing more in less time and with fewer resources) and for pressing for over-collaboration (too many reports, checkpoints, meetings and interactions and exchanges, and belonging to too many teams) with the ultimate result of detracting from an individual’s capacity to get things done. Managers don’t necessarily tie the design of work to impact delivered or value created.
In fact, much work is performative, putting on a display of work that is not necessarily productive (writing impeccable but essentially useless reports, for example).
Managers should be actively looking for and rooting out problems of bad jobs and poor work environments.Melissa Swift’s formula is to be humble and curious in asking how work feels to those who are doing it. Employees know their work better than managers do (an observation which, of course, turns management science on its head).
There are a couple of “monsters” that can be identified and tamed. One is the anxiety monster - we all feel anxiety about whether we are productive enough, or doing good enough work, or being viewed in a favorable light. Anxious managers stand over people, telling them to work harder and faster. We must shut down all the anxious stories that are in our heads.
Employees can be over-anxious about customers, too. We may tend to over-deliver on customer care and customer expectations, to the point where we train them to be so demanding that they go beyond the point where the corporation is capable of fulfilling its own promises.
Once “monster” jobs — those that generate excess anxiety — are established, there’s a tendency for the HR “copy machine” to copy-paste them throughout the company, so that more employees become stressed.
Listening for job stress and devising better ways of working is an entrepreneurial task.The entrepreneurial mindset is to listen to customers (in this case, job incumbents), to identify unmet needs, which are aways based on emotion and can never be articulated perfectly clearly, to creatively design new solutions to the customer’s felt problem, and to institute positive change using the new solution. This implies continuous adaptive change in job descriptions, performance expectations, structures, team and tasks.
The entrepreneurial approach is often hard to apply in the corporation. One reason is that incentives are lined up to favor what Melissa Swift calls “smooth”. Management incentive schemes are often designed to encourage “smooth” — no drastic changes or turns, steady progress. Yet the adaptive entrepreneurial system does not promise smooth, and can’t delver it. Innovation in response to changes in customer preferences or competition can be bumpy. And many organizations suffer from autoimmune disease — the defenses go up as soon as something unknown or unprecedented is encountered.
Good leadership can counter the auto-immune response — but it’s leadership that does less rather than more, relaxing constraints and letting those closest to customers and markets to make any needed adjustments and to respond at the rate of change that the market demands. Business school concepts of leadership have goaded executives into over-managing and over-controlling, and reversing the over-active concept of leadership is one of Melissa Swifts core prescriptions.
The HR Department is a big part of the problem.The deep history of HR is dark. The function was founded to quell violence between labor and management. HR was to stand in the middle and to keep a lid on a boiling pot, as Melissa picturesquely expressed it. Performance management — mechanically measuring humans’ output in these toxic adversarial environments — was never a warm or supportive concept. As big business became more centralized, HR simply became more empowered and widened its scope. There was never much humanism in HR.
HR departments are not typically thinking about work and how work is changing and how to make it a better experience for people. If they were, they’d be thinking differently about matching talent to jobs, thinking more deeply about how alienating and constraining automation technology can be to those who have to use it. They know they are being monitored and measured and assessed.
Melissa recommends couples therapy for technology and those who work with it — to stop each party from driving the other crazy.
Asynchronous work, deconstructed work, transparent work.Melissa’s book has 90 strategies for organizational level and team level problem solving actions and adjustments. We discussed three directions for better work.
Asynchronous work: fewer meetings, which provides greater flexibility for workers, it naturally de-intensifies (you don’t have to have the report ready for the regularly scheduled Thursday meeting), and it makes for more relaxed collaboration across time zones. Asynchronous work tends to be better documented and more permanent.
Deconstructed work: start with tasks to be done rather than job descriptions; assemble the optimum combination of humans and technology to get the tasks done; let talent flow to the work, i.e., it doesn’t matter if it is full time employees, part-timers, project specialists or gig workers or agencies or consultants doing the work, so long as the tasks get done by the best-qualified talent.
Transparent work: make all information available to all employees at all times, nothing hidden or out-of-bounds. As a result, employees and teams have all the information they need to do their jobs, with no need for hierarchical or administrative intervention. Accountability and empowerment are enhanced, and new talent may emerge when you don’t hire for information but for skill in using it.
Additional ResourcesWork Here Now: Think Like A Human And Build A Powerhouse Workplace by Melissa Swift: Mises.org/E4B_208_Book1
Bullshit Jobs: A Theory by David Graeber: Mises.org/E4B_208_Book2
The recent case of retired megastar Usain Bolt losing millions of dollars to bad investments highlights the importance of sound money management.
Original Article: "Managing Money Is as Important as Making It: The Sad Case of Athletes Going Broke"
This Audio Mises Wire is generously sponsored by Christopher Condon.
What is strategy, and is it useful for business? Business schools want you think it is the critical factor in competitive success or failure. They teach structured markets, divided up by market share, with boundaries and external and internal forces to be assessed and countered. “Where to play and how to win.” They see strategy through their lens of financialization and utilize fictitious economic calculations like discounted future cash flows and market capitalization. There’s very little Austrian flavor in their view — no acknowledgement of subjective value and the qualitative drivers of value, customer sovereignty, empathy, constantly changing customer preferences, no role for the entrepreneur in helping customers learn what they can want in an evolving world.
Our guest Erik Schön provides us with an entirely different view of strategy, which he arrives at via a synthesis of three great strategists: Sun Tzu, John Boyd, and Simon Wardley.
Knowledge CapsuleStrategy is how to survive and thrive and, for a business, the key tool is harmonization.Sun Tzu identified Purpose as the fundamental factor that keeps people united: customers, producers, suppliers, partners, owners, executives, employees, supporting each other without fear through success and failure.
In Sun Tzu, there are four more fundamental factors:
Landscape — your business environment.Climate: the forces acting on the environment.Doctrine: ways of operating.Leadership: actions, decisions, choices, and gameplays.Master all five to succeed, or else fail.
John Boyd added the dynamics of continuously changing intentions within the pursuit of the realization of purpose. (We find reflections here of Mises’ concept of constant flux — everything changing all the time.) Boyd’s definition of strategy Is a mental tapestry of changing intentions for harmonizing our efforts to realize purpose in a world that can be bewildering.
The purpose of strategy is to improve our ability to adapt: a vision that magnifies the strength and commitment of its adherents, and a grand ideal or noble philosophy providing a binding paradigm for all.
Boyd’s famous framing of the learning process to develop the ability to adapt is the OODA Loop.
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For Wardley, strategy is the art of moving in and manipulating an environment using tools such as positioning and technological innovation. Wardley’s major contribution is to visualize strategy in the form of a map where the X-axis is movement in the environment in predictable steps:
Genesis: a new technology or solution or brand is introduced; it’s unique.Custom built: a company identifies ways to serve customers with constructed products and services from the new origin.Product: move from custom built to standardization, including sourcing standard parts from suppliersCommodity: there’s nothing left that’s unique, many companies can be producers.Evolution: a new genesis emerges.
The automobile industry provides an example.
Genesis: the first internal combustion engine.Custom built: the first car brands, often from craftsmen and small workshops.Product: Many suppliers, competitive differentiation (Ford versus GM).Commodity: ICE automobiles produced in many countries (Japan, South Korea, China, Italy, etc.) with limited customer differentiation.Evolution: the beginning of the EV era.
Wardley’s approach is that all markets exhibit this evolution. It’s important to know the current landscape and predict the future landscape, moving through it with “the why of purpose” (to survive and thrive) and “the why of movement” (taking a particular action that moves you through the landscape). Everything evolves through supply and demand competition.
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The Sun Tzu, Boyd and Wardley approaches to strategy can be combined in the concept of the Strategy Cycle, Strategists move continually through the phases and components.
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The reference to these strategy masters enables businesses to move beyond business school strategy.Move beyond strategy as wars, battles and combat for market share, towards strategy as individuals, teams and organizations fulfilling their shared purpose.
Move beyond strategy for survival in competitive environments to sustainably thriving in a world with a high rate of change.
Move beyond strategy development as planning, metrics and data towards strategy development for a harmonized direction based on regular assessment of needs (especially customers’ needs) and the organization’s purpose.
Move beyond strategy development as execution and chasing targets to decisions and actions in a harmonized direction by everyone everywhere in the organization based on high situational awareness.
Move beyond business as maximizing shareholder value to business as succeeding together with customers and other stakeholders.
Move beyond leadership for managers and people in hierarchical leader roles to leadership as a service provided by all people in the organization.
Move beyond practices and principles for optimizing parts to harmonizing the whole.
The art of strategy is to succeed by securing harmony among stakeholders, and keeping competition off-balance through evolving better capabilities to influence, adapt and map.
The three strategists offer complementary views of strategic success.
Sun Tzu:Unite society rather than divide.Unite the organization rather than divide.Unite the team rather than divide.Make the organization resilient by cultivating purpose and doctrine.
Boyd:A grand ideal, overarching theme, or noble philosophy that individuals can shape and adapt to unfolding circumstances.
Wardley:Know your user — know your customers and know how to create value through meeting their needs.Set exceptional standards.Be resilient to cope with a wide variety of extremes and changes by rapidly adapting.
The great obstacle to adaptiveness in strategy is inertia in its various forms.Success breeds inertia, and inertia kills. It’s rarely a lack of innovation that kills companies, but rather inertia caused by pre-existing business models. Any past success with any component or element will tend to create a resistance to change. Inertia is a loss of capital — whether physical, human, social, or financial.
Strategists look to identify different categories of inertia and devise ways to counter them.
Category of inertiaCounterpointPeople resist disruption of past normsPast has evolved / lead the charge Write down cost of legacy, run more efficiently Building future agility Already happening in the market, falling behind Fear of transition to the newLet’s build new skills internally Develop capabilities in-house Develop relationships with new suppliers Work on adapting practices, not scrapping them Are we sure we can make the new work? Don’t seek certainty, seek learning Develop new standards, use open source Use multiple vendors, use brokers Improve supplier relationships Changing business models is hard Avoid death spiral; new approaches e.g., ecosystem Risk mitigation; spin off the old Use rewards, education, training Perfect telling the new story Leading without pressure and control.Erik uses the gardening analogy to illustrate the Sun Tzu style of leading without pressure and control. The gardener tends the garden gently, tilling and planting and watering ahead of time, and the flowers grow. Today we might call this style “self-organization”.
The three strategists are very consistent with the action-focused approach to entrepreneurship from Austrian economics. Action is learning. The path is made by walking. Try things out. Draw some Wardley maps as a trial. They’ll take you a long way.
Additional ResourcesThe Art of Strategy: Steps Towards Business Agility by Erik Schön: Mises.org/E4B_207_Book1
The Art Of Leadership: Purpose and Integrity for Sustainable Success by Erik Schön: Mises.org/E4B_207_Book2
Erik Schön on LinkedIn: Mises.org/E4B_207_LinkedIn
A Collection of Wardley Maps: Mises.org/E4B_207_Maps1
A Wardley Map of the Automobile Industry: Mises.org/E4B_207_Maps2
Entrepreneurship is by no means exclusively American. But this country has led the way in unleashing, encouraging and elevating entrepreneurship as the creative and virtuous pathway to the creation of new value for all. As a republic, we’ve established the institutional framework in which entrepreneurship can flourish, and entrepreneurs who are successful in creating value reap — and keep — the rewards. Dr. Samuel Gregg, in his book The Next American Economy, examines how this framework was designed at the founding, and discusses what we must all do to preserve it and re-animate it despite the attacks on it from the left.
Knowledge CapsuleEntrepreneurship and the founding of America are intertwined.America remains the most entrepreneurial country in the world, even if the degree is declining. Our nation has many people willing to pursue the uncertain path of creating new economic value for customers through new products, services and businesses; and, equally importantly, people who will try and buy the new offerings.
Alexis de Tocqueville captured the entrepreneurial character in Democracy In America. He thought everyone in America was entrepreneurial. He noted that those immigrants who arrived would quickly start a business, then move on to another one. He observed the tremendous creative energy of the United States. Immigrants have already embraced change in the act of leaving one country to establish themselves in another, and business entrepreneurship is a direct expression of this same love of change.
In fact, says Dr. Gregg, America was designed by its Founding Fathers — as they plainly expressed in the Constitution, Declaration Of Independence, the Federalist papers and documents like Washington’s Farewell Address - as a commercial republic based on entrepreneurship, and not a political or military or top-down republic or mass democracy. Commerce — or what we would call business — was not viewed with disdain, as it was in aristocratic Britain, but as republican virtue. Washington’s Farewell Address refers to the importance of expanding, of national and international navigation and trading, and about the development of strong markets to give Americans an outlet for their production. Business was viewed as the height of civilizational activity. There was a commercial ethic in the vision of a commercial republic which would grow wealth for all. Economic expectations were high and political institutions were designed to be compatible with these economic expectations.
There is an increasing trend towards government and the administrative state strangling the creative energy of American entrepreneurship.The erosion of institutional integrity shift and suppresses the creative energy of entrepreneurs. A strong tradition of property rights, in which entrepreneurs can feel confident that they will not only be able to earn but also keep the reward that come from satisfying customers and meeting demand, is an important element of the incentive structure for entrepreneurship. Similarly, entrepreneurs need to feel confidence that commercial disputes will be fairly adjudicated in courts. And they also need to feel confidence that government regulation will not act as an unreversible ratchet of restrictions on their value-creation activities.
The trends in the business environment in the US are currently running in the opposite direction: the property rights of successful entrepreneurs are being increasingly questioned and squeezed, commercial interests are viewed unfavorably in courts, and the regulation ratchet is running in the direction of more, not less, restriction on commerce.
Dr. Gregg sees the anti-entrepreneurship trend beginning in the Progressive Era and gathering pace since the days of Woodrow Wilson. Progressives seek forms of control that will suppress economic uncertainty and social turbulence. The entrepreneurial embrace of change and pursuit of new value must be suppressed. If society and the economy is to conform to their design, unpredictable creativity must be excluded. The progressive control urge took expanded form in the New Deal and the Great Society and all the successive opportunistically explosive expansions of government power.
The anti-entrepreneurial tool is regulation and the administrative state.Dr. Gregg employs the term corporatism to mean legislators and elected politicians, government departments and their administrative bureaucracies working together with big corporations and NGO’s to impose control through regulation — “attempting to manage everything for everyone else”. Corporatism is very uncomfortable with freedom, and is more than willing to trade off liberty, and the capacity of markets for entrepreneurial competition, in favor of stagnation and the vision of engineering a specific economic outcome. Their preference is for a form of regulatory state capitalism that exerts control over free enterprise.
Recently developed constraints such as ESG and DEI are a manifestation of state capitalism with a particular ideological edge that emanates from left-leaning politics. Companies can no longer have a free choice in the assembly and orchestration of their human capital, which will seriously impair the capacity of the economy to deliver what consumers expect of it.
Most of the government’s regulation is not aimed at any “public good” (e.g., overall workplace safety) but at special protections for specific interest groups. Often, the businesses who are protecting their interests are the ones who, first, initiate the regulation, and second, write it, through their lobbying firms. If citizens were more habituated to asking who is the group behind any specific regulation, there’d be a greater understanding of this problem and a developing distaste for regulation.
Dr. Gregg sees the expansion of state capitalism and the regulatory state as cyclical and capable of reversal.The trends are in the wrong direction, but are not irreversible. Dr. Gregg expressed great confidence in the ability of Americans to work their way around the regulatory barriers to creative entrepreneurship. He highlighted two of the optimistic themes in his book:
Capital, capital, capital: Regulation has made it increasingly difficult to match up small entrepreneurial businesses with the capital they need. It takes lots of expensive lawyers to navigate the regulatory jungle that exists for capital acquisition in the us. Yet, American entrepreneurs are proving to be just as creative in capital acquisition as in other fields. They can find their way around the regulatory system. Inventions such as crowdsourcing are a good example of new ways to access capital. The fintech industry is entirely dedicated to freer access to capital. Angel funds, regional and local venture capital funds, new entrepreneurial communities (such as Brandjectory) and new two-sided investment platforms provide more impetus.
Deregulate, deregulate, deregulate: If we want to retain the American edge in entrepreneurship, we should focus on reducing the size and scope of the regulation at the local, state and federal level. One of Dr. Gregg’s fears is that individuals become political entrepreneurs, and their efforts are directed towards finding ways to thrive in an expanding administrative state and insufficiently on creating new and improved products. Let’s find creative ways to reduce regulations, rather than creative ways to survive.
Additional ResourcesThe Next American Economy: Nation, State And Markets In An Uncertain World by Samuel Gregg: Mises.org/E4B_206_Book
One of the most helpful insights of Austrian economics for business is the understanding of uncertainty. To complete a sale to a customer is to take that customer on a journey from high uncertainty to lower uncertainty — sufficiently low that they’ll make a purchase and enter into the experience of ownership or receiving service. We illustrate this principle via the market for small business insurance — a service that our guest Ryan Hanley describes as confusing, time-consuming and costly, i.e., fraught with uncertainty for customers. He addresses the problem by freely dispensing usable knowledge, and explained to Economics For Business how that revolutionizes the industry.
Knowledge CapsuleIn a market where knowledge is hard to acquire, a knowledge provider creates new economic value.
The subject of small business insurance is quite opaque for customers. The language is often arcane and the terminology is hard to understand. The type size on contracts is small. It’s often unclear to customers what coverage they need, or what coverage they have, and what coverage they need. Ryan Hanley listened to customers’ questions and requests from his time as a retail sales agent and quickly understood that the provision of easy-to-consume and easy-to-understand insurance knowledge would be immensely valuable to customers. He started writing blogposts and FAQ’s for this purpose.
Expanded experience provides the foundation to be a credible and useful knowledge provider.
Ryan Hanley has held positions in the insurance field from sales agent to VP Marketing to Chief Marketing Officer to CEO. He’s also tried entrepreneurship in other industries. He’s talked to a lot of customers to understand their issues and problems and to try to solve them. This accumulated experience gives him the foundation to be a knowledge provider. He knows what knowledge is missing, what knowledge is most useful, and what form it should take for best delivery.
Knowledge becomes even more valuable to customers when it’s delivered with high empathy.
Ryan stresses that insurance is a superb service. If a customer business experiences a shock — its premises burn down, or it suffers a criminal theft — insurance is there to make things right again. It provides sustainability for a business and reassurance for the business owner and employees. Insurance is a high-empathy service.
However, the customer interface with insurance can be low-empathy — confusing and time consuming, and highly inconvenient to navigate by reading through contracts and filling out forms. Ryan’s solution is “human optimization”: making insurance easier to understand and easier to navigate and providing human contact and the human touch to add value. He points out that the insurtech innovations from Silicon Valley, which aimed to make insurance more efficient via an all-technology / no humans approach, has resulted only in unprofitable and failed startups. Customers need humans to give them trust in a complicated field they don’t understand. Digital automation is not the entire answer.
Freely available knowledge and the human touch combined with better technology elevates the service recipe to a higher level.
Ryan recognized that the native tech for the insurance industry, that had been built up over the years but become frozen and resistant to innovation, was a contributor to customer frustration. His answer was not new digital technology to replace the old, but a clearer identification of the customer problem: the multiple insurance tech systems were not well-connected with each other and not well integrated. The solution lay in better API’s and better software integration, which is what Ryan concentrated on. So now he could bring the human touch, plus new knowledge to fight confusion and opacity, and better technology exhibited as faster flow between content modules.
The business benefit lies in customer relationships and customer retention.
The business model for insurance depends on customer retention. Selling a policy is not profitable on day 1, but becomes profitable over time as cash flows from periodic premium payments. Customer retention is the key to profit and retention reflects satisfaction. Ryan is demonstrating that setting a high standard at the front end of the contract, with a more human interface, freely dispensed knowledge, and convenient navigation of the insurance process, results in profitable revenue streams and a high cash flow ROI over time.
Listening to customers, understanding their needs, and discovering the best way to serve results in retention.
Customers are looking for a special form of reducing uncertainty.
Insurance sells protection from risk. This is math to them, a calculable probability that governs what they charge for premiums and how much capital they need on hand for payouts. For customers, insurance is relief from uncertainty, a subject value that’s not math. They worry about sustainability: will they survive the shock when there is a fire or a crime. Ryan’s approach is to help them advance from high uncertainty (I’m not sure of all the risks, I am not sure what is the right coverage for my business) to lower uncertainty (I’ve been given new knowledge, so I am more informed, I know enough to make a choice of policies and providers). Ryan’s company can customize service (including, for example, matching payments schedules to the seasonality of a customer’s business) so that the customer feels certainty that the service is matched to their need.
Knowledge is education plus creativity. The result is trust.
The kind of knowledge that Ryan dispenses about insurance is education. Recipients are learners, filling in knowledge gaps. It can come in the form of YouTube videos or blogposts or any other form. Ryan’s Rogue Risk site offers hundreds of videos and articles. He is educating the customer base.
Creativity in communication is a vital part of the recipe. Education delivered with creativity stimulates curiosity and productive conversations. Even for a potentially dull subject matter like insurance, creativity add spice and extra interest. Creativity is human, and the human component can deliver trust. Giving knowledge away rather than hoarding it is a great start towards a trusting relationship.
In economics, production and marketing are not separate concepts. Production responds to customers’ needs and marketing is the expression of those needs inside the firm. The entire customer-facing activity of the firm is marketing. Like any other business activity, there is constant flux brought to bear by changing customer preferences, competitive innovation and market evolution. Marketing must be adaptive to change, and a major shift is occurring right now. Mark Schaefer writes about it in Belonging To The Brand: Why Community Is The Last Great Marketing Strategy.
Knowledge CapsuleEstablished strategies and tactics of marketing are no longer effective.Marketing thought-leader Mark Schaefer puts it this way: marketing doesn’t work like it used to. The established techniques were biased towards outbound communication, such as advertising, PR and events. Mark classifies these techniques as “interrupt and annoy” to try to get customers to give their attention to feature and benefit of the company’s offerings. The communications environment shifted from analog to digital and from outbound to interactive, but interrupt and annoy remained the primary technique.
Finally, there’s an alternative marketing strategy.The new strategy goes by the term “community” or “community building”. As economics advises, it’s a product of customer sovereignty. People want to belong to communities that share values and interests. And in the digital age, where work-from-home and glued-to-a-screen are life conditions that can lead to profound loneliness, the need for belonging is amplified. The covid lockdown experience exacerbated the problem.
Community is an experience that is highly valued by customer, distinguished via three features:
Connection with each other. There’s a group feeling of difference that’s not shared with others who don’t belong to the community.Purpose: community members gather because they have a shared reason to do so, whether it is software development or wine appreciation or the development of technical skills. There are shared rituals and traditions and common behaviors that generate a sense of group identity and bonding through common values.Relevance: A thriving community adapt and adjusts as times and members’ needs change. Adaptability strengthens group cohesion and assures continuity and resilience.There’s a business case for community building.Community-building may replace brand-building as a primary pathway to facilitating value for customers and thereby generating strong cash flows. The technique has a viable business model.
Differentiation: when customers bond in community, they’re differentiating themselves and the brand(s) they prefer and support. It’s a lasting advantage.Market monitoring: a community is a continuing conversation, a source of insight and signals of change.High speed information: the flow of information from customers and markets to firms is another source of advantage. The behaviors and preferences of community members can be continuously polled, with the opportunity for fast response.Trust. Businesses are recognizing the importance of trust in relationships with ever-greater clarity. Brand communities are trusted by their members; trust is inherent.Advocacy. Community members become the marketer. They communicate benefits and positive experiences. User-generated content both reduces marketing costs and adds authenticity and belief.Loyalty: The most profitable customers are the most loyal customers. Community members are loyal, and, in fact, go beyond loyalty to “attachment”.Co-creation. Value is created by customers in their own experience, or it can be viewed as co-created through interactions with the firm and its products and services. In brand communities, there is community co-creation, such as in LEGO Ideas groups and the IKEA user community.Membership as a product: Some communities become the business modem as members pay both to join and maintain membership and purchase the products and services of the community.Cultural alignment: community is a trend, especially for younger people experiencing social and digital isolation.Customer data: when members freely express their values and preferences, they create a rich new first-hand data source.Purpose is the critical driver.There’s a case to be made that a brand is its purpose. A clear and compelling purpose provides inner direction for the entrepreneur and the management team throughout the entrepreneurial journey. Shared purpose can bind customers to the brand. The same is true for a brand community; Mark Schaefer talks of bold, piercing purpose that aligns every resource of the company towards the community goal. Harley-Davidson is one (well-used) example: fulfilling dreams through the experience of motorcycling. The purpose is a customer experience, aligned with their values and open to their expansive and creative interpretation.
Corporate purpose, when genuinely felt and well-expressed, Mark writes, can be existential (this is why we exist?), differentiating (how do we make a difference?), values-based (how are our founding values relevant to the world?), distinctive (what headlines will be written about us), adaptive (how is the world changing in a way that unites us with our community?) and fulfilling (how can we fulfill customers’ dreams?)
Additional ResourcesMark’s Books:
Belonging To The Brand: Why Community Is The Last Great Marketing Strategy: Mises.org/E4B_204_Book1
Marketing Rebellion: The Most Human Company Wins: Mises.org/E4B_204_Book2
The Marketing Companion podcast: Mises.org/E4B_204_Pod
Mark Schaefer website: BusinessesGrow.com
The concept of risk provides us with an excellent opportunity to bridge between formal economic theory and personal business experience. Economics provides us with rigorous understanding of risk and uncertainty and the distinctions between them and their various types. But risk — the word that we use in everyday conversation — bring with it subjective feelings that affect how we approach it.
Knowledge CapsuleIt’s appropriate for entrepreneurs to reframe the concept of risk so that they can embrace it wholeheartedly.Risk has traditionally been framed as the downside of a choice. It’s the potential negative outcome for anything we try. But we just have to look at our own lives to see that a lot of risks we’ve taken have generated upside, whether that’s choosing a college, getting married, or taking a particular job. If we feel good about the outcome, then risk is a path to reward.
Part of the reframing of risk is to see it as a process rather than a single choice.Risk can sound like it comes at us as a single choice, or an event, or a once-and-for-all decision. It’s much better to think of risk as a process — a behavioral process rather than a decision-making threshold. The risk process is one of experimentation —taking small steps, trying different things, getting feedback from the market, making adjustments, then trying some more things.
Instead of “starting a business”, we can think of setting out on the pathway to entrepreneurship. Instead of “committing to a future new product launch”, we can think initiating an exploration with low resource commitment until we have better feedback knowledge in order to take the next step and commit more resources. We can think of a new initiative as an experience gap that we look to fill with knowledge from experts and experience from mentors or advisors who’ve done something similar.
The key to this reframed risk process is a courageous commitment to perpetual learning.Through learning, we can all redefine our understanding of risk and re-establish our relationship with it. A part of risk is the ego-bruising realization that we don’t know everything and can therefore make mistakes, or take actions that have unintended consequences.
By embracing learning, we establish a social reward for not knowing — learning is viewed positively, as a reward. Developing new knowledge is one of the primary roles of the entrepreneur. While it may take intellectual courage to own up to not knowing, the courage is rewarded with new understanding and new advantages. There’s always opportunity to learn more.
Imagination is an antidote to risk.Imagination can overcome risk. We all have the capability of imagining future achievements — “future wins”, as Angie Morgan Witkowski put it. Imagination can be an exercise in creativity, and it’s OK to let it run wild, releasing our minds from the restraints that risk can impose. Taking the time for free-thinking can be very beneficial.
The pathway to the imagined future is to marry possibility with probability. In our exercise in imagination, it’s easy to eliminate the impossible. But we shouldn’t limit the possible. We can start from the imagined possible future and then work back through probabilities about whether we can accomplish it. Angie stimulated her business imagination vi a sidewalk margarita bar in Florida and ultimately opened a successful coffee shop in Traverse City, Michigan. It was a process of working backwards from what was possible to what was more probably, given her circumstances.
Similarly, her consulting business started by imagining writing a book about a better style of leadership than is taught in business school. She contacted literary agents, who encouraged her not only to write the book but to also start a speaking business. The audience for her speaking engagements sought consulting help, and she developed a series of workshops as part of the delivery system. Her consulting business is now cross-industry, from startups to the oil-and-gas majors, and worldwide. It started with imagination.
Imagination is complemented by hard work and realistic capacity assessment.It would be wrong to think that the reframing of risk to action and perpetual learning comes additional without costs. Angie mentioned two. One is hard work. All learning pathways must be undertaken with the commitment to working as hard as it takes to advance. It requires time, effort, and continuous review. The intellectual courage that Angie highlighted is hard work in itself — the cognitive work of thinking about how to think, exercising cognitive discipline, exploring flexible options such as design thinking, that require the effort of looking at problems from many different perspectives.
The second cost Angie mentioned is the honest assessment of our capacity. We can imagine future wins and assess the probability of achieving them, but we must be honest about our capacity. Do we have the resources, do we have the skills, can we assemble the right team, are we willing to undertake the hard work?
Putting hard work and capacity together means we don’t risk an inadequate attempt to solve the target problem. As Angie put it, using Marines language, don’t be “half-assed”.
Action is more important than planning.Angie’s prescription in her book, Bet On You, is for one-third of time to be allocated to planning and two-thirds making things happen. The make-things-happen part is what generates the feedback loop and learning that is so important. Here are Economics For Business, we’d probably relegate planning to 10% or less of resource allocation, but the point is the same. Action is the more important.
There is one aspect of planning that can deliver extra value, and that’s planning for failure, or contingency planning. Our imagination should be partially applied to imagining what could go wrong. How would the contingency transpire? What would we do next if it did? We should prepare for resilience in the aftermath of a setback.
A plan, in Angie’s words (which, in turn, come from the Marines), is a reference point for change.
Ultimately, risk must feel good.If the antidote to the downside of risk is imagining future wins, then we can also benefit from a focus on the wins we experience every day. Choose the path that feels good both tomorrow and today, and that makes all efforts worthwhile.
Additional ResourcesBet On You: How To Win With Risk by Angie Morgan and Courtney Lynch: Mises.org/E4B_203_Book
Bet On You Podcast: Mises.org/E4B_203_Podcast
Angie Morgan Witkowski on LinkedIn: Mises.org/E4B_203_LinkedIn
Entrepreneurial business solutions can lead to better outcomes in every economic endeavor. In the field of medical care, entrepreneurship has been hampered by non-market arrangements. There’s some sense of an emerging trend towards better choices for users, a trend that we discuss with economist Dr. Murray Sabrin.
Knowledge CapsuleAll systems evolve. The current system of medical care uncoupled from private markets evolved in ways that result in higher costs and poorer outcomes.
Our economy — and the economic experience of all of us as individuals — would be improved (i.e., greater customer value would be experienced) if we could lighten the burdensome weight of government regulation and its consequent effects on the system of medical care and medical insurance.
Our homeowners insurance, our automobile insurance and our life insurance are market products that give us the experience of seeking information and making informed choices based on pricing and perceived benefits. Medical insurance has evolved differently — it’s tied to work and puts us in a medical system where prices and choices are opaque and highly constrained. The associated costs are a great burden on the economy, and they result in diversions of productive investment from better uses.
The evolution of employment-linked healthcare began in dangerous industries like forestry logging, when employers introduced on—site medical care to treat on-the-job accidents — employers understood the mutual benefit of a healthy workforce. During and after World War II, the incentives for employers shifted: wage controls prevented them from attracting workers with higher pay, and so they introduced the benefit of tax-free healthcare benefits. An industry linking employment and medical care grew by leaps and bounds.
Today, both employers and employees are beginning to understand the drawbacks of the evolved system.In the evolved medical care system today, employees feel constrained because they can’t freely choose their doctors and service providers, and healthcare treatments they might want are often made unavailable to them. They’re not made aware of pricing, and therefore unable to make informed choices.
Employers are beginning to understand the high costs for traditional indemnity insurance, and many of them are seeking alternatives. Dr. Sabrin listed a number of these emerging innovations.
- Employer self-insurance.
Instead of incurring the heavy cost of insuring via the conglomerates like Blue Cross Blue Shield, Humana, Aetna, United Healthcare and others, many employers are shifting to self-insurance, hiring an independent third-party administrator to set premiums for normal expenses, and utilizing re-insurance against the cost of catastrophic medical events.
- Medical savings accounts.
Financial innovation has opened the possibility of utilizing current savings for future medical expenses, ideally deposited tax free, appreciating tax free and withdrawn tax free (although, inevitably, there are government restrictions). It’s another component in the free-market medicine revolution.
- Medical cost sharing.
Some affinity groups take the route of medical cost sharing — groups pooling funds to pay individual medical costs. Some of these groups may create membership lifestyle qualifications — non-drinkers, non-smokers, etc. — to link healthy behaviors to lower medical care costs.
- Wellness rather than healthcare.
The realization is dawning that medical care costs are inflated by unhealthy lifestyles. Employers and employees share a mutual interest in a healthier workplace and healthier workforce. Better alignment of incentives could encourage healthier eating and drinking habits, greater levels of exercise, and generally more health-conscious behavior. The feeling of entitlement to healthcare that can result in a lowered drive to stay healthy is a moral hazard that has been induced by the current medical care system. Reducing medical care costs via a healthier workforce is a win-win for employee and employer alike.
Restoring the doctor-patient relationship via Direct Primary Care.
The primary care doctor who has a knowing and caring relationship with individual patients, and who knows their ailments and their lifestyle, and their family and economic circumstances, is a historical tradition in American life, a part of the American dream. The corporate medical care system took this relationship away in many ways, replacing it with an impersonal system of “in-network” availability of physicians with no personal relationship component.
Direct Primary Care is restoring the doctor-patient relationship following principles of entrepreneurial business design. A doctor contracts with a small number of patients — few enough to ensure availability and access — who pay a subscription fee, sufficient to provide cash flow for the doctor’s office and immediate support functions. The doctor constructs a personally curated set of network connections to specialists, such as cardiologists or urologists, and to services such as imaging and lab analysis, so that patients can be directly connected with pre-selected and approved providers for specialist needs.
Direct Primary Care can eliminate or circumnavigate much of the bureaucracy, paperwork, and creativity-stifling sclerosis of current day corporate medical care systems.
- Pricing transparency.
A parallel innovation to DPC is demonstrated in transparent pricing clinics and surgeries, the clearest example being provided by Surgery Center Of Oklahoma (SCOO) which famously provides an open price list for commonplace surgeries, with no surprise surcharges or hidden fees. These prices are often much, much lower than would be charged for the same service by corporate hospitals; the quality is often higher; the speed of getting an appointment is faster; and the most important trait is that the pricing is transparent to the end-user. Patients become consumers in the traditional sense of the word — able to make a free choice based on open pricing information.
- Better self-monitoring.
How’s your health? You may not have sufficient information for a good answer – the medical care system often makes information hard to access. One improvement is the self-monitoring that is technologically enabled today. Your Apple watch, for example, can tell you a lot about your vital signs, as can apps+devices like Kardia or a simple scale.
Consumers may also be able to find a local DPC doctor or naturopath with whom to share the data for recommendations on natural solutions for any signals they might detect. This is a decentralized approach to healthcare that’s consistent with the general trend away from restrictive top-down centralized structures and processes.
Additional ResourcesThe Finance of Health Care: Wellness and Innovative Approaches to Employee Medical Insurance by Murray Sabrin: Mises.org/E4B_202_Book1
From Immigrant to Public Intellectual: An American Story by Murray Sabrin: Mises.org/E4B_202_Book2
MurraySabrin.com
MurraySabrin.Substack.com
It’s the ambition of every entrepreneurial business to advance from a standing start to customer—recognized leadership in its chosen field. It’s achievable, even without breakthrough technology and venture capital financing. Trini Amador’s Gracianna Winery is one of our Economics For Business entrepreneurial businesses of the year for 2022 for precisely such a journey story. Trini joins us to review the principles, processes and programs that are driving success.
Knowledge CapsuleGracianna is the most awarded winery.Metrics of success can vary across categories and industries. In the wine industry, awards presented in tastings conducted by prestigious panels and arbiters are important signals to customers. In a recent period, Gracianna winery, a small craft producer in the highly competitive Russian River wine area of Sonoma County, California, has become the most awarded in its class. And since that class is, by the owner’s choice, world-class — the best-of-the-best — the achievement is elevated to the highest possible level. Examples of the awards won include gold medals at the Sommeliers Choice Awards and the Sunset International Wine Competition, and double gold at the Los Angeles International Wine Competition. More awards are listed at Gracianna.com/Awards
Gracianna winery has also won hospitality awards for its tours and wine tastings, including a #1 position on TripAdvisor for Things To Do In Healdsburg, CA (out of 117 competing alternatives).
Everything begins with a commitment to understanding customer needs.Trini and his family set themselves a goal of making a mark as a world class winery. They’ve certainly done that. How? Trini Amador is an entrepreneur in the Austrian tradition: the entire journey starts with deep understanding of customers and their needs. Who are the people who enjoy world class wines and associated experiences, and why do they choose to participate in this industry as consumers? What kind of experiences do they seek? How do they want to feel about those experiences?
Why do they undertake travel to visit different wineries? Why do they choose California, and Sonoma County and the Westside Highway in the Russian River Valley? How do they like to buy online? Why do they join wine clubs? All of these choices are emotionally driven — the answers lie in the heart and not the data.
Becoming a world class winery is a direction of travel, and the destination becomes clear with more and more learning about customers and their needs, wants and preferences. Brand vision is integrated with customer understanding and empathy.
Focus and feedback can take a brand to the top.Trini describes his company and his team as obsessively focused on customers. As they collect more and more customer knowledge via more and more interactions, the better they get at serving customer needs.
There are really only two I techniques: listen and observe. Since the Gracianna experience includes onsite tastings and tours, the Gracianna team can meet customers face to face and listen for their responses, preferences and hopes. And since all Gracianna wine is sold direct via the internet, butting activity can be observed directly. The requisite business skill is always to pay attention for signals, and always attend to the feedback that results from interaction. All guests are self—selecting themselves to be part of the Gracianna story. They’ve chosen the relationship. Gleaning the motivation behind their doing so is the goal of the marketing team.
Consistent, precise execution is more important than strategy.Once the brand’s direction is set, and an initial understand of customers is established, then execution takes over. Execution is a daily discipline, and the power tool is consistency: establishing a high standard and maintaining it in every action.
It’s perfectly possible to build a brand this way. Trini likened his approach to building a bird’s next — one twig at a time. Every act of execution, every customer service interaction, every e—mail and every tasting service is another twig added to a perfectly shaped, ultra—strong construction. Small brands can claim ownership of an equity this way (such as “best tasting room experience” on TripAdvisor) without expensive investment in communications; just execute, execute, execute. Let employees on the team exercise both their responsibility and their creativity in precision execution. Always aim for effectiveness (the best possible execution) rather than efficiency (the lowest cost or least—resource execution).
The best kind of planning is contingency planning to establish a prepared adaptiveness.Wine is, at its fundamental level, an agricultural business. Trini calls it rhythmic — grow, harvest, make wine, store wine, release a vintage. No two growing seasons are ever alike. In addition, there can be crises — excess rain, floods, unusual growing temperatures, fires, pests. The best way to deal with these variations is contingency planning, i.e., imagining all the things that could go wrong and having a set of actions in mind if they do.
Adaptiveness is a core attribute for all entrepreneurs, and is especially applicable in wine. Explore and expand is an orientation that fully applies — once the curves that nature throws have been negotiated.
The greatest entrepreneurial attribute is courage.In face of all the challenges and amidst all the uncertainty of an entrepreneurial business, Trini maintains that the key to a successful outcome is not so much strategy as courage. Make the best decisions you possibly can based on understanding customer needs, and then have the courage to act on the decision. The action generates interaction, which results in feedback, which provides the knowledge and energy for the next decision and next action.
Courage is the entrepreneur’s best business tool.
Additional Resources"Gracianna: Award Winning Winemaking and Entrepreneurship" (video): Mises.org/E4B_201_Video
Gracianna.com
Lisa Amador’s Cookbook, Comfort! A Gracianna Member-Inspired Cookbook: Mises.org/E4B_201_Cookbook
Trini Amador’s "Brand Uniqueness Blueprint" (PDF): Mises.org/E4B_201_PDF
We’ve conducted 99 conversations with value-creating entrepreneurs, and we’ve conducted about 100 Q&As with business school professors who research and teach value creation. Here’s a headline summary of what we’ve learned.
Knowledge Capsule1) A firm is defined by its purpose.Firms with a clear purpose that aligns everyone who works there, along with all suppliers and partners and customers, perform at a high level over the long term. Lack of clarity of purpose is associated with fluctuating performance and often with “fade” — permitting competitors and market changes to erode away a firm’s advantage.
Knowledge Capsule #199: Mises.org/E4B_200_A
2) A successful firm’s purpose is always based on value for customers.Purposeful firms identify a vision of value received by the customer, and commit themselves to it. They craft a business model to deliver the vision, including continuous increases in efficiency and continuous innovation, thus expanding the value space in which they operate. They build and maintain strong relationships in all directions. They look to the long term, including future generations.
Per Bylund and Mark Packard on Subjective Value, The New Economics Of Value and Value Creation: Mises.org/E4B_200_B
Econ4Business.com/value
3) Firms need a deep understanding of value.We say in Austrian economics that value is subjective. It’s formed entirely in the mind of the customer, as result of a customer’s learning process: becoming aware of a firm’s offering, evaluating its attractiveness, comparing it with alternatives, putting it to use and assessing whether the usage experience met expectations. They learn from their own perspective, in their own context, and in the process of running their own system (their household, their office, their factory) and living through dynamic changes that alter their perspective. Value is a 2-way flow: the value proposition flows to the customer, and the value experience flows back to the firm as cash flow and feedback.
The value cycle is complex and understanding it is very demanding, as is understanding the customer and their system. Winning firms work hard to build a deep value knowledge.
The Value Learning Process: Mises.org/E4B_200_C
4) Purpose + Value Creation + Entrepreneurship.In Austrian economics, entrepreneurship is the driver of the business system. The term is often misinterpreted as pertaining to start-ups and small business innovation. It actually pertains to value creation. Entrepreneurship is an approach to business that starts with the customer and their needs — a definition of what new value opportunities are currently unmet — and develops the knowledge and assembles the capability to craft a product or service to meet those needs. There is time uncertainty and resource risk in committing to this development. Any firm and any project that pursues this new knowledge with the intent of creating new customer value is entrepreneurial, irrespective of scale.
Entrepreneurship also weeds out elements that are not value drivers — bureaucracy, obsolete assets and unproductive infrastructure such as luxury office suites. Entrepreneurial firms are focused and efficient.
This is Value Entrepreneurship: Mises.org/E4B_200_D
5) Entrepreneurial firms operate unique value-centric business models.Entrepreneurship is action, and the set of actions the firm takes to make money consistently over the long term is called the business model. Business models vary by industry — some industries are more profitable than others — and by firm — in every industry, there is something about some firms that makes them more profitable than others. That something is their business model.
The business model that emerges from 199 Economics For Business episodes is the 4V’s model:
Value understanding: building an advantaged and exclusive knowledge base on understanding your chosen customers and their value needs and value preferences.
Value facilitation: designing and assembling a system to meet those needs and preferences and taking it to market for feedback on customer acceptance and approval.
Value exchange: market implementation at scale to generate reliable recurring cash flows from customer purchases and relationships.
Value agility: systems to receive and respond to feedback in a dynamic, responsive flow.
Per Bylund introduces the Austrian Business Model: Mises.org/E4B_200_E
The Austrian Business Model Video: Mises.org/E4B_200_F
Hermann Morris’s Business Model: Educate The Industry: Mises.org/E4B_200_G
- The entrepreneurial mindset is different.Over 199 episodes, we observed the following characteristics of the entrepreneurial mindset:
Greater capacity for imagination: imagining great futures for customers;
Better judgment: judgment is intent (the strong emotional relationship with a desired successful outcome), plus intuitive decision-making when data are incomplete, plus confidence in action-as-experimentation, whatever the degree of uncertainty;
Learning: entrepreneurial firms are learning machines, and especially good at challenging their own assumptions.
Empathy: the skill to understand how customers feel subjective value, and to process data through the customer’s mental model;
Orchestration: entrepreneurial firms seldom have direct control over all the resources required to deliver value, and they are expert at orchestrating others’ resources, including their time and skills and knowledge.
Embrace of change: entrepreneurs don’t fear change, they welcome it as an opportunity.
Peter Klein: Opportunities Don’t “Exist”. Entrepreneurs Create Them: Mises.org/E4B_200_H
Victor Chor’s Entrepreneurial Orientation: Mises.org/E4B_200_I
- Explore and expand.Entrepreneurial firms not only embrace change, they make it, through a process we call explore and expand. It means always running lots of experiments to see what works unexpectedly. Experiments should be designed to refute existing assumptions. There should be a wide variation of experiments, not just a series of nuanced changes. Entrepreneurs look for a big variation in outcome and so they make big variations in inputs.
The Age Of Strategy Is Over: The Replacement Is Explore And Expand: Mises.org/E4B_200_J
- Harnessing the highest values.What guides customers’ behaviors are not features and attributes, like pricing and performance metrics and guarantees, but values. The firmest guidance comes from the highest values. If a customer’s highest value is family security, they’ll never buy any offering that doesn’t align with their value system. Successful entrepreneurial firms know how to climb the values ladder from features to highest value, providing strong rungs at every level, and always going all the way to the top.
Internally for business, the highest values are service to others, delivered in the form of value creation, and ethical behavior.
Value As A Basis For Business Building: Mises.org/E4B_200_K
- Managing the loopBusiness is a flow. In business-as-a-flow, there’s no start and no finish. It’s non-linear. The environment is entirely uncertain and unpredictable. A business forms its intent, and then chooses and implements actions it judges will advance that intent. There’s no way to know what the result will be, and so the business commits to receiving and reading the feedback, making appropriate adjustments, and then implementing new, adjusted actions, to gain the next round of feedback.
This is the flow of knowledge-building, and it flows as a repeated loop, with the same process but different actions, new learning and continuous adjustment.
With sound and active monitoring and management, the loop will generate some durable learning that merit repeated action. Cash flow will flow back to the company, and profitable returns will grow. The loop can be self-reinforcing.
Mark McGrath: OODA Loop: Mises.org/E4B_200_L
Bart Madden: Proficiency With The Knowledge-Building Loop Is The Key To Value Creation: Mises.org/E4B_200_M
Value for customers is the purpose of all entrepreneurial business. Firms big and small must know, follow, and adhere to the principles of value creation. This is pragmatic not theoretical — the consequence of a failure to do so is that the firm cannot survive.
Bartley J. Madden studied value creating firms as a co-founder of a successful investment research firm and then managing director of Credit Suisse HOLT. He is now an independent researcher and founder of the Madden Center For Value Creation in the College of Business at Florida Atlantic University.
He joins the Economics For Business podcast and shared a summary of a lifetime of research.
Knowledge CapsuleA systems thinking approach provides the best route to understanding value creation.The business firm is a sub-system within a bigger system, that of society. The effectiveness of the firm is tied to organizational learning and the evolution of dynamic capabilities. Bart Madden’s pragmatic theory of the firm treats it as a holistic system with a well-defined purpose. If it is successful in achieving its purpose, it will benefit the larger societal system.
The purpose of the firm is a four-fold composition of mutually reinforcing goals.Sometimes, the business literature is guilty of treating purpose as a PR statement, a catchphrase that can be communicated without it necessarily governing the firm’s behavior. Bart Madden’s view of purpose demonstrates much greater depth, appropriate for complex systems management. Purpose is 4-fold:
A vision of the value that can be realized by customers, and that can inspire and motivate employees to work for a firm committed to ethical behavior and making the world a better place through customer value. [[{"fid":"137418","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"Example 1","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"Example 1","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"Example 1","class":"media-element file-image-no-caption media-wysiwyg-align-center","data-delta":"1"}}]] Customers consume value by experiencing it in their interactions and relationships with the firm. The customer’s experience is dynamic within their own system of competitive offerings and alternative choices.Survive and prosper through continual gains in efficiency and sustained innovation. These are long term performance variables that depend directly on a firm’s knowledge-building proficiency. A firm must generate a return that is greater than the cost of capital, and as it matures, this return can be eroded away by competitors who offer lower prices or different features to customers. Building knowledge and translating it into new business capabilities is critical for long-term survival. [[{"fid":"137419","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"Example 2","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"Example 2","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"Example 2","class":"media-element file-image-no-caption media-wysiwyg-align-center","data-delta":"2"}}]]Work continuously to sustain win-win relationships in every direction. Relationships with customers are primary for value creation, and relationships with employees and managers must generate the understanding, motivation and commitment to delivering customer value, while relationships with suppliers, collaborating firms and other partners must result in their best support for value creation. It’s a way of living and doing business that engenders trust all around. Shareholders are also rewarded as a consequence of these relationships.Take care of future generations. The long-term view of the pragmatic theory of the firm as a system within the bigger system of society emphasizes thoughtful concern for the future, so that return on capital can be sustained. Paying attention to minimizing waste in the earliest product and service design stages can serve the future, and this includes minimizing pollution (a form of waste) and reducing harm to the environment.[[{"fid":"137421","view_mode":"image_no_caption","fields":{"format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"Example 3","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"4":{"format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"Example 3","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"Example 3","class":"media-element file-image-no-caption media-wysiwyg-align-center","data-delta":"4"}}]]A firm that is successful in achieving its four-part purpose benefits customers, employees, partners, suppliers and shareholders, as well as society at large.
Nurturing and sustaining a knowledge-building culture is the most critical driver of long-term performance.Knowledge-building is a continuous loop:
Knowledge base, purposes and worldview: Every firm has a knowledge base that determines current perceptions or current worldview, which includes ideas and beliefs and assumptions about interacting with the world.
Perceptions: We see the world through our perceptions and construct our reality that way. We may be self-assured about some favorite ideas about the obvious way to proceed, but we may be proven wrong via future learning.
Purposeful actions and consequences: With its purpose in mind, the firm takes actions, and each action has consequences, which may or may not have been anticipated.
Feedback: Learning from actions and their consequences is consumed as feedback, a critical component of the knowledge-building loop. The knowledge base changes as a result of this learning. An existing assumption may be replaced. Humility is important when traversing the knowledge-building loop.
New understanding and new perceptions: As a result of feedback and learning we may be able to evaluate our assumptions differently and perceive the world in a new and more accurate way.
It’s hard to be skeptical about our own strongly held beliefs, and therefore a cultural commitment to experimentation — the kind that’s capable of revealing obsolete assumptions — is necessary.
Knowledge-building stems from firm culture.Knowledge-building proficiency is a culture which views everyone in the firm as a value creator and a knowledge worker who can continuously improve their own problem-solving skills. This, in turn, motivates all employees since they can take great satisfaction from their jobs.
One of the errors of the traditional command-and-control management structure is that it assumes the smartest people are “higher up”, and it takes decision-making away from those closest to the customer and to the most relevant knowledge. The higher-ups set short-term targets for the employees, which is inconsistent with treating individuals as learners and value creators.
Knowledge-building occurs, and must be nurtured, at every layer of the firm.
The correct view — and the correct measurement — of firm performance is the life cycle.All firms traverse an inevitable life cycle. Bartley J. Madden’s books and research picture it this way.
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During a period of high innovation, economic returns are high, and firms can reinvest at a high rate. This inevitably fades as competitors erode the advantage. In maturity the returns approach the cost of capital, and the business model may fade to the point where it fails to make the long-term cost of capital. That’s why firms must always be investing in long term new innovation projects for continuous refreshment and to repeat the high return stage. They must demonstrate to investors a skill in making these high return long term investments. The stock price is an appraisal of this skill.
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The life cycle components are the long-term cost of capital, the return on capital that results from knowledge-building proficiency, the fade rate and the reinvestment rate. The metrics of firm performance are those related to the life cycle.
Additional ResourcesThe Pragmatic Theory of The Firm and The Knowledge-Building Loop (PDF): Mises.org/E4B_199_PDF
Books by Bartley J. Madden:
Value Creation Principles: The Pragmatic Theory of the Firm Begins with Purpose and Ends with Sustainable Capitalism: Mises.org/E4B_199_Book1Value Creation Thinking: Mises.org/E4B_199_Book2CFROI Valuation: Mises.org/E4B_199_Book3Reconstructing Your Worldview: The Four Core Beliefs You Need to Solve Complex Business Problems: Mises.org/E4B_199_Book4Paper: "Bet on innovation, not Environmental, Social and Governance metrics, to lead the Net Zero transition" by Bartley J. Madden (PDF): Mises.org/E4B_199_Paper
Good Strategy Bad Strategy: The Difference and Why It Matters by Richard Rumelt: Mises.org/E4B_199_Book5
Plain Talk: Lessons From A Business Maverick by Ken Iverson: Mises.org/E4B_199_Book6
Brands are prized by corporations as significant value-driving economic assets. Brands help customers enjoy more valuable experiences, raising willingness-to-pay levels and thus improving cash flows — higher cash flows as a result of higher prices, faster cash flows because branded products tend to turn faster than their non-branded counterparts, longer lasting cash flows because brands have longevity in customers’ perceptions, and less volatile cash flows because brand loyalty can smooth out the effects of economic booms and busts.
For these reasons, corporations invest in brands and brand building. Catherine Kaputa makes the case that individuals should invest in themselves as brands, and makes the tools of brand-building available to individuals for personal brand-building: the brand of you.
Knowledge Capsule You are a brand, assessed subjectively by your customers. Think of yourself as a brand. Think of your customers - your boss, other leaders and decision-makers in your firm, your colleagues, your clients, your suppliers. They all have a subjective perception of you and the value to which you can contribute in any business situation. Is it the perception you want? Do people see you as the problem solver and solution designer for their problems? Like any brand owner, you can work to actively shape that perception. As Catherine Kaputa puts it: If you don’t brand yourself, others will, and they may not brand you the way you want to be branded.
The first tool in the branding toolbox is positioning. The branding community has developed the idea of brand positioning. In the perception space in which your brand operates, you seek to identify a unique, highly differentiated position. You want to be perceived as different and better. Positioning is the identification and selection of that unique space in the minds of customers and the basis of the of credibility, reputation and trust to be able to make the claim.
Importantly, positioning requires outside-in thinking. Think of your customers first, their needs, their mindset, and their perception of the other brands in the space. Your positioning must be in their minds, not yours.
Differentiation is a most important element of positioning. Typically, perception spaces are competitive. Customers looking for solutions to problems and better experiences scan the space for alternatives and make comparisons between them. Know your competitors, assess them through the eyes of your customers, and find a positioning that is both different from and better than alternatives for your customer, using their mental model and assessment criteria. Aim to “own” that unique space - meaning that the customer identifies you as the only one or the best one of their alternatives to meet a particular need.
Attach an idea to yourself. A way to pin down a perception in a customer’s mind is to attach an idea to a brand, in this case yourself as a brand, in a way that the connection is immediate and becomes automatic. The idea should be singular and highly focused. Catherine Kaputa recommends a process of subtraction to reach a singular idea — you’ll start with a multi-layered and possibly complicated idea, but if you keep subtracting the least relevant, least important and least differentiated elements, you’ll arrive at the pared-down singularity. You should be able to express it in a phrase or a sentence, one that you can keep repeating to embed it.
Her own example in her marketing career was to brand herself as “good with difficult clients”. Every marketing services company has clients or accounts or marketing challenges that are deemed to be difficult and not everyone wants to be exposed to that risk. Someone who steps up and enjoys performing well on such a stage is both differentiated and highly sought after.
Personal brand positioning strategy templates provide another tool for self-branding.
In her book The New Brand You, Catherine Kaputa provides 10 brand positioning templates as examples of how an individual might approach the process of self-branding and build their own brand.
Download "Ten Personal Brand Positioning Strategies" in PDF: Mises.org/E4B_198_PDF
These are complete templates for rigorous use and application, appropriate for individual interpretation, embellishment and nuance.
One example is the Innovator strategy. Let’s use this template as an example of the self-brand positioning process.
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What’s the customer need that the Innovator addresses? Identify your target audience and the problem they want solved. Innovators are needed to create something new, when existing strategies are failing or sales are declining or new market entrants are redefining the terms of competition. New solutions are sought, and Innovators are the ones people turn to. Innovators are recognized as the creative resource that’s required.
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What are the attributes to point to in order to claim the Innovator positioning? Catherine Kaputa lists 5:
Visionary with clear objectives: not just creative, but capable of identifying business objectives for creativity and of seizing opportunities.
Brilliant at problem-solving: full of ideas, but always directed towards solving important problems.
Bold risk-taking: when others hold back, Innovators are eager to design and run experiments from which to learn, knowing there’s no such thing as failure, just new knowledge.
Fresh thinking: not following the crowd but diverging from the norm.
Inventive: Innovators demonstrate the capacity to be first in new designs, new thinking and new ideas.
The point is to evaluate yourself against the attributes of the positioning type: is this you?
- The next step is a positioning statement. Catherine provides examples:
Sample Positioning Statement: An innovative professional in an industry beset by mergers and dynamic change positioned herself in the following way.
Draft Sentence: For senior managers, boss, clients, industry who need new products and services I stand for innovative problem solver in industries undergoing massive change.
The format to use is: For (target audience) who needs (problem you solve) I stand for (value proposition).
- Add reasons to believe. Pick three reasons and 3 keywords or phrases as to why customers should invest in your positioning statement by hiring you or giving you the project.
Innovator is just one of multiple possible strategies. Yours may be one of these or a combination of several. There’s a personal test you can take at Mises.org/E4B_198_Test for initial input to start your positioning process.
Positioning is a means not an end: there is more work to do. Catherine Kaputa follows the logic of brand positioning all the way to implementation. It’s not a theory, it’s a practice. There are actions that brand marketers take to communicate and embed their positioning. She cites three major ones: visual identity, verbal identity and brand marketing.
Commercial brands spend a lot of time, effort and resources on a brand’s look: logo design, package design, website colors and typefaces, video style, and so on. The goal is to communicate a style and an engaging and brand-appropriate visual personality. The same principles apply to personal branding - choose your look, your dress-style and fashion carefully and thoughtfully.
Verbal identity comes from the words you use, the story you tell, and how you communicate in presentations, e-mails, tweets, speeches and conversations, whether in the conference room, the auditorium or on zoom. Work on it.
Marketing your brand should be guided by your goals for your personal brand. Once you have them defined, choose your media, your message, your content, your campaign tactics and your metrics.
Additional Resources The New Brand You: How to Wow in the New World of Work by Catherine Kaputa: Mises.org/E4B_198_Book
Find your own brand positioning (Mises.org/E4B_198_Test) on SelfBrand.com
"Ten Personal Brand Positioning Strategies" (PDF): Mises.org/E4B_198_PDF
Business success goes beyond numbers and planning and finance acumen. There’s an emotional component to it, ranging from the courage to make decisions without knowing the outcomes in an uncertain future, to the resilience of weathering storms and coping with unanticipated crises. There is also, of course, the joy of achievement and goal-attainment. There’s a concept identified as emotional intelligence that individuals and teams can cultivate as an element of a mental model that’s well-aligned with business performance and positive business outcomes.
Knowledge Capsule The entrepreneurial method is to pursue change, but people’s natural attitude is to resist change. We have an inbuilt, biological resistance to change. It triggers fear and anxiety that get in the way of moving towards the change that we seek. In addition to this emotional resistance, we develop habits that keep us in the status quo, and present another barrier to behavioral change. We all must fight an internal battle between our old habits and desired new habits.
Entrepreneurs develop a special emotional intelligence that motivates action. Entrepreneurs are in the business of making change. They can overcome the natural emotional and behavioral barriers because they have a highly developed emotional intelligence. They have such an emotional relationship with their vision of a successful outcome for their efforts that they can overcome fearful restraints and resistance to change. They are especially highly motivated to take action. It’s their emotion that drives action, not intellect.
Emotional intelligence is much more influential in business success than IQ. A 40-year study at UC Berkeley found that EQ (emotional intelligence) is 400% more powerful than IQ in predicting which individuals would have success in their field. Private companies like PepsiCo and Apple have uncovered similar findings in their internal studies.
High emotional intelligence not only releases personal energy and creativity, but it also results in higher levels of interpersonal trust and shared engagement with others. With high emotional intelligence, we are driven to help others to enjoy better experiences as well as to advance out of our own comfort zones to access new areas of achievement.
The consequence of achieving high levels of emotional intelligence is higher levels of trust and engagement in business, and, thereby, better business results.
Everyone can improve their emotional intelligence and benefit from its compounding effect. We are pretty much born with our IQ — we can’t increase it. But everyone can raise their level of emotional intelligence. Not only that, but emotional intelligence is a compounding asset — we can raise it and raise it again and keep on raising, so long as we work at it.
Part of the equation is personal energy management. Phil Johnson identifies personal energy as the core element at the heart of the power of emotional intelligence. We “give our energy away” when we permit others to disrupt our emotional flow — make us annoyed or angry or resentful or frustrated. As a consequence, we feel the need to “steal energy from others” by getting the better of them or by exercising a command-and-control management style. The net result is strife, dissension, and misalignment — where team or corporate energy is wasted. We can avoid this waste by cultivating emotional intelligence.
There are high-ROI habits, practices and skills that help to build emotional intelligence. Happily, we can practice some of the habits and skills that develop and demonstrate emotional intelligence.
One such habit is authentic listening: when we take criticism personally, we give away energy. So, if we eliminate all personal inner-directed emotion from our reception of comments and suggestions from others, we can utilize all the experience and knowledge that’s shared with us for betterment and improvement. Don’t resist, don’t judge. Don’t let attachment to our own preferences get in the way of receiving input. Don’t raise walls. We have no personal interest in what others think of us, only in the information they can impart, which might be useful
The other side of the coin is authentic communication: be sure that all the content of our communication is factual and positively motivating and designed to be helpful to others, strengthening trust and engagement. If we develop a consistent reputation for authentic communication, we’ll raise engagement (and Gallup reports that employee engagement is at a very low level today, which is a great cost to economic productivity).
In addition to habits and practices, Phil Johnson urges us to commit to the emotional labor of recognizing our own fears, biases, and status quo preferences, and to establish an emotional distance between our motivations to action and our ego-based fear. It’s emotional labor that pays interest — it has a high ROI.
Emotional intelligence releases the power of intuition, and creates a state of flow. When we fear making decisions, we try to rationalize those decisions, to seek objectivity and lower uncertainty. When we distance ourselves from fear, we can unleash intuition — that decision-making capability that is beyond our understanding and comes from our unconscious brain. Intuition takes over more and more as we master emotional intelligence. We make choices that are not intellectual — we go beyond our intellectual ability.
Emotional intelligence takes us to a flow state. We get away from thinking and move towards intuitive doing, beyond our comfort zone beyond our fear and anxiety.
Additional Resources Phil Johnson on LinkedIn: Mises.org/E4B_197_LinkedIn
Phil Johnson’s Zoom Calendar: Mises.org/E4B_197_Zoom
Videos from alumni of Phil Johnson’s MBL (Master Of Business Leadership) Program: Mises.org/E4B_197_MBL
UC Berkeley Study, EQ>IQ: Mises.org/E4B_197_Paper
Success in business — serving customers well, and achieving growth in revenues and assets with a return on capital greater than its cost over the long term — is tied to knowledge-building, whereby everyone in the company learns more and more about specialized and advantaged methods of generating value for customers. Customer value fueled by knowledge-building flows back to the company as cash flow as a result of customers’ willingness to pay (which, itself, is a piece of knowledge to be discovered through testing and experimentation).
The uncertainty of the future means that a lot of knowledge-building must be achieved through experimentation — testing ideas to find out if they work or not. The earliest stage of this testing is bound up in the concept of criticism. Bart Vanderhaegen, a philosopher, epistemologist, and business consultant, explains the role of criticism to Economics For Business.
Knowledge Capsule There is broad agreement on the need for adaptiveness in business. It is becoming more and more accepted to view firms as operating within a complex adaptive system in which the interactions of millions of agents, and the resultant emergence of new outcomes and new system properties, require an acute sensibility regarding change — and speed of change — in the business environment and an ability to make adjustments in response or, if possible, in anticipation.
This adjustment process often goes by the name of adaptiveness.
What, exactly, is being adapted? Bart Vanderhaegen’s analysis is that it is ideas that are being adapted and adjusted. He defines idea in this business context as a goal and a plan to achieve that goal — a desired end and the associated means. It is ideas that ultimately result in changing people’s behavior, changing product and service offerings, and changing markets.
If the idea is wrong, it will fail in achieving any desired change. To establish why or how an idea is wrong requires criticism.
Criticism is an artifact of the science of knowledge. Critical rationalism views knowledge as useful information we use to solve problems we face. It can never be viewed as final — it’s conjecture about possible solutions that we are continuously challenging and criticizing to expose any error that we can subsequently correct to improve upon the solution, and to get closer to economic reality. That’s adaptation.
Firms actively seek the criticism of the market. Once ideas have been activated as products and services, firms are comfortable with the criticism of the market. As Mises observed, the customer, by buying or not buying, returns a verdict on every business’s offering. And business welcomes the criticism, in the form of sales report, or market share analysis, or market research. The market is full of feedback, and in the case of non-buying, the feedback is criticism and triggers improvements or an adaptation of the plan.
In business, there tends to be less comfort with criticism in the pre-market stage, but it’s a necessary tool for refining options and making decisions. In Bart’s way of saying it, the word criticism, when used in business, has “kind of a weird smell around it”. There’s a culture of what he calls justificationism. We are taught to project confidence bout business plans. Executives claim expertise in the domains for which they were hired. The boss is correct.
This is all misplaced. What we should be confident about is capacity to solve problems, and not be scared of making mistakes, but rather to be eager to adapt our knowledge to observed reality when it changes.
By utilizing criticism methodically, businesses can unleash its power. The proper use of criticism is to criticize ideas and not persons. We always want to celebrate the owner of an idea, and grant them autonomy to accept or reject criticism. Bart’s three step method for business criticism is:
Start with the presentation of the idea by the idea owner. There should be the opportunity for a full and reasoned presentation. Questions of clarification can be asked, but no criticism at this step.Then follows the offering of criticism. It should be high quality, constructive and specific as to what elements are in doubt and why, and what can be improved. General opposition such as “That will never be accepted here” (which could be said of any idea) is not acceptable.The criticism session is completed with a consent stage, in which the idea owner indicates which criticisms he or she finds relevant and will act on to improve the idea, whether in ends or means or both. Consent is in the discretion of the idea owner and should not be the result of any pressure by critics, whatever their rank or status. There is no “softness” in this: there is a shared and passionate commitment to improve. Successful adaptive businesses develop a positive culture of criticism. It’s important to analyze and classify the prevailing firm culture. Some cultures will discourage or reject criticism as a method for improvement, especially those that are hierarchically organized and have a tradition of authoritarianism.
The appropriate culture values truth and values adaptiveness, and celebrates the identification of error as a successful step towards improvement. Bart called this culture a “tradition of criticism”, which sounds contradictory since the word tradition is usually associated with preserving the status quo; but a tradition of criticism implies a kind of stability around the practice of criticizing. People become comfortable with it, and try to become better at it, and are proud to be part of the path to betterment through criticism.
The Amazon 6-page memo system is a good example of the tradition of criticism. Idea owners are required to prepare a detailed memo describing the idea and the business case and this is submitted to a committee of reviewers in a dedicated meeting, escalating in rank towards the most senior management as the idea is vetted, improved, and increasingly strengthened. It’s a tradition and a part of the Amazon culture.
Such a culture is not initiated with an announcement or a campaign, but emerges organically as a universal tool for everyone in the firm to utilize.
Additional Resources Pactify Management: PactifyManagement.com
Bart on Twitter: @B_Vanderhaegen
Bart’s podcast: Fallible Management (Anchor.fm/FallibleManagement)
Bart’s email: bart.vanderhaegen@pactifysoftware.com
A great benefit of the internet age is the capacity to accumulate, accelerate, and intensify connections between entrepreneurs, knowledge sources, investors, mentors, collaborators, and service providers. Businesses with a valid value proposition who are in the launch and early expansion phases can interconnect a network of powerful and qualified resources to support their growth. A good way to do so is to utilize a platform (another product of the internet age) designed for the purpose. Tom Malengo established a platform called Brandjectory to serve just this purpose for consumer packaged goods (CPG) startups.
Key Takeaways and Actionable Insights. Brandjectory’s value proposition is to solve the problem of how to build an investor-ready business. The purpose of a B2B business is to help customers achieve their own purpose. Brandjectory helps with the purpose of becoming investor-ready, the condition of qualifying for funding in the eyes of investors. The problem is multi-faceted, from having an investable value proposition, to having the systems and structure in place to qualify for investment, to overcoming the functional obstacles of expansion, to having access to investors, to having the capability to pitch effectively and persuasively. Brandjectory helps with all phases, for all stages of investable business from pre-market seed stage to post-market Series A where a proven business model and revenue stream represents the bar.
All knowledge is specialized: select and know your sector. Brandjectory focuses on consumer packaged goods businesses, often identified by the acronym CPG. It’s a sector with open-ended innovation opportunities — e.g., how to make foods and beverages and cleaning products and pet products healthier — along with an identifiable set of obstacles to overcome, such as the cost and difficulty of securing and maintaining distribution in supermarkets and other retail channels. An investable business knows the available innovation gaps and has a practical knowledge of barriers and how to overcome them.
Define value in your sector with reachable target customers. The Brandjectory system stresses the understanding of subjective value — that it’s an experience of the customer, and is defined by what they feel is important to them and how they feel a new brand will satisfy their need in that area of their life. Value demands an emotional connection, sustained over time. Too many founders, says Tom Malengo, CEO of Brandjectory, do not exhibit a full understanding of value. They are more focused on what’s new or different about their product, or on their recipe or ingredients. This is a functional perspective, and misses the emotional component. Tom’s technique in assessing a founder’s understanding of subjective value is a careful but intense questioning, driving towards a true focus on what’s important to consumers.
Value understanding must be translated into a value proposition. A value proposition is a structured template for the communication of proposed value to the consumer, enabling them to recognize it. The value proposition must capture the emotional element of value — how consumers will feel better. It’s not just about good taste, for example, but the joy of consumption, the family sharing, the feeling of contributing to health rather than undermining health.
On econ4business.com, you can read about value propositions (Mises.org/E4B_195_Value), and watch the E4B value proposition design video (Mises.org/E4B_195_Video).
Potential investors will probe for the founder’s true understanding of value propositions — it’s a qualitative rather than quantitative assessment. A founder must be skilled and effective at communicating this understanding.
Investor-readiness also implies an identification of all the challenges to growth and how to overcome them. Investor-readiness will vary by business stage. The state of readiness might encompass the capacity of the sales network, or of production processes, or the scalability, sustainability and security of the supply chain, or the strength of processes and systems, or the innovation pipeline, or the quality of the advisor group. Tom’s guidance to founders ensure that they know all the questions investors will ask, and leave nothing to chance in framing their answers.
The required knowledge-building is achieved through networking and connecting. A major benefit of the Brandjectory platform is its network of advisors, industry experts, mentors, and investors. Founders can connect to them and meet them, and not just listen but also gather knowledge through questioning and discussion. Plugging in to a powerful knowledge network is less stressful than pitching and more conducive to learning.
The members of the network have a wide range of incentives. Investors can pick up information about trends and new ideas even if they don’t invest directly. Industry experts can sense the response to their information and knowledge sharing and get market feedback. Many mentors enjoy the sense of giving back to their industry and community after years of working. All entrepreneurs can, and should, assemble a network like this. Brandjectory is a convenient way to do it for CPG entrepreneurs.
It's important to understand the role of knowledge in firm performance.
Tom Malengo says knowledge is power for entrepreneurs — the power to solve problems, address challenges and overcome obstacles. It can be a competitive advantage to gather more specialized knowledge than competitors and incumbents.
Professor Per Bylund sees specialized knowledge as solving the production problem (see Mises.org/E4B_195_Book) — the difficulty of initiating new economic production that no-one else has ever attempted, i.e., innovation.
Brandjectory takes the problem-solution approach to knowledge building. Entrepreneurs who confront a problem or issue or knowledge gap can ask the appropriate question of the appropriate expert or tap the experience of a more seasoned businessperson and benefit from the exchange, a kind of accelerated learning.
Brandjectory is a celebration of the all-American practice of entrepreneurship. Tom Malengo views entrepreneurship as the fabric of civilized society, a tradition that is especially strong in America. Our first settlers and many of our founders were entrepreneurs, and the encouragement of new ideas from any and all sources, giving everyone the chance to pursue their commercial development and experience economic success is woven into our way of life.
An entrepreneur, as Tom sees it, is someone who refuse to tolerate the existing status quo and demands better and is willing to exert their own effort and expend their own resources to bring it about — a very Misesian view. Through Brandjectory, he intends to help and support all those in pursuit of betterment in CPG. His platform concept — where the business model is to invite entrepreneurs to join for a fee, with unlimited free access to the knowledge platform and expert network, no commissions, middleman dealmaker cuts, brokerage charges, retail markups, affiliate costs or any other “bite” — is pure support for aspirational growth companies.
Additional Resources Brandjectory website: brandjectorynow.com
Tom Malengo on LinkedIn: Mises.org/E4B_195_LinkedIn
Breakthrough theory becomes effective practice when it is successful applied by real-life entrepreneurs. The E4B entrepreneurial method is actualized by Hermann and Elizabeth Morris in the very distinctive business model for their brand, The Nail Hub.
Knowledge Capsule The true purpose of a B2B business is to help your customers succeed. While outside observers focus on transactions — how much does this business sell, what are its revenues? — entrepreneurial business owners and operators focus on customers and customer relationships. Revenues follow from relationships. This insight is critical, since it guides business model development.
Business-to-business models are especially responsive to relationship strategies. When a customer feels that the relationship with a supplier makes their business performance better, they can become a customer for life. That’s a recipe for strong and sustainable growth.
First, observe the ecosystem in which you operate, and identify gap opportunities. Systems thinking is an important component of the entrepreneurial method. A firm is a component or a node in a network of interconnected services we can call an ecosystem. Hermann’s and Elizabeth’s ecosystem is the Nail Fashion industry. Nodes include salons and salon owners, the nail technicians (sometimes employees, sometimes independent contractors) who provide service to consumers in the salons, equipment manufacturers and suppliers, product manufacturers and suppliers (for nail gel, etc.), and product distributors.
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Hermann and Elizabeth were able to identify a number of gaps in the ecosystem. Many salon owners were enthusiastic about their industry but not well-trained or experienced in the basic economics of business. Many of the technicians were passionate about their trade, but not highly trained in the latest techniques and technologies and in product selection. There were aspects of marketing that were underdeveloped, such as audience segmentation. And there were inconsistencies between products in both quality and safety.
In the mind of the entrepreneur, these gaps are opportunities. The entrepreneurial question is: how best to fit in and contribute to the ecosystem. The business model response is determined by individual entrepreneurial orientation.
The beginning orientation was that of an operator. Given their knowledge of both the high potential of the industry and the gaps to be addressed / problems to solve, the Morrises’ entry point was as an operator. They embarked upon the journey to design a differentiated salon experience with superior nail technique, better products, better trained technicians. They ran the salon with better business acumen (they both came from high-level corporate positions and were able to bring sophisticated operating and financial experience). They segmented with an unusual and especially comfortable in-salon appeal, and via location.
They were successful. There was a lot of learning, which Hermann identifies as overcoming pain points.
The next growth step comes from re-orientation to larger scale. How could the Morrises scale their salon business? They thought through multiple openings (e.g., open and operate 20 salons), acquisition (acquire 20 salons), and franchising (sell franchises to multiple independent owners).
All of these alternatives would require new capability development: establishing standards and a repeatable business model, including a reliable financial model, designing a multi-unit system of supply chains, capital deployment, décor, training and location scouting, and a new kind of marketing to salon managers or franchisees.
The Morrises were reorienting to thinking as proprietors of a new kind of multi-division business. It’s a different orientation, seeing the same ecosystem from a different perspective.
Meanwhile, Elizabeth had the idea for a podcast to share her expertise and knowledge and passion for the industry. It was free business advice, free guidance, free technical training, teaching different aspects of running a salon and technical aspects for nail technicians. Its purpose was a service to consumers (better salon experiences), to technicians (better craftsmanship) and owners (better business operations). The podcast was called The Nail Hub. It generated a great positive reputation in the ecosystem and a lot of positive feedback. The knowledge that The Nail Hub podcast shared was enthusiastically welcomed.
The Nail Hub podcast feedback resulted in a further re-orientation. The Nail Hub podcast was helping salon owners and those technicians who were independent contractors renting positions in salons to improve the way they ran their businesses: better management, better understanding of customer needs and segmentation, better approaches to pricing, revenue and profits, better techniques, and better products.
What if a podcast can become a business model? Hermann and Elizabeth developed an entirely new B2B services business model which could be summarized as “educate the industry on how to operate a business, and supply them with the highest quality products to fit their business”.
Importantly, the education is free to consume. The Nail Hub YouTube channel is free to access, and offers over 140 videos on every aspect of business operations, finances, equipment, products, and techniques. The videos are expensive to produce. The model is that the investment in education will be repaid through loyal customers buying the products that The Nail Hub offers for purchase.
The curation of products itself is a service. The Nail Hub has identified a distinctive set of criteria for product selection (health, safety, non-toxic ingredients, cruelty-free) and does the research and validation so that purchasers can be confident in their choices and tin he integrity of their promises to the end-consumer.
The products are not the lowest price, they are the highest quality. Salon owners who have not fully absorbed The Nail Hub’s education on consumer segmentation, pricing, and customer experience will not be a good fit within The Nail Hub’s customer set. The Nail Hub business model has a high internal consistency and integrity.
The Nail Hub has re-oriented to B2B service provider educating an entire industry to provide superior consumer experiences, better product quality and profitable operations — i.e., re-orienting from facing those challenges to helping others to face and overcome them.
One of the cornerstones of the B2B services model is authentic subject matter expertise. The Nail Hub can help salon owners and nail technicians thrive through their independent action because Hermann and Elizabeth developed a deep subject matter expertise. They’ve been salon owners and faced all the developmental issues that owners face. They’ve trained nail technicians. They’ve evaluated salon equipment and they’ve committed their resources and time to researching high quality, innovative products that meet their highest standards. Hermann stresses that the arduous development of subject matter expertise is the necessary foundation for a trusted service business.
Another is to choose customers carefully. The Nail Hub is making a substantial investment in their customers via their free training and education. The business model that they enable is specific: the highest standards, with the best trained operators, providing a reliably superior consumer experience. The pricing model is premium, which supports the use of the highest quality products and the provision of the highest quality salon environment. Race-to-the-bottom operators who pursue the lowest prices as a competitive edge are not a good fit in The Nail Hub ecosystem, and Hermann makes this a clear element of The Nail Hub’s B2B communications. Choose your customers to match your positioning.
The evaluation of the business model does not lie in conventional metrics. When the business model is to invest in the success of customers, the conventional metrics of revenue, margins and annual profits are not the primary measures of success (although, of course, they must be acknowledged). The evaluation of the model comes via the feedback loops. Is the educational service welcomed? Does it result in better operations on the part of salon owners? Do salon owners and independent technicians become customers for life? Do product manufacturers clamor for entry into The Nail Hub’s curated product set? Are product trends — safe, non-toxic, healthy, etc. — moving in the desired direction?
This is the entrepreneurial ethic: make customers more successful, make the world a better place.
Additional Resources "Evolving The Nail Hub Business Model" E4B Graphic (PDF): Mises.org/E4B_194_PDF
The Nail Hub YouTube Channel: YouTube.com/TheNailHub
The Nail Hub Website: TheNailHub.com
There is a threshold of diversity below which no organization can operate with complete effectiveness. Diversity in this sense does not only include the “Big 3” DEI elements of race gender and sexual orientation, but also education, experiential background, business partner diversity, learning capabilities — all of the organizational resources that Austrian economists refer to when they talk about the creative combination and recombination of heterogeneous assets. Dr. Ella F. Washington, author of the book The Necessary Journey, joins Economics For Business to make the business case for diversity.
Knowledge Capsule The business case for diversity is built on the sustainable competitive advantage in productivity that it can bring. Dr. Washington’s book is a global, multi-variable survey of the effect of diversity orchestration on business results. She describes a wide variety of business cases, in large, medium-sized and small firms, in businesses ranging from global hospitality services to IT to alcoholic beverages production and marketing, and many more. She looks at diversity not just through the “big 3” lenses of race, gender, and sexual orientation, but also educational achievement, cultural background, learning capability and interpersonal communications variables. In all cases, well-orchestrated diversity made a demonstrable and positive difference in business outcomes. Diversity is a tool for competitive advantage.
The business case is globally applicable. Dr. Washington has studied and provided consulting services to global firms and to local and regional firms in many countries. She sees diversity not as a provincial political issue but as a business tool for elevating human performance. There is a lot of hard work involved in identifying and understanding local differences, and some challenging decision-making and communications issues. Getting diversity right is not always comfortable, and many perspectives must be balanced. But it pays off in results.
Value and empathy are at the core of diversity management. Subjective value lies at the core of Austrian entrepreneurship. Subjective value is in the mind of the customer, it’s a feeling that’s experienced. When businesses deliver a valuable experience, customers engage enthusiastically. The same is true for a group of employees. An organization that can empathically feel the experiences of all its employees, and can orchestrate the environment and the culture that recognizes, caters to and enhances their felt experiences, can achieve the exciting collaborative energy of alignment and harmony. Austrian principles of subjectivism and empathy apply in all areas of business thinking.
People want to feel valued, and the feeling is personal and individual. No matter the size of the corporation, each individual counts in their own way.
Diversity policies always benefit from the free incorporation of multiple perspectives as compared to centralized mandates. Dr. Washington’s case studies consistently demonstrate that decentralization and localized management is a better tool for productive diversity that central mandates. One of her case studies concerns Sodexo, a French company specializing in food services and facilities management, employing over 420,000 people in 80 countries all over the globe.
Through the processes described by Dr. Washington, Sodexo came to realize that thinking and acting locally was the key to achieving the diversity target of collaborative productivity AND elevated human performance through valued experiences. Diversity solutions could not be formulated in the central HQ, or even country-level HQ’s, and even regional and local offices. It was the individual sites where people work together in small teams that should be the focus. A general goal was established — it was termed “Spirit Of Inclusion” — and then specific programs were resourced and implemented at the local level in ways that comported with local needs.
To quote from one of the Sodexo executives, “engagement across the organization very soon became an enabler of business growth and business success”.
Diversity has a future orientation — influencing future performance. In the US, diversity policies are often pitched as addressing past wrongs. In another case study, the President of Infosys, an India-based technology company, stressed his focus on building the services of the future. A diverse work force is, in his words, the most viable business model. Since the company would be engaged in building new services for a new future and a more diverse audience (i.e., in new countries, new situations, new circumstances), then it’s smart to try to imagine the needs of that future workforce, and how to maximize its capability for future success. A diverse workforce is better able to develop superior understanding of a diverse customer base.
One of Infosys’s diversity tactics was to extend hiring in the US to community colleges. Many tech firms focus on 4-year university graduates exclusively. Infosys felt that (a) they might not be competitive in hiring those candidates, and (b) such a focus excluded a lot of bright, trainable people from two-year community college programs. They also found out that the two-year students often exhibited greater “learnability” — they could be trained and coached in the Infosys way with outstanding results in achievement and productivity.
Another source of diverse talent is the individual making a mid-career switch. Infosys opened up its thinking and its recruitment to include this type of diversity too. Career-switchers tend to excel at learnability.
As is always the case in entrepreneurial economics, imagining a better future opens the pathway to better implementation. At the close of her case studies, Dr. Washington tells us her respondents’ answer to a question about the workplace utopia of the future. All the answers are different, but the principle is the same: conceptualizing the most productive workplace in terms of how employees feel and how the feeling can be translated into effective and consistent contribution, collaboration, and business results. How do firms awaken and stimulate the best capabilities of all their employees? That’s the business case for diversity.
Additional Resources The Necessary Journey: Making Real Progress on Equity and Inclusion by Ella F. Washington: Mises.org/E4B_193_Book
TheNecessaryJourney.com
Dr. Ella F. Washington on LinkedIn: Mises.org/E4B_193_LinkedIn
When firms apply the principles of Austrian economics to business management, we call the result the Adaptive Entrepreneurial Method. It’s adaptive in that it is a continuous learning process, and it’s entrepreneurial in elevating customer value realization as the most important business purpose.
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Businesses that follow the adaptive entrepreneurial method put customer value first. Value in Austrian economics is customer value: contributing to customers’ feelings of being better off as a result of the interaction with an entrepreneurial business or service provider. A useful way to think about value is in terms of alignment and order. A value exchange is a harmonious alignment between customer and entrepreneur, in which both parties benefit and both parties’ interests are served. Order is represented by the customer’s decision, a point of clarity in a world of multiple choices, overlapping preferences and broad-based uncertainty.
Entrepreneurial businesses make value their purpose and identify it in alignment and harmony with customers. Everything else — cash flow, profits, growth — follows.
Entrepreneurial orientation enables the right interpretation of data and information for customer value realization. Mark McGrath emphasizes the powerful role of entrepreneurial orientation in business success. Orientation is a mindset — a kind of internal operating system — that guides firms to translate information from customers, partners, competitors and the market into an effective, winning vision and mission.
The essence of orientation is learning. Uncertainty is assumed, and orientation is the unique set of filters through which entrepreneurs and management teams process the quantitative and qualitative data that customers and markets present. Mises called it economic calculation: the entrepreneurial capacity for combining a constantly changing stream of information into a business decision. The decisions are always reviewable and revisable; a learning mindset makes entrepreneurs comfortable with frequent decision changes in response to changing information and feedback. Principles — such as the primacy of customer value — remain the same; it’s actions that are adjusted.
Businesses that don’t learn can get locked into models that no longer reflect the realities of the marketplace, and lose their effectiveness.
People, ideas, and things. Learning, adapting, and changing are difficult capabilities to master. Continuous change can feel disorienting absent the right mindset. How do companies achieve this mastery? Mark McGrath quotes Joh Boyd on the eternal verity of people, ideas, and things — always in that order.
The first critical component are the people engaged in and operating the business. They must be good at change, comfortable with constant flux. They must accept VUCA — volatility, uncertainty, complexity, and ambiguity — as the normal condition. At the same time, management must be conscious of how each new change or wave of change impacts people, and anticipates the effect it will have on them.
In this change-accepting environment, unlimited new ideas can emerge via the creative process. They can be tested, and marketplace results become the yardstick. When new ideas look promising in terms of the results they potentially enable, then things can be changed: capital can be redeployed in new combinations, marketing campaigns can be revised. When people are pre-prepared, smooth transitions are achievable.
Continuous Reorientation And Entrepreneurial Intent. While entrepreneurial orientation is the firm’s operating system for processing information, it is not fixed. Adaptive firms are continuously reorienting, Active reorientation supports learning, recognizing that all perceptual models are only as good as the moment they were developed. They must be renewed to stay relevant. Challenging assumptions and reframing problems must be continuous in order for firms to thrive and use change to advantage. Effective orientation looks to the future rather than the present, emphasizing agility and avoiding clinging to outdated models.
Reorientation precedes intent and reshapes it. Entrepreneurial intent can be equated to what systems thinkers call vision. A vision is shared and provides a North Star for everyone in the firm, but that doesn’t preclude adjustment in continuous alignment with customers. The vision is to serve customers, and customers are also changing and adjusting. Thinking in terms of intent (rather than, say, implementing a rigid plan) permits greater flexibility in pursuit of the vision.
Entrepreneurial judgment is decision and action. The theory of entrepreneurship emphasizes judgment — that mysterious-sounding capability of entrepreneurs to make economic calculations from a mix of data and intuition. That can sound like a kind of mulling over of options. But it’s much more active than that. The entrepreneurial method emphasizes deciding and acting. Decisions are recognized as hypotheses; it’s impossible to know exactly what to do, so action-oriented develop hypotheses about what actions could have the effect they desire. The hypotheses are carefully aligned with their intent in order to double-check the logic as far as possible. But the purpose is not to be “right” but to generate feedback information so that alignment can be better informed by reality.
Action — the implementation of decisions — is an experiment, a test of the hypothesis. Action produces interaction (with customers, with retailers, with competitors, with the changing market environment) and thereby provides new information in the form of feedback, which might indicate the need to change actions next time.
The number of hypotheses and tests can be narrowed; what’s important is that they reflect as wide a range of perspectives as possible — from those at the front line interacting with customers, whether in person or at the call center or online, from engineers and operatives, from finance and HR, and from all relevant points of view. The more diverse the range of perspectives, the more likely it is that different angles of view will provide new insights and illuminate blind spots. Make sure that internal communications are organized so as to make it possible for all perspectives — including dissenting Cassandras - to be recognized and acknowledged.
Candid self-assessment of people in business leadership roles is a good place to start the adaptive entrepreneurial journey. Some elements of the adaptive entrepreneurial model require the discarding of standard ways of managing. For example, many businesses spend considerable time and effort developing plans that lock in budgets and resource allocations, and don’t make allowance for constant adjustment and change. It’s useful to take inventory of these practices and question whether they can be abandoned or reformed in pursuit of agility.
Additional Resources The "Adaptive Entrepreneurial Method" Graphic (PDF): Mises.org/E4B_192_PDF1
"Destruction and Creation" by John Boyd (PDF): Mises.org/E4B_192_PDF2
Mark J. McGrath on LinkedIn: Mises.org/E4B_192_LinkedIn
"Orientation: Bridging The Gap In The Austrian Theory of Entrepreneurship" (AERC 2022) by Mark J. McGrath and Hunter Hastings (PDF): Mises.org/E4B_192_PDF3
We are living through a particularly bad moment in history for free markets and capitalism. Government, not business, is promoted as the solution to all problems. Young people have never known any other environment, and one of the consequences is the skepticism about capitalism that they learn in school, college, and university. One solution to this problem lies in better business education — shaping how young minds think about business by shedding light on the social and individual benefits of capitalism that might otherwise be deliberately shadowed by misinformation and misdirection.
Allen Mendenhall is leading the way with a new business curriculum at Troy University.
Key Takeaways and Actionable Insights There are unmerited concerns among young people today about the ethics of capitalism and business. Business is too often cast as the “bad guy” in the movie of life. Business is portrayed as exploitative and greedy, and businesspeople as self-serving. Historical scandals like Enron and WorldCom are cited as case studies. But this presentation is a caricature; there’s no evidence to support it. Business is the essential component of the capitalist system that has raised standards of living and quality of life all over the globe and especially in the West, where markets are somewhat freer.
Business didn’t have the same bad rap in the past. In the nineteenth century, there was a great celebration of the civilization-advancing commercial republic powered by the protestant work ethic. The image of the businessperson was a positive trope — it was a good role to be a businessperson creating value for others. Businesspeople were the good guys. They innovated, collaborated and served. We’ve lost that imagery.
A lot of the unmerited concern emanates from educational institutions, especially universities. Who is teaching young Americans to be skeptical about capitalism and business? A large portion of the blame goes to educational institutions, and especially universities. There’s an anti-business and anti-capitalism bias among the teaching profession in higher education that is communicated to students.
In this academic anti-business campaign, there’s a special role for economists, who have dehumanized economics by trying to make it a mathematical science. All their equations and computer models have the effect of taking humanness — the role of subjectivism, individual preference, and individualized emotion — out of economics. They try to reduce human behavior to a predictive data-driven algorithm.
The heritage of economics is humanizing. The mathematical approach to economics is not the tradition of the Austrian school approach, which embraces a humanizing perspective. Commerce cultivates virtue; the pursuit of honorable profit leads businesses to act with good faith and integrity in joining with partners to produce products and services that are valued and welcomed by customers because they serve their ends in their search for betterment in their lives.
The concept of honorable profit is often alien to students, and requires new learning: that profit is an emergent result of all the detailed interactions of individuals in a market, sending price signals to producers to indicate what society wants them to produce. Profit is a result of these signals indicating that society wants the producers to continue offering their goods and services.
Understanding value is central to understanding the ethics of capitalism. The emergence of profit is an outcome of the generation of value for customers. Value is central to the ethics of business, and Professor Mendenhall’s new course at Troy University places it squarely in the center. Value is subjectively determined by the customer, and the purpose of business is to help them realize the value they seek with the right products and services responsive to their wants, preferences and goals.
But here’s where the plot twists. The big corporate business community — representing less than 1% of businesses by count but the biggest proportion of GDP by dollar revenues - has been incentivized by Wall Street to pursue shareholder value (goosing stock prices) and stakeholder value (the diversion of value away from customers in favor of non-customer interest groups). Value for customers and even profit now takes a back seat to supposedly serving constituencies such as climate activists, victim groups, and, of course, government. Stakeholder value can act as cover for the CEO who fails to generate profit: they can claim to be focused on socially more important things.
The generation of value for customers, guided by the confirmation signal of profit, is no longer primary — except in Professor Mendenhall’s Troy University curriculum.
The perspective of entrepreneurship can help students appreciate ethical business. While young people express disdain and distrust for capitalism, they often have a more positive attitude about the concept of entrepreneurship. They realize that entrepreneurs are problem solvers, and that they add value to people’s lives. People benefit from the risks entrepreneurs take and the personal sacrifice they make. Entrepreneurial innovation makes lives better.
Students appreciate this, and can even identify some corporate CEO’s to whom they are willing to grant ethical approval — individuals such as John Mackey or Richard Branson. And many young people see entrepreneurship as aspirational — they want to start their own businesses and make a lot of money (i.e., profit!). Looking at business from an entrepreneurial perspective generates more positive attitudes, and we can show that all businesses started entrepreneurially, and are sustained by their continuing entrepreneurial performance, i.e., profitably delivering value for customers. If there are questions about corporate ethics, they relate to their non-entrepreneurial functions — such as HR (whence a lot of corporate wokeness emanates), legal (the people who write the opaque and deceptive terms and conditions that justify surveillance), finance (directing activities like stock buybacks that divert value from customers), and compliance (keeping corporations closer to government and more distant from markets).
Part of Allen’s approach to his students is to teach the entrepreneurial mindset — not just for business, but for life in general. He calls it “unleashing the inner entrepreneur” and includes what he calls “the economics of your dreams”, the secret of win-win, the creativity of the market, the entrepreneurial principles of career building, starting a profitable business, and character and leadership.
He also covers personal finance skills — developing knowledge of stocks and bonds and mutual funds and other financial instruments, insurance, retirement planning (even at age 18!), investing, spending, and, of course, personal management of student loans. It’s the entrepreneurial approach to life.
We should develop a new value proposition for business schools as humanness schools. Business schools today are part of the problem. They don’t focus enough on how business can be the catalyst for positive change. They should be committed to solving problems affecting not just business, but humanity as a whole. But reading business school leaders’ and graduates’ speeches and their books demonstrates that they’re not trying to help humanity as a whole but a few selected businesses and a few particular industries. They’re not dedicated to helping ordinary people, as they should be.
Allen’s new curriculum aims to redress that imbalance.
Additional Resources AllenMendenhall.com
"Corporate Wokeness Hurts The Groups It Purports To Help" (AEIR) by Allen Mendhall: Mises.org/E4B_191_Article1
"Troy professor: Students ‘very enthusiastic’ over anti-woke business scholars program" (Yellowhammer News) by Dylan Smith: Mises.org/E4B_191_Article2
Allen Mendenhall on Fox Business—"Ending Wokeism in the Corporate World": Mises.org/E4B_191_TV
Entrepreneurial businesses embrace adaptiveness and change, and continuous innovation enabled by flexible and responsive organizations, empowered at every level. That doesn’t mean there’s no role for managers. Inside the corporation, entrepreneurial management co-ordinates the business flow of responding to changing customer wants and preferences, so that resources are allocated and reallocated to the production activities that customers value the most. In fact, management is becoming more important, not less. Professors Peter Klein and Nicolai Foss explain entrepreneurial management in their latest book, Why Managers Matter: The Perils of the Bossless Company (Mises.org/E4B_190_Book), and Peter Klein visits Economics For Business to highlight the key points.
Key Takeaways and Actionable Insights Management co-ordinates the constant flux of entrepreneurial business. The essence of the adaptive entrepreneurial organization model is responsive change. Entrepreneurial businesses don’t lock themselves in to 5-year strategies and annual plans. They recognize that markets are in constant flux as a result of changing customer preferences, changing competitive activity, changing technologies, and changing conditions in business channels and in the economy. Change is the normal condition. It’s what Ludwig von Mises termed constant flux.
Management is required inside the firm to adapt and respond to change outside the firm. It’s not possible to manage the change in markets, but it is a necessity to manage resource allocation and productive activities inside the firm.
Management is co-ordination and orchestration, not authority and hierarchy. We might think of the concept of management in its industrial age guise of authority and hierarchy: some people “higher up” in the organization telling others “lower down” what to do. This kind of hierarchical authority can’t work in the digital network age; it’s too slow to process incoming data from the marketplace and too rigid to quickly or effectively implement newly imagined responses to those incoming data.
But in Professor Klein and Professor Foss’s analysis, management no longer equates to old-fashioned authority and hierarchy. Management is co-ordination: assembling the right resources — both human capital and complementary capital assets such as supportive technologies — in the right combinations (often referred to as “teams” in today’s management language) for the right shared task with the right shared goals. Professor Klein likened this to orchestration — there’s a conductor who guides the orchestra in playing the same symphony together, without telling the individual players how to play their instrument, and leaving the details of implementation to the individuals and their specialized skills.
Some orchestras may have better results than others because their teams have been well-recruited and well assembled and they respond better to management co-ordination. All firms and teams are complex adaptive systems, with emergent outcomes influenced by internal forces, one of which is management.
Management is culture more than authority. How do managers achieve a better outcome as a result of managing their teams? Professor Klein believes that they institute a successful culture, as opposed to designing an organizational structure. He defines culture in terms of norms, customs and practices — the accepted way (or simple rules) of “how we do things around here”. More specifically, in the customer-centric entrepreneurial firm, “here’s how we plan to facilitate value for our customers around here”. Skilled managers paint the pictures — the “vision”, if you will — in the minds of employees of the customer value standards the firm will achieve, and the customer experiences that the firm will facilitate.
Modern managers are comfortable with and quite expert at adaptation. The modern managerial culture is a far cry from traditional hierarchical managerial authority. It has the built-in flexibility for adaptiveness to the rapid rate of change in today’s digital business world. A well-functioning management process in a loosely structured organization can change internal production processes, teams and resource allocations in response to external changes in customer demand and marketplace conditions.
In fact, Professor Klein points out, through relevant case studies, such a management structure can be better at adaptation than, for example, a network of independent contractors and suppliers that would be challenged to orchestrate responsive changes to an external change, since each would have a different experience and process it through a different cultural orientation. They wouldn’t co-ordinate as well or as quickly as internally managed teams.
In certain cases, management authority can sometimes be a relevant organizational tool, so long as it is applied in a contingent fashion. The relevance and usefulness of authority varies by circumstance and business situations. Its usefulness is contingent, and managers must be sensitive as to when to apply authority and in what style.
Why Managers Matter identifies two distinct styles of managerial authority, Mark 1 authority and Mark 2 authority. Mark 1 authority is traditional command-and-control, exerted top down — superiors telling subordinates what to do.
Mark 2 authority is exercised through design rather than command: finding the right person for the task, combining the best-qualified people in teams, and giving them a goal with a wide latitude in their process and implementation in achieving the goal.
An important element of the contingent approach is to empathically identify the subjective preferences of employees. Some will respond well to flexible, open-ended direction that enables them to exercise their own initiative. Others might prefer the certainty of clear direction. One type of salesperson might be highly motivated by a 100% commission remuneration plan, another might feel more secure with a base salary with the potential for an achievement bonus upon exceeding quota.
Professor Klein identifies two broad sets of conditions for the exercise of Mark 1 and Mark 2 authority. When there is a high degree of interdependence between people, teams and tasks, such that it is critical that tasks are highly coordinated, completed at the same time and combined in a highly specific fashion, then management intervention is required and it will include Mark 1 elements. When production is more modular, when tasks and projects can be completed interdependently, then Mark 2 management can be exercised through a decentralized, flat and culturally aligned organization. (Professor Klein cited the example of the type of higher education institution where he works; all the professors can design and teach their classes, do their research, and publish their papers and books with a high degree of autonomy.)
Management is becoming more important, not less. In a rapidly changing world, where employee attitudes and experiences are very different than in the pre-digital world, and where global markets and their interconnected structures are more uncertain and cyclically unreliable, and where the pace of disruptive technological innovation is accelerating, good management is more important than ever for the success of our economy and our society. Smart managers are needed to find the right balance between operational excellence through established processes and adaptive change through adjustment and experimentation, a balance that business scholars call the ambidextrous organization. It can’t happen without management, and without managers.
Additional Resources Peter Klein’s book page: Mises.org/E4B_190_Klein
Why Managers Matter: The Perils of the Bossless Company by Peter Klein and Nicolai Foss: Mises.org/E4B_190_Book
Public Affairs book page: Mises.org/E4B_190_PA
Entrepreneurs always generate new value for customers; that’s what they get paid for. It’s not always necessary to create a new market; there are many creative ways to expand the value potential of established markets and carve out a territory in the new expanded space.
James Kent, founder of the innovative apparel brand Rogue, White and Blue, talks to E4B about the entrepreneurial value creation method he pursues in growing a distinctive and differentiated brand in what might look to outsiders like a crowded market, but which to him looks like unbounded opportunity.
Key Takeaways and Actionable Insights Entrepreneurs start with what they love — it’s the first source of differentiation. James is a lover of open-air experiences — of walking and hiking and exploring trails and off-road lands, of snowboarding in the mountains, and enjoying all the freedoms of exploration and everything to do with the great American outdoors. “What do I love?” is one of the first questions an entrepreneur asks of themselves, and James is certain of his answer.
Adding knowledge and experience fortifies the entrepreneurial recipe. All experience and most knowledge are individual. What we pay attention to, and how we learn is always unique to us personally. James picked up some valuable experience by working in sporting goods retail stores, both interacting with customers in stores and working his way up the corporate ladder into management positions. This commercial experience in sporting goods was highly complementary to his love of the outdoors, and the two became a productive combination in James’ entrepreneurial approach.
James was able to gain some even more fine-tuned experience by working as the first employee of a start-up, running an office in a location removed from the head office. This provided exposure to the entrepreneurial experiences of risk-taking, autonomy, maximizing the use of limited resources and using business development tools like Google AdWords — all directly useful for a future business journey.
A third layer of relevant experience came from joining the National Guard in a patriotic spirit of service. The service ethic is fundamental to all entrepreneurial endeavors.
The stage is set: what kind of business to launch? James asked the entrepreneurial questions. What do I love? The outdoors and outdoor recreation. What do I know? Apparel and apparel retail. What are my resources? Passion, the genuineness and clarity of commitment, design ideas, and a small amount of savings. Who are my customers? People who share the same passions.
Where will differentiation come from? It came from a reservoir of genuine feeling and the combination of two streams of thought: recreational love of the outdoors and patriotic love of country. The combination became the brand Rogue, White and Blue, described by customers as “the patriotic version of Patagonia”. It’s wild and unexpected like the American landscape, and it embodies patriotic design ideas, both in visual look-and-feel and in functional attributes such as Made In America.
The commitment to a differentiated brand platform creates a differentiated supply chain, differentiated production, and differentiated presentation. Entrepreneurs design their production infrastructure and supply network backwards, starting with the brand and then identifying the system components that will bring it to life.
James had design ideas in his mind. He self-taught himself Adobe Illustrator to get them from his mind into digital documentation, occasionally hiring outside designers on Fiverr at low variable cost for some specific refinement tasks. Modern technologies ranging from design software (and the training videos and additional user content available online for new adopters) to digital printing to internet-enabled collaboration sites like Fiverr can be combined to create a complete value network with limited fixed cost investment.
The next step down the supply chain was to find screen printers and James tested alternatives until he identified the best craftspeople in that specialized profession. He made them his business partners, which enabled him to benefit from their expertise in identifying the right Made-In-America apparel manufacturers and the right high-quality fabrics. By ordering garments through the printers, he was able to give the printers a more profitable business model while offloading some risk (e.g., of misprinting) onto them. The shared value space was big enough for everyone in the network.
The integrated platform of a differentiated brand and a differentiated supply chain is the result of entrepreneurial commitment: to brand integrity, quality, style, and consistency.
Finding customers through entrepreneurial action. At the outset, there wasn’t any marketing budget for Rogue, White and Blue. How does a brand get customers in those circumstances? Not by advertising but by entrepreneurial action: by meeting customers personally. James had a good instinct for who his customers would be based on input from like-minded friends and family. So, he went out to meet similar people by setting up a sales table at selected events where they might congregate. The first one was a gun show, and then more broadly outdoors-themed events. James vividly remembers the excitement of show attendees stopping by his booth, immediately bonding with the “patriotic version of Patagonia” brand feel — they didn’t need to be told, they understood it without prompting — and paying cash for the products. Rogue, White and Blue started with a batch of 96 T-shirts which quickly sold out.
Growth is funded by cash flow and there is no shortage of growth drivers and growth ideas. Cash flow is the most important financial indicator of business performance and it’s the most important source of growth capital. Profit is an accounting notion, and debt-financed development has its own set of risks. Cash flow is a pure indication of customer approval and customer value. Therefore, it provides the best funding source for both working capital and investment capital — turning the value experienced by consumers into the funds that enable expanded and enhanced value experiences in the future.
Rogue, White and Blue has expanded into more designs, new apparel items, a strong website to drive sales, and a reinforced brand presence.
Customer feedback loops ensure continuous improvement and progress. Meeting customers face-to-face or getting their feedback via the internet — these are feedback loops that help entrepreneurs refine their offering. The feedback may concern product quality, design, or brand imagery; it’s all positive input for an entrepreneurial business that is open and not defensive whenever there is criticism.
The entrepreneurial life is exciting. How are we all going to share in the productivity of the economy? The old way was to take a job and participate as an employee, hopefully ascending the hierarchical ladder of a firm or translating increased experience and skill in a profession for higher wages.
As the digital economy unfolds, and more of the work is being performed through algorithms and A.I. and machine learning that’s translated into process automation, the traditional ways of sharing in economic production will be blocked.
The better alternative is economic participation and reward through entrepreneurship. James Kent describes the entrepreneurial life as exciting and fulfilling. It requires a thorough commitment and it’s hard work — he described the long nights he’s devoted to the Rogue, White and Blue brand — which he finds energizing and motivating. There’s a commitment and a service ethic, and a consequent freedom.
Additional Resource Use the promo code E4B for a site-wide discount at roguewhiteblue.com
We define entrepreneurship in terms of people working creatively to make others’ lives better. That’s a very broad statement, of course, so it’s instructive to observe how individual entrepreneurs choose to make some customers’ lives better in some specific ways by applying special skills and knowledge. Let’s call it finding an entrepreneurial focus.
Economics For Business talks to Jordan Lams, founder and CEO of Moxie, an industry pioneer in manufacturing, branding, and distributing cannabis products.
Key Takeaways and Actionable Insights. Entrepreneurs find their focus — or, sometimes, it finds them. Bruce Lee is reported to have said that the successful warrior is the average man, with laser-like focus. Entrepreneurs develop focus on particular customers, in order to understand them better, empathize with their wants, and deliver them the experiences that they value. Developing this focus may take time, or it may come early in the journey, but empathy always provides the pathway.
Jordan Lams observed the pain of a family member during a time of illness, and how cannabis products could bring some relief and comfort. From that time, he became focused on the health and medical benefits of cannabis in a broad range of personal circumstances.
From a position of focus, entrepreneurs develop the deep knowledge that becomes their marketplace advantage. Entrepreneurial focus directs research and knowledge gathering. In Jordan’s case, he gathered academic research, medical literature, and clinical studies, and he talked with medical practitioners about cannabinoid therapies. Networking brought him into contact with researchers and doctors and clinicians and product developers. He established a uniquely robust knowledge platform.
Focus plus knowledge leads to opportunity tension. Some entrepreneurial theorists have coined the term opportunity tension — that period when an entrepreneur’s focus and knowledge point to a market opportunity, but there remains unresolved risk in the process of seizing it. The entrepreneurial solution, of course, is to take the risk. Jordan executed his commitment by taking a job in the retail sector of his chosen industry — a place to meet customers one-on-one, and look backwards at the supply chain.
Customer orientation is refined by direct contact, conversation, and experience. Working in retail enabled direct customer contact and unfiltered conversations about customers’ preferences and wants, the benefits they sought compared to the benefits they experienced, and a general deepening of customer knowledge.
In addition, Jordan was able to observe the supply chain, including the interruptions and inconsistencies that detracted from customers’ experiences. Product quality was inconsistent and supply was unreliable. To an entrepreneur, this looks like opportunity.
Knowledge, experience, and customer contact provided the ingredient for a new firm and a new value proposition. Jordan sums up the firm he founded, Moxie, as knowledge + infrastructure. A status quo of incomplete knowledge, inferior and inconsistent products in unreliable supply chains can be replaced by a new market of shared and distilled knowledge delivered via consistent and trustworthy quality. Customers are able to develop trust and confidence in a brand based on knowledge (“we know what we are doing”) that brings new maturity in the form of scale and process control and quality assurance to an emerging market category.
The company’s knowledge base enables vertical integration because the knowledge is broad and not narrow, the recruitment of strong partners because shared knowledge makes for robust collaboration, and new standards of quality, adherence to which strengthens customer expectations.
The firm’s foundation supports both R&D and open innovation. All markets are changing at high rates of speed at all times. That’s why innovation is the essence of entrepreneurship. Standing still is a losing option. Jordan invests I R&D in the form of lab research (in pharmaceutical quality labs) exploring new product forms and new combinations, while also participating in the open innovation of knowledge sharing that goes on throughout the industry. R&D supports both specialization (making current offerings even better) and market expansion (new products, new forms).
Brand building will be the patient route to long term growth. While business environments change fast, one way to invest with patience in a consistent direction is to build a brand. A brand can reflect customer values — the things that matter to them — in a way that creates lasting bonds. On its website, Moxie positions its brand as a force of character: courage, grit, determination, nerve. It provides an emotional connection to customers who value self-realization and self-actualization.
Patient entrepreneurs can see the regulatory maze as a locus of opportunity, too. Moxie was the first licensed cannabis brand in California, and sees itself as a pioneer in leading institutional and regulatory progress. Instead of viewing regulators as business obstacles, Jordan employs his empathy skills to understand their position, their role, and their needs. He provides them with resources of information, industry knowledge and collaboration, and contributes where he can and where it’s appropriate to help them arrive at decisions and translate them into subsequent implementations.
As in building a company and building a brand, patience can pay off in future strength.
Additional Resources EnjoyMoxie.com
Jordan Lams on LinkedIn: Mises.org/E4B_188_LinkedIn
Business is a form of applied economics. Its purpose is to make people’s lives better. Profit is the signal from society that business is doing a good job in the customer’s estimation. This is a completely human system, a form of human action and interaction. Business schools take the approach of mainstream economics, that mathematics is the tool of choice, expressed in data analytics, accounting, financialization, and numbers-based plans and strategies. The Austrian school approach offers a very different path. Professor Per Bylund joins the Economics For Business podcast to highlight some important differences.
Key Takeaways and Actionable Insights Business logic based on understanding subjective value. The purpose of business to facilitate customer value. The pursuit of new economic value brings new firms into existence, the continuing realization of new value experiences for customers results in business growth, and recurrent refreshment of value propositions keeps businesses thriving and healthy.
Consequently, value is fundamental to business. Yet it is widely misunderstood. Sometimes it’s misconstrued as shareholder value, a function of stock price performance. Usually, it’s financialized as a set of numbers and indexes.
True value is in the mind of the customer. It’s the experience of feeling better off as result of interacting with a business — making a purchase, taking a subscription, or using a service that makes life feel better, and that feels like a superior choice compared to alternatives.
Customers decide what to value, and therefore what to purchase, and thereby decide the success of a business. All businesses must learn this value logic, and Austrian economics for business provides the understanding that points to the implications for business action.
Thinking in subjective terms. An understanding of subjective value reverses the flow of business thinking. It’s easy and conventional to think in objective terms about products and prices — what a firm produces and offers and the price the firm charges. It’s harder and somewhat counter-intuitive for businesses to think about how each individual customer feels — what’s important to them, individually and personally, about the unique ecosystem in which they make their choices (e.g., their family profile, what kind of a house they live in, or the subjective resource allocation priorities of each of the individual firm they work for).
The customer decides what is valuable to them, and that’s the basis from which business action must proceed.
Value-guided creativity. Business is a creative discipline. Because customer preferences and priorities are continuously changing, because competition is continuously aiming at making a superior customer proposition, because technology is continuously making new benefits and new customer experiences possible, and because we can’t possibly know how all this will work out in the future, businesses must always be changing, improving, adding, renewing, becoming somehow better in the future than they are today.
The only way to invent the future in this way is through creativity — new ideas, new combinations, new routes to convenience, new removal of barriers. Creativity can be random and unpredictable — we don’t know what is going to be successful out of all our creative ideas. Therefore, we apply constraints so that creativity operates within productive boundaries, and the generative constraint is customer value. If all our creative ideas are guided by the constraint of “will the customer find this more valuable”, then the opportunity for productive innovation is greater. If we place ourselves in the shoes of customers, and try to simulate what they will feel when they experience a new value proposition, we’re on the track to business success. This is value-guided creativity.
Business as a flow. Business schools emphasize planning and strategy (and strategies are often just long-term, bigger plans). These are tools of prediction and control — predict the future (we will achieve $10 million in annual revenue this year) and control how we get there (100 salespeople must sell $100,000 each). The numbers can fill a spreadsheet.
Similarly with organization design: the spreadsheet in this case is an org chart, with layers and reporting pathways and divisions and units, another exercise in statics.
The Austrian recognition of constant change results in re-thinking business as a flow. Thinking in statics is potentially disastrous because the world can change while your firm does not. Thinking dynamically opens the firm to feedback loops from the marketplace, listening to customers and monitoring when their preferences change or competition shifts, and being open to adapting and adjusting.
Organization design gives way to orchestration, the constantly changing arrangements dedicated to the improvement of the customer’s value experience.
Every business can and must act entrepreneurially. Our term for the orientation towards and capacity for constant change — constant pursuit of new customer value — is entrepreneurship.
In the popular vernacular, the word entrepreneurship has come to be associated with charismatic individuals, like Elon Musk or Jeff Bezos or Reed Hastings. They are identified as the instigators of and catalysts for new value generation. That’s fine — such individuals are important in challenging the status quo. But for effective and commercial and sustainable new value generation, the entire firm must be entrepreneurial — highly sensitive to how a particular configuration of resources and a particular business model and value proposition serves customers, and to changes in the business environment that require adjustment on the firm’s part. The firm must be flexible enough to make these adjustments. Often, the market data comes to the firm from the edge, where front line employees working directly with customers gather the inbound information about change. The entrepreneurial firm ensures that the new information flows freely and is acted upon, and gives those closest to the customer the authority to make responsive changes.
Business schools often teach static and defensive concepts such as economies of scale and competitively insulated market structures. Business for them is production management. Business from the Austrian school perspective is value discovery, value facilitation and responsive change in the form of new products, new services, and new value.
Entrepreneurial empathy as a tool. When we think of business tools highlighted in business schools, we might think of strategic planning, data analytics, accounting, process management, incentive compensation, and financialization.
The tool of choice for the entrepreneurial firm is empathy. Empathy is customer-first thinking. It focuses on identifying and understanding what customers feel is missing in their life, what they long for and wish for. There’s a gap between customers’ actual experiences and their desired experiences. They can’t articulate solutions, but they’re brilliant at identifying the potential for improvement. If the customer feels that some experiences could be better, or that they’re struggling in some capacity with an experience, that’s a signal for the creative entrepreneurial firm to experiment with new ways to deliver that betterment.
Entrepreneurial firms create better futures for their customers via empathy. They bring customers new things that they can want, that weren’t available to them in the past or of which they were not aware.
It’s not all numbers. Just as mainstream economics has been rendered irrelevant and meaningless to real people because of its insistence on the use of algebra and mathematical models instead of real world observations, so mainstream business schools have made business into a world of spreadsheets, accounting, data analysis, bar charts and graphs, and structures and formulas.
Austrian school business thinkers understand the role of qualitative assessment — understanding people as humans as opposed to statistics, understanding emergent processes, understanding feelings and subjective value, and that the things that matter to people, both employees and customers, are values not numbers.
That’s why narrative and sense-making stories are taking the place of plans and strategies. Software development provides a good example: user experience design is a narrative about how customers prefer to interact with the software they are using, rather than a focus on lines of code.
Action and feedback loops. The ultimate replacement for business school concepts of planning and strategy is action. Entrepreneurship is action. Action generates an effect — a feedback loop from the marketplace that signals the result of the action. The customer purchased or did not purchase. The rating improved or worsened. Revenue grew or declined. In the A/B test, B was preferred.
The feedback loop is processed as learning, and new decisions can be made and new actions taken based on that learning, eliminating some possibilities, and opening up others. Innovation is introduced to the market and new learning follows new innovation in a continuous loop.
In the thinking of entrepreneurial action, acting faster and sooner is better, because the effect is generated faster, the feedback loop accelerates, and the resulting new action is fresher and and more responsive to the customer’s needs. When action is bolder and more daring, the feedback loop is more informative and clearer in its signals. The future unfolds as a result of entrepreneurial action.
Entrepreneurs don’t act alone or in isolation. The unfolding of the future is the consequence of many actions on the part of many people and firms. The market, therefore, is a process. Action and reaction keep it moving in unpredictable ways — resulting in what complexity theorists call emergence.
The Austrian School is a complete system for business. We didn’t have sufficient time with Professor Bylund in the podcast format to cover the complete range of business functions, including marketing and accounting and business model design, but these are all improved and enhanced by what we can call the Austrian approach. The goal of Economics For Business is to deliver this complete system in the form of tools, posts, articles, papers, books, videos, and podcasts like this one.
Additional Resources Austrian School Versus Business School: A side-by-side comparison (PDF): Mises.org/E4B_187_PDF
How To Think About The Economy: A Primer by Per Bylund: Mises.org/Primer
How do new markets form? When consumers change their tastes and preferences and behaviors, how are the markets to serve them activated? The markets don’t yet exist — entrepreneurial action is required to create them. The answer to the question, of course, is that entrepreneurs — real people taking the real business risk to initiate new business experiments — provide the new energy and new initiative to create markets where previously they didn’t exist.
Jared Wall is one of these creative entrepreneurs, and thchempspot.com is his creation.
Key Takeaways and Actionable Insights. Courageous entrepreneurs lead the way into new markets as they are still forming. Entrepreneurs bring the energy that opens new markets and new pathways to economic value. New markets can emerge as the result of changing consumer tastes and preferences, new channels or platforms, new forms of delivery, new technologies or a combination of several catalysts — but the energy, initiative and drive of the entrepreneur is always the necessary ingredient for the ultimate emergence of new value and new market arrangements.
New discoveries and new innovations often provide the entrepreneur with market-opening mechanisms. Serving customers in new and different ways doesn’t always require new products and services, but it is often the case that the discovery or invention of novel combinations can lead to innovation — that is, new and better experiences for customers that were previously unknown or unavailable or narrowly distributed. In the market for consumable cannabis products, there emerged a new THC variant called Delta 8 THC, a cannabinoid that offered both different product performance and different accessibility. The emergent new ingredient provided the pathway to a whole new market opportunity.
Legislation and regulation are complications and barriers in formative markets, but often their ambiguity provides an opening for innovative entry. The courageous entrepreneurs who lead the way into formative markets often encounter legislative and regulatory barriers, since these are static drags on progress and innovation and never keep up with the changes in markets. At the same time, the regulatory thicket can sometimes be useful to the entrepreneur who can cut a new opening others can’t imagine.
In the market for consumable cannabis products, Delta 8 THC became such a new opening, which was cut when some content in a comprehensive congressional Farm Bill encouraged the commercialization of certain kinds of hemp, of which Delta 8 THC was one of the by-products. Legislators and policy authors can’t think about the future the way entrepreneurs can, and they did not envision the future world of innovation they were unlocking.
The regulatory maze is an aspect of legislation and regulation — but every maze has an exit path.
Innovation in formative markets combines and compounds. Jared Wall launched thchempspot.com to offer Delta 8 THC experiences to consumers. Those who shop at the site find a lot more innovation than just this ingredient. There are multiple new consumable forms for varied experience delivery — gummies, chocolate bars, chewing gum, soft gels, and peanut brittle, among others.
Where do these innovations come from? Not from the R&D labs of major corporations, that’s for certain. They originate in the creative minds of imaginative entrepreneurs, and they take shape in their experiments and prototypes and willingness to try new things. Will they all be big successes? Of course not. But they will all generate feedback loops of acceptance or non-acceptance, reviews and ratings and experience sharing; they’ll contribute to innovation as an ongoing cycle of learning. Society enjoys better choices because entrepreneurs unleash their creativity and don’t hold back from experimental designs.
Market infrastructure and market institutions can’t always keep up with entrepreneurial change, but new supportive services quickly appear to lubricate frictions and provide institutional arbitrage. All commerce needs infrastructure such as payment systems and institutions such as banks, and market formation can sometimes move faster than infrastructure and institutions can adapt. Jared Wall had this experience — PayPal and major banks cut off services because thchempsot.com, while serving legitimate customers with legal products, was deemed a “high risk” business, outside their terms and conditions.
Yet, in a quite inspirational way, business services emerge in these situations to navigate around the barriers of poorly adapted institutions. Jared found consultants who offer the service of connecting so-called “high risk” businesses with value-network partners willing to collaborate with them. Jared was quickly able to replace his payment system and banking infrastructure. There was a service interruption, but it was temporary. A new network of mediating services quickly formed to bypass institutional barriers.
The creation and sharing of new information is a big part of the innovation equation. Jesus Huerta De SotoJesus Huerta De Soto; Socialism, Economic Calculation, and Entrepreneurship; 2010; Chapter 2, "Entrepreneurship". identifies the creation and sharing of new information as the central activity of entrepreneurs - informing customers of new products and services and new offerings and prices. Entrepreneurs are constantly creating, updating, and improving the information resources they make available to customers. High quality information enhances value.
On thchempspot.com, Jared provides information in Q&A form, pull-down menus, and product descriptions. He’s self-published an informative e-book that’s free on the site, and he publishes an informative newsletter. We can sometimes feel unclear about the value of information, but in formative markets its importance is primary not secondary.
Every business should have an exit plan in mind from Day 1. Why? Because it’s impossible to control the timing of an exit or the changes in circumstances that might precipitate it. Venture capitalists know this, and build in their exit formulas at the time of their initial funding. Entrepreneurs should think the same way. And, like any business process, selling a business is a knowledge-based process that repays an investment in learning its techniques and critical success factors. Economics For Business talked to Jessica Fialkovich, a successful business builder in her own right, who founded Exit Factor, an advisory firm that helps entrepreneurs get the most from selling their businesses.
Key Takeaways and Actionable Insights Entrepreneurship provides better career control and security than corporate life. Jessica climbed the corporate ladder, investing effort and skill into being a great employee. But she was just a name on a list when the GFC came along - a list of those to be let go when Lehman Brothers (her employer’s funder) collapsed.
She realized that entrepreneurship provided her with great security. There’s uncertainty, but the entrepreneur decides what their future is, takes responsibility for those decisions, and accepts the accountability.
She built a successful business through hard work and the discovery process of identifying target customers and finding new and better ways to bring them value. Her chosen business was in wine sales to wine-loving customers, many of whom were connoisseurs. She developed many specialized services including finding rare wines for collectors, and her clientele spanned the globe. She incorporated the latest technologies and innovated in marketing techniques. She worked long hours, talking to customers across 16 time zones from Japan to California.
Then she decided to sell.
Entrepreneurs experience a lot less support when selling a business than when building it. When you’re successfully growing a business, everyone wants to help, providing you with business services and supplies, and advice and ideas. What Jessica found when she came to sell was that she was on her own. It was hard to find expert help, or the requisite resources, or pretty much any kind of support infrastructure for a transaction of the size she was planning. For big business, there’s investment banking. For the 99.9% of businesses outside the Fortune 500, there was nothing similar. There were some so-called business brokers, but they were not dedicated specialists, not professionals in the specific process of selling, unreliable and poor at client service.
As an alert entrepreneur, Jessica understood that this finding signaled a market need. The first step to design for an under-served market is to draw on relevant experience from parallel markets.
Business development always starts with first principles: is there a market to be served, in that some potential customers feel an unmet need or have a meaningful problem to be solved? Jessica had first-hand knowledge of the problem, and talking to entrepreneurs in similar situations reinforced her confidence in the market’s potential.
The comparison market Jessica chose was investment banking, which can be thought of as selling businesses of a larger scale. There’s an established investment banking process and a timeline of steps and milestones from preparing an evaluation, to developing the pitch deck, to the identification of the best buyers and the tailoring of a marketing plan for them. Jessica’s husband had some relevant investment banking experience which enhanced the knowledge transfer from one field to another, and provided a reality check for the process design.
Business-to-business services development and execution has its own set of rules; the most important one is the nurturing of relationships. A business brokerage is a high-intensity B2B service bundle requiring a lot of in-person customized relationship management. There’s pitching the potential customers in the first place, customizing the service tom their particular business and to meet their specific needs, with a big need for staff training to deliver these specialized services. B2B service providers must be both sales experts and process experts. That requires a lot of human capital.
Jessica’s answer was to design and build a system-based model that, once in place, could be repeated and reproduced via well-trained staff with the right IT support.
She has found B2B services to be even more demanding than sourcing rare wines for connoisseurs. Selling a business is somehow more personal and individual. A client’s perception of what their business is worth may be quite different than the market’s perception. It’s the nurturing of relationships that smooths out the potential jagged edges in these transactions.
Some insights for entrepreneurs selling their business. Identify your exit options from Day 1 of your business. Since it’s impossible to control exit timing - which may be due to unforeseen changes in circumstances - it’s best to lay the runway from the start. Plan to run a salable business, as well as one that’s profitable and growing. Don’t have a fire sale or panic sale or be unprepared.Tailoring your selling process to the size and type of your business is important. There are different influences on what moves valuations up or down depending on business size, but, in all cases, it’s a process with a beginning, a middle and an end to be planned for in advance. You’ve got to know how to find buyers, how to source offers, and how to keep your business in good shape for due diligence.Conduct regular health checks for evaluation. Always know what your business is worth. Find out how businesses are valued in your industry or sector. Make sure your business shows well on the criteria that are applied in your field.EBITDA multiples are the dominant valuation metric. You may read in the Wall Street Journal about businesses being acquired for brand value, or for technology integration, or for other reasons of corporate M&A strategy. For small and medium size businesses, EBITDA multiples remain the dominant metric. There’s some art regarding what the precise multiple may turn out to be, but it’d within a range and is not going to vary wildly.There is some room for qualitative factors and subjective valuation. Jessica listed subjective factors ranging from the degree of business involvement of the owner (and the worry that their future absence might be detrimental) to the perceived quality of the brand and its imagery and reputation.The ultimate asset is a proven and scalable business model. If you can demonstrate that your business model returns increases in revenue and profit growth for additional investments in capital or people or marketing, then you are most likely to find an eager buyer. Make sure you can model your business in this way and that the data are clean and credible. Additional Resources Getting The Most For Selling Your Business by Jessica Fialkovich: Mises.org/E4B_185_Book
ExitFactor.com
Jessica on LinkedIn: Mises.org/E4B_185_LinkedIn
Do the principles of customer value generation that we espouse in our Economics For Business program apply equally for both B2C and B2B businesses? The answer is emphatically yes. B2B customers are seeking subjective value and a value experience just as B2C customers are. They have a clear sense of the things that matter to them, and those include emotional and personal values as well as price and functionality and performance.
In fact, trends that begin in the B2C domain often quickly begin to influence the B2B domain, and the alert entrepreneur can track those trends in B2C and establish an early advantage by exploring them for their business customers. Rick West has done exactly that with his business services company, Field Agent.
Key Takeaways and Actionable Insights In addition to identifying a meaningful problem, and providing an effective innovative solution, entrepreneurs in today’s B2B market must offer the right service delivery platform. Rick West created a company called Field Agent to provide B2B customers with a meaningful service: monitoring their retail stores and shopper behavior and collecting in-store data about the interactions of shoppers, stores, shelves, displays and products. This kind of information is high value for both the retail operators (like Walmart) and the companies that sell products through retail stores (such as Procter and Gamble or The Coca-Cola Company). The set of services often goes by the terminology of “shopper marketing”.
Typically, such business service offerings have a long and cumbersome sales cycle. The service provider and the service client get in contact, there are meetings, prices are negotiated, and contracts are prepared and signed. Then, once the service is executed, there are more steps in analytics and preparation of presentations of findings, and another big meeting to discuss the findings and recommendations. Lots of meetings, lots of travel, lots of time, lots of lawyers.
Is this the right service delivery platform? It’s been virtually institutionalized over time. But it’s not a good fit with modern business models and the modern technology-shaped environment.
The Amazon effect. Think about purchasing on a shopping platform like amazon.com. The customer first self-educates. If there’s a complex product to buy – such as an expensive flat screen HDTV with internet connectivity and interaction with all the latest entertainment ecosystem devices like Roku and streaming services like Apple TV – the customer might search for information via google, might visit some ratings sites, do some comparison shopping, and generally collect information to get to the point where they are confident of making a purchase. They don’t need to speak to an HDTV salesperson or a “customer success manager” or to sign a paper contract.
Or think of a slightly more complex transaction such as buying a car on Vroom. There are some contracts to be signed via DocuSign, but confident shoppers are comfortable with self-educating, making their decision, committing, and experiencing the delivery of the car to their home, perhaps with the added service of taking away their old one.
This is the world of services and service delivery we live in today. Your B2B customer also has a life as a consumer and an internet shopper, and is fully aware of the efficiency, convenience, and safety of these kinds of transactions. Call it the amazon effect: customers becoming comfortable with the “click-to-cart” experience, without interpersonal interaction with a salesperson or other service personnel.
Why not in B2B services?
Click-to-cart has arrived in B2B services. Rick West’s customers for Field Agent services can purchase them on plumshop.com. A full array of shopper marketing services is offered via pull-down menus in categories such as Audits, Marketing, and Insights. Under these headings are Display Photography, Price Check, Shelf Management, Price Sensitivity Study, and dozens more, all in the language of shopper marketing that’s well understood by the knowledgeable B2B service buyer.
Clicking on any one of these takes the client to a price list and a detailed description of the service and its output, all in the colorful and engaging presentation style of an e-commerce site (like amazon.com!) The client can create an account online and make a transaction just as easily as buying a TV on amazon (and probably easier than buying a car on Vroom).
Self-educated buyers know exactly what they want, and the description and designation of the services are crisp and clear. Clients can check out testimonials, comparison shop, and take all the steps any smart B2B service purchaser would take to get themselves to the point of confidence and trust.
Some customized services will always be a client requirement, but there will be a rapid shift to more and more self-service. Some clients and some projects will always require a custom, tailored response, and Rick’s company has both custom service and automated service capabilities. One point he makes is that a first project might be customized and accompanied by in-person client service, while for the second or repeat purchase, the client will be comfortable with the click-to-cart process.
Rick’s guessing a 70:30 split for automated versus customer services over time in his field, especially as the interface software learns and becomes better and better at responding to client needs and preferences.
B2B entrepreneurs are trend-spotters in the B2C domain. People are people. Economic behaviors that we can observe in consumer shopping and buying are bound eventually to show up in business-to-business markets. They’re the same people – your B2B client is a consumer when not at work. Smart B2B entrepreneurs keep an eye open for B2C trends that can be expected to transfer to B2B and jump on them early.
Additional Resources Field Agent: FieldAgent.net
Plum: PlumShop.com/fa/shop
Rick West on LinkedIn: Mises.org/E4B_184_LinkedIn
How do companies make decisions? Data certainly don’t make decisions, nor do analytics, nor do the computers they run on. Human begins make decisions — the human factor is crucial. Subjectivism is paramount, even in the age of big data and A.I. The key still lies with the people who are interacting with the data to generate human insights.
Ahmed Elsamadisi is one of the leading data scientists in the world. He’s worked on self-driving cars and nuclear defense and some of the biggest business challenges on earth. He believes that it is the stories we tell from data that drive business success. We are privileged to interview him at Economics For Business podcast, and he gave us a lot of useful advice we can all use every day in managing our businesses.
Key Takeaways and Actionable Insights The data community has made data and algorithmic analysis far too complex, to the point where it’s no longer useful for business. The path-dependent route to today’s complex data tables was paved with lots and lots of columns and lots and lots of rows. These data tables are leftovers from the early days of computing SQL language was designed to manipulate these rows and columns. A.I. comes along and can analyze all the possible combinations of data cells. Business executives ask their data departments to generate a lot of these combinations to search for patterns. It often takes a long time, a lot of revisions, and generates no clear answers.
Another aspect of history is the use of dashboards. We tend to design dashboards rather than formulate good business questions. The metrics on dashboards are sometimes useful for operations but they’re often not at all useful for understanding the causal connections between data points. Consequently, different people can interpret them in different ways and there is no consensus as to what they mean and what to do about it.
The purpose of data analytics is to generate good decisions that lead to action. The entrepreneurial method drives towards D and A: decisions and actions. Analytics should help to formulate the hypotheses on which to base decisions. The problem with complex dashboards and algorithmic pattern recognition is that they often don’t give clear direction on recommended action, especially when the interpretation varies depending on who is doing the interpreting.
Ahmed’s experience is that sharing a numerical dashboard with 10 executives is very likely to result in 10 different interpretations, and the resultant confusion and disagreement freezes action rather than accelerating it.
We need data to tell us stories that we can all rally around. The most powerful tool for developing consensus around action is narrative — often called storytelling. While 10 dashboard interpretations might lead to 10 different action plans, a single well-told story can align everyone who hears it, understands it, and internalizes it. We heard about the power of narrative in episode #181 (Mises.org/E4B_181) in which Brian Rivera explained the role of storytelling and sensemaking in The Flow System of management, and in episode #152 (Mises.org/E4B_152) where Derek and Laura Cabrera explained the power of aligned mental models for driving business. Stories achieve alignment.
Ahmed Elsamadisi built his service, narrator.ai, to output data analytics in the form of a story. The complexity riddle is removed and replaced with a narrative that all executives, not just data scientists, can understand. Narrator.ai re-integrates data science with the all-important human element of understanding stories.
The way to get data to tell stories is with a conversation. Ahmed says that the way we ask questions (data queries) is flawed. It’s quite a normal practice to set the A.I. to search the data tables to look for patterns to see if anything interesting emerges. This is what Ahmed calls “lazy hypothesis generation”, which is never going to yield useful actionable insights (yet many big analytics companies are taking in huge customer revenues for just this service). Clients may claim to be making data-driven decisions but that’s mis-characterizing this business behavior, typical though it may be.
Ahmed advises us to think more in terms of a conversation with data. To facilitate this, he has developed a universal data model with just three variables: an entity (such as a customer), an action, and time. Every business question is about a customer taking some action in some time period. The universal data model enables the conversation: what action did the customer take in what period of time, e.g., when did they open the email and what action did they take after opening it. This is not a database query, it’s a more thoughtful question about the customer experience and how to understand it.
Ahmed told us that training customers in this conversational mode of interaction with the universal data model results in a cultural shift in thinking. The conversation can go back and forth in several iterations until the understanding is fully honed. Clients hear the data talking to them through the stories that narrator.ai generates. The have deeper insights and a story to share to form a consensus around the action that the story suggests. Narrator.ai clients have used stories for everything from describing new product specs to updating board decks.
Great conversations with data are based on empathy and thinking about the customer experience. At Economics For Business, we elevate customer empathy a the most important business skill, in the context of an understanding of customer value as subjective, a good feeling from an enjoyable or satisfying experience.
Ahmed advises us to think in this same way when formulating conversations with data to generate insights. If we think about the customer’s experience, desired and actual, and the actions they take before and after that experience, and the time context of the experience, we’ll do well in formulating good questions. The action component of the universal data model is central to the Austrian deductive method: knowing what people do can help us deduce motivation and expectation. Knowing what they did next can shed light on the ends they had in mind. Actions like opening e-mails or repeat buying are also revealing of intent and expectations. The more we converse with the data, the more insight we can gain.
Storytelling with data is another implementation of subjective quantification — with the benefit of enhanced intuition over time. In episode #176 (Mises.org/E4B_176), Peter Lewin introduced us to the Austrian concept of subjective quantification — turning customers subjective valuations into numbers such as capital value on a balance sheet. We tested the subjective quantification term with Ahmed, and he endorsed it — with a major addition. It’s important to include the dimension of time. If, over time, we have better and better conversations with data and formulate better questions and hypotheses, we’ll get better and better at generating insights. Our intuition will improve. We’ll get a better “feel” for the data. Even our empathy can become more accurate.
Additional Resources Narrator.ai and its excellent blog, Narrator.ai/Blog
"Top Ten Signs You Have A Data Modeling Problem": Mises.org/E4B_183_Blog
Ahmed Elsamadisi on LinkedIn: Mises.org/E4B_183_LinkedIn
It’s often the case that lead users — the most sophisticated, committed, and energetic users — are an excellent source of innovation ideas. Those customers who are most engaged are thinking the most intensely and the most creatively about what they want from the usage experience. We came across a particularly instructive example: video game modders. Who are modders, what do they do, and what can we learn from them? Professor Gordon Miller has studied this important entrepreneurial phenomenon, and he joins Economics for Business to share his knowledge.
Key Takeaways and Actionable Insights. Modding is user-generated value innovation. Modding, from modifying, is the act of a changing a game, usually through computer programming, with software tools that are not part of the game. This can mean fixing bugs, modifying content to improve it, or adding content. But modding is not an activity taken on by those at game companies—developers release patches and downloadable content, not mods. Modding is instead done by players and fans of the game… Modding is more than adjusting the preferences or game settings, it is making changes that cannot be made through the game as it is.
Game producers and designers enable and encourage this user innovation. Game producers have come to recognize that the creative ideas and initiatives of the modding community can contribute new value to their businesses and franchises. Games like Minecraft enable users to explore, within a predesigned GUI, a practically endless 3-dimensional world to build innovative structures and other things like functional computers and console emulators. Minecraft also makes available code and tools for modders to create mods that are essentially new games, or major innovations within the original game. The famous DOTA (“Defense Of The Agents”) game is entirely the product of the modding community, encouraged and enabled by the developer, Valve Software.
Modding is a practical application of the theory of absorptive capacity. Absorptive capacity refers to the capability of a firm to recognize, collect, assimilate, process, transform and use external knowledge for competitive advantage in innovation, flexibility, and overall business performance. The external sources of knowledge are knowledge networks, either formal or informal or a combination of both. Formal networks might include suppliers and partners, university research departments and labs, and even industry share groups. It’s sometimes called open innovation — actively looking at and tapping into what other firms are doing.
Informal networks are those like the modder community — lead users, user groups, tinkerers, and so on. This is sometimes referred to as distributed innovation or user innovation — it’s not the producer originating the innovation, but an external informal source.
The challenge is to be able to generate awareness of these sources of knowledge, evaluate them, bring them inside to the company for evaluation and processing, and turn them into useful innovations or internal changes.
In highly dynamic industries, it is productive to tap into these knowledge networks. Professor Miller refers to the external networks of knowledge, both formal and informal, as the wisdom of the crowd. If you are operating in an environment characterized by high dynamism and rapid change, the wisdom the of crowd is an important and often decisive resource.
The wisdom of the crowd can contribute to innovation and business performance, especially in the form of idea diversity.Innovation performance improves through better firm capitalization of knowledge resources.The wisdom of the crowd offsets firm rigidity — making it more receptive to new ideas,Entrepreneurial judgment can increase innovation performance by increasing absorptive capacity.Innovation performance feeds back into absorptive capacity, creating an iterative self-improvement loop. Professor Miller proposes three areas of business development by capitalizing on external user groups. First, firms struggling to innovate due to internal rigidities may well benefit from developing communities — similar in concept to modding communities - connected to their own industries. By absorbing and incorporating the learning that occurs in such groups, they can take advantage of readily available innovative ideas for change.
Second, these communities may also provide a wellspring of talent for enhancing the firm’s absorptive capacity in useful ways. This is a pool of unique and entrepreneurial individuals with the potential to enhance the firm’s human capital and make the firm more explorative.
Third, even if the firm does not fully tap in to all the knowledge coming from the community, there is still the potential for new solutions to emerge that are stimulated by external ideas. There are always hobbyists and fans, and technology easily facilitates their interactions. Crowdsourced knowledge provides a uniquely useful tool for enhancing organizational innovation.
The wisdom of the crowd is a path to profit. Modding as an art form allows players to express what they most want games to be. This becomes a useful indicator for determining the most profitable paths to pursue. Firms seeking to enhance their innovative capabilities and remain profitable must pay attention to external sources of learning, however informal.
Additional Resources Download our free E4B PDF: "Assessing Your Firm’s Absorptive Capacity": Mises.org/E4B_182_PDF
The Invisible Hand In Virtual Worlds: The Economic Order of Video Games by Matthew McCaffrey: Mises.org/E4B_182_Book
The traditional approaches to the structure and management of firms are becoming barriers to customer value. The Austrian capital theory approach recognizes that all value in the corporation flows to it from the value experiences of customers. Therefore traditional organization design — centralization, hierarchies, divisions, bureaucracy, command-and-control — insofar as they are poorly aligned with customer value actually detract from the value of the firm.
There are alternative approaches to business organization, several of which we have highlighted in Economics For Business. One well-articulated alternative is The Flow System (Mises.org/E4B_181_Book). We talk to one of the authors of the concept, Brian Rivera.
Key Takeaways and Actionable Insights The first principle of all business organization is the delivery of customer value. The superiority and broad applicability of the Austrian business model emanates from its value-dominant logic. The purpose of business is to facilitate a value experience on the part of the customer. Only value matters, and all else (resources employed, raw materials used, production costs, organization, supplier partnerships, etc.) follows. Austrian capital theory enables managers to identify value drivers (i.e. what resources, raw materials, production costs, organization, partnerships result in the most value for customers).
The focus of the Flow System is to deliver the best value to the customer through FLOW: the interconnection of complexity thinking, distributed leadership, and team science.
Flow is another term for entrepreneurial judgment. In Brian Rivera’s book, The Flow System, flow is described as “a narrative of in-the-moment decision making of judgments”. It is entrepreneurial action and interaction with the environment, irrespective of structure. It’s goal-oriented adaptive and collaborative behavior of teams and firms.
The Austrian perceptions of the market as a flow, value as a flow and capital as a flow mean that the Austrian business model is perfectly consistent with The Flow System.
Mastering complexity thinking is fundamental to implementing the flow system. Many business environments exhibit high variability and uncertainty. We’ve used the term VUCA to characterize them: volatile, uncertain, complex and ambiguous. All business managers and entrepreneurs can benefit from adopting a complexity world-view, and understanding business as a complex system.
Complex adaptive systems are open, continuously dynamic, evolving, learning, and responsive to external changes. They can oscillate between order and disorder, they’re non-linear and can’t be predicted or controlled.
Brian Rivera highlights a number of techniques to manage in such an environment, including:
Sensemaking: the development of narratives or storytelling to conceptualize the complex environment and develop an appropriate set of mental models. The question to ask is, “What’s the story?” — the story that can unite the firm and its partners around a shared understanding and shared purpose.
Weak signal detection: in complexity, signals are never clear; uncertainty is the norm and errors are always a possibility. Weak signal detection is simply intensifying the scnning of the environment for insights and noticing more, so that both threats and opportunities can be detected earlier to avoid surprise.
Action: the only source of real knowledge about the world is experience, and experience results from action. Therefore, The Flow System emphasizes action — the D and the A in the OODA loop.
The Flow System employs a new definition of leadership: distributed leadership. Distributed leadership is described as leadership that extends horizontally, vertically and every place between. The tools of leadership are not structures (such as hierarchy and top-down management) but methods:
Psychological safetyActive listeningIntentShared mental modelsBias towards actionCollaborationMentoring. Perhaps the most essential factor is psychological safety among team members. It’s a group property — a shared belief in which the team is safe from interpersonal risk taking. Individuals can speak up, take risks, and experiment without fear of criticism or reprisal so long as every action fits within the shared belief framework. There is no command structure, and teams are the building blocks of the organization.
There’s a new field of team science for collaborative functioning in the workplace. Team science is multi-disciplinary. Teams are necessary for the development of solutions in many problem areas, and the research behind team science has been conducted in many fields (ecology, healthcare, organizational science, psychology and more).
A team is a collection of individuals with a shared goal, who interact and are interdependent in their tasks, who have different roles while sharing responsibility for outcomes, and constitute a social entity embedded in a larger system (a business unit or corporation) requiring them to manage relationships across organizational boundaries.
A major section of the book The Flow System is devoted to an overview of the current state of team science as it relates to business organizations, covering team size and composition, teamwork, team processes and team transitions, team culture, team effectiveness, and combining teams for multi-team scaling.
Here’s a sample concerning the functions of shared leadership in a team:
Compelling team purpose — exceeding individual goals.Members work jointly to integrate their complementary talent and skills.Outcomes are collective, joint efforts.Members adapt their working approach to each other.Mutual accountability plus individual accountability. Core principles and attributes of The Flow System. Customer firstValue is a flowComplexity thinking, distributed leadership and team science can facilitate the flow when they are interconnected and synchronized. Additional Resources E4B Knowledge Graphic — "The Flow System Guide" (PDF): Mises.org/E4B_181_PDF
theflowsystem.com
flowguides.org
The Flow System by by John Turner, Nigel Thurlow, and Brian Rivera: Mises.org/E4B_181_Book
Teams That Work: The Seven Drivers Of Tea Effectiveness by Scott Tannenbaum and Eduardo Salas: Mises.org/E4B_181_Book2
Entrepreneurship today is a movement, a welling-up of new economic creativity, combined with a great desire for economic freedom and the joys of self-reliance and discovery. The movement is newly empowered by enabling institutions that simply weren’t around a few years ago, including the internet and its digital economic platforms. Professor Raushan Gross is a great observer and great documenter of this entrepreneurial surge, and he joins the Economics For Business podcast to share some of his original and distinctive observations about the very human aspects of his new entrepreneurial studies.
Key Takeaways and Actionable Insights Let’s not over-theorize and over-professionalize entrepreneurship: it’s people finding new ways to thrive by creatively serving other people. There’s an explosion of university entrepreneurship programs, entrepreneurship research and entrepreneurship methodologies. There’s an attempt to professionalize entrepreneurship, to make it a product of business schools.
Raushan Gross sees things differently, through a humanist, subjective and ethical lens. He looks at the culture of entrepreneurship, the social movement of individuals making their way in life in a new manner, seeing new opportunities to make their lives better for themselves and their families by making life better for others.
There’s a newly emerging set of institutions and a new class of entrepreneur: the digitalpreneur. Economists take an interest in how institutions shape behavior and economic activity. They see institutions as constraints. They sometimes call them “the rules of the game”. Professor Gross has a different take. The new institutions of entrepreneurship — the internet, digital platforms, e-commerce, digitization in general — are not constraining; rather, they are openings to a new space with new possibilities. This digital space is welcoming. There’s abundant knowledge to be shared. There are new ways to think about access to resources, about production and marketing and organization. There’s a new world of price signals, much more flexible and fast-changing, and the route to cash flow and profit is faster.
Professor Gross identifies digitalpreneurs as a new economic class: not higher or lower, not defined by their origins or background, free to move at any speed and to access any place in their relentless, unbounded pursuit of entrepreneurship.
Today’s entrepreneurs are rewriting economic history: from the invisible hand to the visible hand to the digital hand. Adam Smith introduced the metaphor of the invisible hand — the concept that individual economic actors and firms entrepreneurially pursuing their own profit goals generate the economic system we call free market capitalism, with benefits for all of society. Friedrich Hayek expressed a similar idea as “spontaneous order”. The invisible hand guided the rapid growth in real standards of living of the industrial revolution.
Then the visible hand imposed itself: the concepts of management control, and of planning and centralization. Creativity, innovation, and rapid growth were suppressed, while bureaucracies expanded. We got “Bullshit Jobs”, in David Graeber’s locution, from which creativity and caring were expunged.
Professor Gross takes us beyond both the invisible hand and the visible hand to the digital hand, which gently guides digitalpreneurs to participate in or even create new markets. The digital hand is generative. It enables digitalpreneurs to operate their own digital platforms, to construct their own digital economy, to assemble their own economic knowledge and to find their own unique place in the knowledge economy. The digital hand opens up new pathways to economic freedom.
Digital entrepreneurship can be conducted at any scale, but watch out for the dead hand. Where are the corporations in their embrace of digitalpreneurs? Certainly, there are the new digital corporations like Amazon and Google who seem willing to hire members of the new class and turn them loose in creative experimentation. But what about the old economy corporations who need to make the transition to the new world? Are they hiring entrepreneurs? Are they enabling entrepreneurs, freeing them from bureaucracy and from the command-and-control hierarchy? The evidence so far is that they are not.
How to integrate the entrepreneurial orientation into a corporate organization remains an unsolved mystery. How can the corporate advantages of reach and scale be leveraged to further realize the senses of purpose and meaning that drive entrepreneurship? How can corporations shift to the entrepreneurial culture?
They need to find ways to eliminate what Professor Gross calls the Dead Hand — bureaucracy, regulation, control, risk-aversion, centralization, procedures, and rules.
But corporate culture is not the only barrier to the realization of the entrepreneurial society. There are other cultural barriers to overcome. Professor Deirdre McCloskey is famous for her analysis that the catalyst for what she calls The Great Enrichment — the 3000% increase in real standards of living in certain Western countries from 1800 to the present — was a change in how we talked about entrepreneurship. The perceptions and descriptions of the bourgeois life of commerce transitioned from scorn to admiration. Entrepreneurs came to be seen as bold and innovative, a force for good, providers of desirable services enhancing the quality of life.
Professor Gross sees a fresh need for such a change in language and cultural support for the new age of digital entrepreneurship. One example he gives is the language of venture failure. Initiatives that are concluded early or don’t hit some target or don’t attract sufficient buyers or don’t generate enough profit to be sustainable are deemed “failures”. This characterization tends to lead to erroneous conclusions about risk (as in risk of failure) and about the people who engaged in the initiatives (“failures” or, worse, “losers”).
There’s a much different and better way to frame the same data as learning, and augmenting the pool of knowledge. When we think of entrepreneurship as a flow, we can visualize how information flows from the past to the present, elevating the intelligence of every entrepreneur and every firm that’s operating today. Not only does knowledge flow, it compounds, so today’s entrepreneurs can be exponentially more informed than their predecessors.
The more we adopt this win-win cultural approach to cumulative entrepreneurial knowledge-building, as opposed to the win-lose language of failure and success, the closer we’ll come to the beneficent entrepreneurial society that Adam Smith imagined, before he was so rudely interrupted.
Additional Resources Join Economics for Business today and receive a free copy of The Emerging Institutions of Entrepreneurship eBook by Raushan Gross: Mises.org/E4B_Join
Entrepreneurship is a general feature of the market economy.
Download the slides from this lecture at Mises.org/MU22_PPT_07.
Recorded at the Mises Institute in Auburn, Alabama, on 25 July 2022.
There is an excellent, deeply researched, Austrian economics-founded theory of customer value: the value learning cycle, which we explored thoroughly in Episode #178 (Mises.org/E4B_178). How do entrepreneurs and executives apply that theory to create customers, delight them, and grow strong brands and businesses? That’s the subject of the second part of Mark Packard’s business handbook for value creation, Entrepreneurial Valuation: An Entrepreneur’s Guide To Getting Into The Minds Of Customers (Mises.org/E4B_179_Book).
Key Takeaways and Actionable Insights Entrepreneurs can’t directly access the customer’s mental model, but they can apply empathy to run simulations. Entrepreneurial empathy is the ability to see the world through the mental model of the customer. We all see the world through mental models rather than directly, and each of us has our own, unique mental model. But mental models can also be shared and aligned. A mental model is a way of thinking about real situations or about the real world. It’s quite possible to describe someone else’s mental model. We can first ask them questions (“How do you think about your current situation?” “What do you do when the car you drive gets to 50,000 miles on the odometer?”) and then run hypotheses or ideas through the model that emerges (“How do you like this?”, “How does this make you feel?”, “Would you buy this product?”)
Empathy is knowledge-based, and therefore can be practiced by any entrepreneur. It’s not the case that some people are more capable of empathy than others. Since empathy is knowledge-based, it can be learned, developed, and trained. It’s a process of filling different buckets of knowledge about your customer. There’s factual knowledge about them, as well as factual knowledge about their consumption or usage (e.g., location, frequency, any reports, or ratings they’ve provided). And then there’s experiential knowledge — what an experience felt like to them.
Only the customer has this experiential knowledge, only they can feel it. But if the entrepreneur can understand the customer’s mental model, it’s possible to simulate what that experience might feel like — feel what they feel. It’s possible to get closer and closer by experiencing it yourself: eating the food you’re offering them or the beverage you’ve designed, using their mental model rather than your own. The customer’s experiential knowledge is tacit — it can’t be communicated directly — but entrepreneurs can get closer to it through simulation, and interpret it through empathic technique.
Be aware that there is always the risk of what Mark calls interpretive loss — we listen or observe but we don’t interpret the data properly or fully. Our downloadable pdf provides direction on where interpretive loss occurs and how to safeguard against it.
There are some techniques to reinforce the accuracy of empathic investigation. Lead users: In every category, there are users who feel needs and experience unsatisfaction / dissatisfaction more intensely. Give investigative priority to them.Contextual in-depth interviews: Communication can be more productive using specific techniques from our E4B tools library. The contextual in-depth interview technique is one of our useful tools.Ethnographic deduction: Ethnography is the technique of observing users in action. It’s a better tool than a survey or questionnaire — what users do is more informative than what they say when answering surveys. Researchers deduce motivations from observation.Behavioral data: Some data streams can be the equivalent of ethnography — observing users buying or searching as an indicator of their needs, preferences, and concerns.Entrepreneurs can also learn from themselves: We are all both consumers and producers. In the categories that are most important to you, observe your own behavior as a user. Be aware of your concerns as a customer. Make your empathy channel customer-to-customer. From value propositions to innovation. Developing a value proposition is a problem-finding process. Designing an innovation is a problem-solution process.
Problem-finding is the development of knowledge of a problem to be solved from the customer’s perspective, using the experiential learning from the mental modeling exercise. A problem is not the same as a need — it’s a specific gap in the solution landscape of products and services from which the customer can choose, a gap that can be filled with a new solution yet to be identified but capable of identification.
Problem-solving is the application of resource knowledge and technical knowledge to identify a new solution. The entrepreneur must navigate multiple uncertainties to arrive at a solution — demand uncertainty (is there real demand?), technical uncertainty (will it work?), resource uncertainty (will I be able to gather the resources to get to a solution?), capability uncertainty (can I do this?), and competitive uncertainty (will someone else beat me to it?).
Mark’s book includes a multi-step process for problem-solution creativity. One of the most interesting is knowledge combining.
What’s a pancake boat? It’s a combination of two very basic words and ideas that represents the potential for something new. Perhaps a very flat-profile boat for floating under low bridges. Or a breakfast barge touring the harbor. The point is the combination. When entrepreneurs can combine technological knowledge with problem knowledge, it’s possible to invent a new solution without inventing a new technology.
Mark has two suggestions to help with knowledge combining. One is to become interested in technologies. If you are having a hard time devising a solution, it’s probably because you are not familiar enough with technologies that are already available to do so. Find tech websites that can keep you up-to-date on the latest discoveries and applications. The more you understand about the properties and capabilities of resources and technologies, the better you can leverage those properties and what they do.
The second suggestion is a specific method. List as many different resources, technologies, and skills that you know about — software skills, hardware skills, people skills, technologies you’ve worked with, processes you’ve worked with, etc. Keep the list updated.
Then turn to the problem you are trying to solve. Mentally step through all the resources on your list and bring each of them into active memory. Try to think of a possible solution using each one. Keep going through the whole list. You’re bringing technical knowledge schemas forward while holding your problem knowledge in active memory.
Do any of the solutions stand out? Are there any that are truly outside-the-box? Are any of them impossible with current technology? That’s good. Do more research. You might find a breakthrough answer.
It takes time, commitment, and resources, but when you are passionate about the entrepreneurial process the effort will pay off big time.
Entrepreneurs get inside the mind of the customer to make the world a better place. The goal of entrepreneurship is to enhance and improve the state of well-being experienced by customers. To achieve this goal, entrepreneurs aim to understand the customer’s mental model, and run creative solutions — potential futures — through it to simulate the customer’s new experience. It’s a counter-factual exercise, but entrepreneurs can improve their capacity, and their odds of success, with practice, commitment, and the use of some of the cognitive techniques Mark Packard recommends.
Additional Resources "Contextual In-depth Interview Technique" (PDF): Mises.org/E4B_179_PDF
"Interpretive Value Learning" (PPT): Mises.org/E4B_179_PPT
Entrepreneurial Valuation: An Entrepreneur’s Guide To Getting Into The Minds Of Customers by Mark Packard: Mises.org/E4B_179_Book
Getting into the minds of customers is the universal need of everyone in business. A new book by Mark Packard, Entrepreneurial Valuation, provides a new understanding of how customers identify value in the constant, never-ending flow of the value learning cycle. Mark joins Economics For Business for a two-part episode on how entrepreneurs can better understand value in order to delight customers.
Key Takeaways and Actionable Insights Getting into the minds of customers is the universal need of everyone in business. The business world is enthusiastically adopting the insights of Austrian economics. They appreciate the unique economic perspective that can help grow and strengthen customer-facing businesses — and that means all businesses. Professor Mark Packard is presenting his insights on customers and how their minds work when choosing what to buy in a new book, Entrepreneurial Valuation, with the sub-title An Entrepreneur’s Guide To Getting Into The Minds Of Customers (Mises.org/E4B_178_Book). It’s a business book for every business and every businessperson.
The first step is to experience value as customers experience it. They learn it. The purpose of business is to create value for customers. And for customers, the pursuit of value is everything. It’s life — a never-ending process of identifying what they expect to be valuable to them and trying to weigh up their choices between alternatives. Human beings are always valuing, all the time. In fact, Mark makes the point that we should think of value as a verb, not just as a noun. Value as a noun has a specific meaning: it’s an experienced benefit that constitutes a change in well-being from a state of unwellness to a better-off state. The benefit is the experience, and it can be ascribed to something that made us feel better off, which therefore has value.
Valuing — the verb form of value — refers to human beings constantly deciding what to do and what to choose based on their valuation process. And that process is learning — learning from previous value experiences, and learning from observing others. As customers, people are always asking: what makes us and others the best off we or they can be?
Entrepreneurs must have their own, complementary, value learning process: learning what customers value and, ideally, what they will value in the future.
Customers can be unsatisfied or dissatisfied. It’s important that entrepreneurs address these value states differently. The default state for people is unsatisfied. We have unmet needs that we feel all the time. Mises called it a state of uneasiness. Needs like hunger can be satisfied in the short term, but the satisfaction degrades quickly. Needs like security or freedom or friendship may always be unsatisfied, or at least part of the time. There is always a state of greater well-being to aspire to.
Dissatisfaction is a different state. A customer may have applied their value knowledge — made a valuation — to predict a future value experience, and it falls short of their expectations. They made an error. This results in a feeling of dissatisfaction
Both states are opportunities for entrepreneurs: to meet a hitherto unmet need, or to substitute satisfaction for dissatisfaction via a new or better solution. It’s important to know the customer’s state of well-being and its source.
Customers have limited value knowledge and considerable value uncertainty, yet they must make value predictions. Customers use the value knowledge they possess, from previous value experiences or observing others in the market, to try to predict a future improvement in well-being for themselves. What choices should they make to achieve this improvement?
How do they make the prediction? They perform a mental simulation of future value experiences. They imagine themselves having a future value experience with a particular product or service. Via the simulation, they form their predictive valuation: the benefit they expect to experience in the future.
When they actually use the product or service, they assess the actual value experience and compare it with the prediction, thereby updating their value knowledge. They ascribe to the product or service the satisfaction or dissatisfaction experience they feel. Or they might ascribe it to a set of circumstances or some other context. In any case, they have a new mental model: a new experience they can ascribe and use for future predictions.
Value learning is a cycle. Self-assess to identify unsatisfaction and dissatisfaction;Search for new value propositions with new satisfaction potential;Compare the new value proposition with alternatives (and with others’ experiences);Make an economic calculation: willingness to pay;Purchase;Usage experience — including objective value experienced in consumption and subjective value experienced as degrees of feelings of satisfaction (e.g., delight at exceeding expectations versus satisfaction at meeting expectations versus disappointment at failing to meet expectations);Assess usage experience compared to value expectation;Adjust value knowledge base and revise future expectations. Austrian economics helps businesses get into the minds of customers to monitor and understand their value learning. Economics is a much better discipline than finance on which to construct an approach to growing a successful business, because economics is the science of choice: how customers choose the ends they pursue and how they choose the means they perceive as best for attaining their ends.
It’s the Austrian school of economics that is most useful. Traditional economics believes that customers seek utility — what’s useful to them. But subjective value doesn’t reside in utility, it resides in the satisfaction that comes from the feeling of making the best choices. Behavioral economists believe that customers have a tendency to make poor choices (from the economists’ point of view) because of incomplete value knowledge.
But Austrian economists accept the customer’s mind as it is. The goal is to understand how customers choose and how they experience value in their everyday lives, how they negotiate value uncertainty, how they set expectations for the future and how they compare actual experience with expectations. What goes through their minds? To know that requires getting inside their minds, which is what Professor Packard is trying to help us to do with his new book.
Additional Resources "Experiential Value Theory: How Customers Think About Value" (PPT): Mises.org_E4B_178_PPT
Entrepreneurial Valuation: An Entrepreneur’s Guide To Getting Into The Minds Of Customers by Mark Packard: Mises.org/E4B_178_Book
"Tools For The Value Learning Process" (PDF): Mises.org_E4B_178_PDF
Many of the best-known civil rights leaders eschewed entrepreneurship, emphasizing that blacks seek employment in the professions and government jobs.
Original Article: "Entrepreneurship Should Be the Goal, Not White-Collar Jobs"
This Audio Mises Wire is generously sponsored by Christopher Condon.
The business-as-a-flow orientation embraces continuous adaptive change within the firm. Traditional slow-motion control mechanisms like strategy and planning are no longer appropriate. The new toolkit that entrepreneurs are developing includes the after action review (AAR), a learning tool rather than a misguided attempt at predictive control.
Key Takeaways and Actionable Insights In a VUCA world, entrepreneurial orientation embraces change and adaptation in order to reach goals. Learning fast is critical in times of accelerated change. A business firm must change at least as fast as its market and its external environment if it is to survive and thrive — ideally faster. In earlier podcasts, we’ve made reference to the OODA loop as a non-linear change management framework: Observe changing data, filter those Observations through your firm’s capabilities, culture, heritage, and experience to understand what the new data means to your firm specifically, re-Orient if it’s indicated, make new Decisions and take new Actions, and monitor the feedback loops for updated Observations. Speed of progression through the loop is a competitive advantage — make changes faster than your competitors.
One of the keys to successfully managing change is a bias for action. It’s possible that in some situations some businesses may fear taking action — they lack confidence in their own hypotheses and are concerned that their action might be “wrong”. Austrian entrepreneurship takes a different perspective. Entrepreneurial orientation and intent shape decision-making by giving it a high potential focus and, thereafter, every action is framed an experiment from which to learn. Learning enables a greater capacity for reframing. Curt Carlson, in E4B podcast #175 (Mises.org/E4B_175), told us that relentless reframing is key to success in innovation. Learning through action is paramount.
The tool for learning from action is the AAR – After Action Review. The After Action Review is a simple device that asks the questions: what did we intend would happen, what did actually happen, what can we learn from what happened, what will we change next time we take action.
Intent — What are the intended results and metrics?It’s important to continually review the shared understanding of intent among those participating in any action or project or initiative. Shared intent is the mechanism that supplies direction and thrust so that everyone is moving in the same direction. It’s sometimes called commander’s intent (in the military) or leader’s intent (in Agile team science). It’s key that every team member subscribes to and can articulate the intent.Performance — What happened? Is there a performance gap compared to intent?“What happened” can be a challenging question because observation is often subjective, and individuals in different vantage point and with different perspectives can provide different reports or estimations of what happened. Cultural factors become important – front line actors and individuals located lower in a hierarchy must be able to speak freely about what they observed without fear of contradiction or condemnation by superior. A performance gap must be viewed as a learning opportunity that is good for the entire team and the firm as a whole.Learning — What was the cause or source of any performance gap?In a high-speed learning culture, teams are eager to identify causes or issues that give rise to performance gaps. In complexity thinking, it is not always possible to identify linear cause-and-effect linkages, but it’s generally possible to identify areas for improvement as a result of experiencing a setback. It may simply be necessary to run more experiments until a better performance can be attained. It may be possible to identify obstacles that can be removed. It may be possible to identify risks that can be mitigated. In any of these cases, learning via experience (i.e., after action) advances knowledge and augments adaptiveness.One possible learning is that the intended result is not, in fact, within the capacity of the firm, leading to either a decision to augment capacity or a decision to redirect existing resources into other lines.Next Time — What should we change?Learning leads to new hypotheses which can be implemented through new action. The After Action Review identifies what changes in behavior are appropriate to try in a future action. There’s the opportunity to eliminate waste, or abandon no-longer promising trials, or experiment with improved ideas. In a learning culture, there is eagerness to return to action armed with new knowledge and to explore new potential. AAR’s can span all time periods: before action, during action, after action. When should a firm conduct AARs? All the time. In fact, there’s a role for before action reviews, during action reviews and after action reviews. All have the same structure.
What is / was / is going to be our intent?What challenges will we expect to face / are we facing / did we face?What have we learned in the past / what are we learning right now / what caused the latest gap?What will make us successful this time / what adjustments should we make right now / what will we change next time? A learning culture and orientation are critical to the successful application of AAR’s. Learning via AARs is not mechanical, it’s cultural. The culture of the firm must be that there’s no development, no progress, no improvement without learning. Mark McGrath links the learning culture to the growth mindset. The relevant assessment is not one of strengths versus weaknesses but the mindset of the firm compared to that of its competitors. Seeking growth is a mindset, and so is learning. It’s a humble mindset in which we recognize our bounded understanding and seek eagerly to augment it with new knowledge.
There are simple shared rules for individual AARs and for the learning culture: shared goals and mental models, open to every level of the organization, psychological safety, transparency, shared findings, preparation for next time. Within these rules, every firm can build a capacity for learning that becomes a capacity for growth.
Additional Resources E4B AAR template (PPT): Mises.org/E4B_177_PPT
Background reading: NextForge.com
"Orientation: Bridging The Gap In The Austrian Theory Of Entrepreneurship" by Mark McGrath and Hunter Hastings (AERC 2022 Paper): Mises.org/E4B_177_PDF1
Mark McGrath on LinkedIn: Mises.org/E4B_177_LinkedIn
OODA Loop: Mises.org/E4B_177_PDF2
At the core of the entrepreneurial orientation that is the engine of vibrant, growing, value-creating, customer-first businesses, we find the principles of subjectivism and subjective value. Subjective value embraces not only the value the customer seeks, but also the value that entrepreneurs establish in their companies: capital value. Once businesses master these two principles in combination, they can open new horizons of innovation and growth.
Key Takeaways and Actionable Insights A fundamental advantage of Economics For Business over traditional business schools is the understanding of subjective value. It’s hard for conventional businesses, and for the traditional instruction in business school, to fully embrace all the insights of subjectivism and the subjectivism of value. The traditional bias is towards numbers, quantification, prediction, and financial control.
Value is conflated with price and profit. Value is what customers will pay, cost is what the producer pays for inputs, and profit is the difference. Value is inherent in the thing that is produced. Finance and accounting are the numerical tools for computing these relationships.
When business embraces subjectivism, the value is not in the thing. Human minds bring value to the thing. Value comes ultimately from the consumer or end-user. They evaluate the offerings available to them and make value decisions, to part with their money (or not) to claim the value that’s offered.
Value is better thought of as a verb rather than a noun. It’s an emotional driver of decision-making.
Firms can’t impose their concepts of value on customers. A key difference for the subjectivist approach is that customers alone determine value and producers can’t create it and sell it. Value is experienced by customers and, of course, experience lies entirely with them and can’t be reproduced or projected or simulated by producers.
That doesn’t mean that there’s no role in value generation for businesses. Steve Phelan broke down the firm’s value role into 3 parts: value imagination, value delivery and value capture.
Value imagination is a belief about the future — entrepreneurs imagine (or have a “hunch” about) a future in which a target customer experiences value from the producer’s offering, the goods and/or services they make available to customers. This imagination step is a major component of the entrepreneurial journey construct we employ at econ4business.com to help businesses generate value and grow. It’s creativity at work — where value creation starts.
Value delivery is implementation of the imagined value: designing the goods / services for commercial offering, assembling all the components required for implementation (including people in team roles as well as production assets) and taking the offering to the marketplace with a price and a value communication bundle.
Value capture concerns how much of the value experienced by the customer flows back to the producer. Typically, value production takes place in a system — perhaps including retail channels, or a wholesale partner, or a bank of financial partner. How much of the value flow do they take? Or how about competition, who might copy and undercut. Or suppliers who violate contracts or under-perform on contracted services. Entrepreneurs must pay close attention to value capture.
Subjective value thinking extends to business investment decisions. Subjectivism applies not only to value but to the assets of a producing firm. The subjectivist approach understands assets as providers of potential services that customers might value. Most classes of assets (including people) can be assigned to multiple different uses and multiple configurations for the provision of different services. Entrepreneurship weighs up — evaluates — all the possibilities and assigns the assets to their greatest value generating uses.
Value calculus assesses the value-producing arrangements inside the firm. Entrepreneurial producers of value face in two directions: outward to the market and customers, and inwards to the firm and its internal organization.
Looking inwards, producers must calculate which assets — including both human capital assets and physical assets — in which combination result in the greatest value for customers at the least cost. This requires an evaluation that assesses value flowing to the customer from the firm. Since value is subjectively determined by the customer, this calculation is extremely challenging. Peter Lewin called it subjective quantification, and Steve Phelan used the term value calculus. It’s a combination of qualitative and quantitative assessments that’s learned over time. It’s highly contingent on the (changing) value preferences of customers.
Internally, managers must combine their people assets and physical assets in a way that produces most value based on this uncertain and changing value calculus. Entrepreneurs and owners can’t be the decision-makers for everyone, and so the organizational technology must be designed for greatest value generation. Instructively, that organizational technology has been changing over time — from highly structured and divisionalized organizations to today’s more open, networked, and interconnected organizations.
The tool for capturing this value calculus is EVA — economic value added. Capital is a value. In fact, Ludwig von Mises remarked that it was unfortunate that business ever coined the term capital goods, because it tends to make us think of capital as something solid and fixed. It’s not — it’s the result of the value calculus that Steve Phelan talks about.
Capital value can be measured, but not in the way that is captured on a P&L or a balance sheet — creating numbers that appear to be exact, and fixed and fully determined. Entrepreneurs must estimate capital value and the estimate is that of the valuer. They do so algorithmically — there’s a process and a routine but it’s not necessarily mathematical. It includes breaking down the asset combination into smaller and smaller components — perhaps individual people or teams, or perhaps divisions versus the entire company, or perhaps some set of components that can be thought of as an integrated grouping — and assessing their relative capital value contribution. Money values can be used since this helps the expression of relative value, but the algorithmic computation is never exact. Its validity is always in the eye of the valuer. The goal is to find costs that don’t add value, or don’t add as much value as other costs.
Accounting and finance — one looking to the past to measure what happened and one looking to the future to predict what will happen — offer objective-looking numbers, but they truly reflect the subjective value calculus of the entrepreneur in trying to allocate economic value added as accurately as possible.
Additional Resources "An Austrian Theory Of The Firm" by Peter Lewin and Steven Phelan: Mises.org/E4B_176_PDF1
Austrian Capital Theory: A Modern Survey of the Essentials by Peter Lewin and Nicolas Cachanosky: Mises.org/E4B_176_Book
"Entrepreneurship in a theory of capital and finance — Illustrating the use of subjective quantification" by Peter Lewin and Nicolas Cachanosky: Mises.org/E4B_176_PDF2
Curt Carlson has devoted his life to value creation and innovation — VC&I as he sometimes characterizes it. He has been CEO of SRI, a “pure innovation” company where the business model was to create important new innovations that positively impacted the lives of many people. Examples of his innovations are Siri (ultimately sold to Apple) and HDTV (the technology that enables the streaming so many people enjoy today).
He started a consulting company called Practice Of Innovation, which established methods of innovation available to everyone and every firm. Now he teaches at University, aiming to develop a new generation of innovators.
He talks to Economics For Business (econ4business.com) about value creation and innovation as a life skill.
Key Takeaways and Actionable Insights Value Creation is a complex adaptive system. Value creation is a system of many agents, components, arrangements, technologies, constraints, and unpredictable emergent outcomes. There are a challenging number of variables, and there’s a requirement for highly integrated collaboration and recursive and iterative process, utilizing adaptive feedback loops and continuous readjustment. It’s hard — and quite rare — to get right and easy to get wrong.
The essential element of value creation is the mental model. The mental model for value creation is solving important and meaningful problems for others. It shouldn’t be about launching a new business or a new technology, but about helping others. And, since people don’t think in terms of “I have a problem to solve,” the value creator must also understand the customer’s mental model. They experience dissatisfactions. They wish things could be better. They make trade-offs. They can’t always articulate what they want. They have to learn what to want, and value creators can help them to understand what they can want in the future.
Mental models are fundamentally important to the creation of value. We all have mental models of the way we’d like the world to work. The value creator is able to identify — “get inside” — others’ mental models and see the world the way others see it. This perspective is vital — the critical first step in the value creation process.
The calculus of value is subjective. Value can only be defined by the individual who experiences it. Individuals make a mental calculation of value – it might include some numbers and some thoughts, feelings, preferences, and ideas. They are able to make this calculation in their own mind, even though the potential costs and benefits lay in the future.
The dimensions of value are many. When evaluating the purchase of a car, for instance, the price is part of the calculation, but so is the appearance and pride of ownership, the comfort, the gas mileage, the color of the seats, the cost of maintenance, and many, many more features and attributes and functional and emotional benefits.
Despite the difficulty and complexity, people are agile and adept at making this complex calculation. Value creators must be able to appreciate how customers make the subjective calculation — the calculus of value.
The removal of barriers to the experience of value is a good way to create it. Convenience is often highly valued by customers. It represents the removal of barriers to value – easier to operate, less time taken, less physical or mental effort required. These are all valuable. The iPhone provided a more convenient way to enter data (responsive touch screen versus traditional keypad), and this played a big part in its adoption and success. The mental model is that people want to do things that are easy to do. They don’t want the clumsiness of a tiny keyboard on a phone. They don’t want to read a 20-page user guide for a new piece of software. They don’t want packages that are difficult to open or retail stores that are crowded and hard to shop. Identifying and understanding mental models like these gives skilled value creators their competitive advantage. If barriers are perceived negatively by customers, then create value for them by getting rid of barriers.
A need is not a problem to be solved. A need is a mental model. Reframing is the tool for understanding. Curt uses the example of the slow elevator in a prestigious office tower. Residents complain. Engineers might try to solve the problem by re-engineering the elevator for greater speed. A value creator would try to identify the mental model of the complainers. That’s reframing. They are annoyed because they feel that their valuable time is being wasted; they’re bored for a few seconds. Understanding this mental model opens up the possibility for new value approaches. Add a digital screen in the elevator with a news feed so that people can use the time to catch up on the latest headlines. Or add a mirror so that they can use the time to check their clothes and hair before going into the meeting.
Most value creation challenges can be better addressed through reframing. In fact, Curt describes his innovation method as “relentless reframing”. The art of value creation is teasing out the customer’s mental model. Do it again and again, back and forth between the value creator and the customer, to get the understanding of the customer’s mental model right.
Value creation is coupled with innovation: VC&I. The definition of innovation is not just the new idea or new product or new service. It’s the sustainability of any new solution once it’s delivered into the marketplace. Customers use it and prefer it, they pay enough for it to sustain the financial business model, they repeat their purchases and provide supportive comments and assessments. To be truly sustainable, the innovation must appeal to a lot of people, not just a few early adopters. The benefits must be greater than the costs to the user, based initially on their value calculus, and subsequently on their actual experience. And the offering must be better than competition. To get customers to change from a competitive offering, Curt says the degree of superiority must be 2X to 10X.
Curt uses the N-A-B-C process tool as a methodology for innovation teams. On previous visits to the Economics For Business podcast, Curt has laid out the framework of his N-A-B-C model and how to use it. See our E4B graphic tool (Mises.org/E4B_175_PDF) and the Key Takeaways summary from the podcast #37 (Mises.org/E4E_37).
N = Need: Identifying and understanding the customer’s mental model, and perceiving the world as they perceive it, getting to their perspective of how the world can be improved. This is where relentless reframing applies.
A = Approach: Designing an innovative solution with a sustainable business model. The temptation is always to jump straight to the approach without truly understanding the Need, according to Curt. This always leads to error and requires a pivot.
B>C = Benefits Per Costs: This is the customer’s value calculus, very hard to get right as a result of its multi-dimensionality and combination of qualitative and quantitative measures.
C = Competition: What are the alternatives among which customers are choosing, whether direct or indirect - remembering that not buying anything is an alternative they’ll consider. Overcoming inertia requires a high degree of superiority.
Our econ4business.com toolkit (Mises.org/E4B_175_PDF) includes a full explanation of how to apply this tool.
Value Creation and Innovation is a life skill that can be taught to everyone. Solving others’ problems is a deeply human activity. We’re all wired to do it for each other, every day. Value creation can be taught to kids of any age in school, and it can become a life skill. It can be taught to people studying any discipline in universities and colleges, from humanities to hard sciences, so that they can apply it in their field. It can be taught in every firm, whatever the line of business.
The resultant life skill is the mental model that life is about solving meaningful problems for others. It’s about understanding and appreciating others’ mental models. Reframing is the tool for gaining this understanding. Value creation is a fundamental capacity for everyone. They can make an impact on society by solving problems that matter.
Additional Resources "N-A-B-C Innovation Process" (PDF): Mises.org/E4B_175_PDF
Curt Carlson on Innovation Champions: Mises.org/E4E_91
"Answering the Million Dollar Question (Part 1)—How Value Creation Forums Help Create Winning Research Proposals": Mises.org/E4B_175_Article
Negative feedback loops are the ultimate source of value. Mises called it “uneasiness and the image of a more satisfactory state”. Bill Gates said that “Your most unhappy customers are your greatest source of learning”. Negative feedback loops give us the opportunity to improve our service delivery capacity, and the value proposition behind it. Sterling Hawkins has identified the ultimate feedback loop for personal performance. He calls it discomfort. We should seek discomfort, analyze it, understand it, and utilize it as an ultimate tool for improvement. His book is titled Hunting Discomfort (Mises.org/E4B_174_Book) and we talk to him about it on the Economics For Business podcast.
Key Takeaways and Actionable Insights Discomfort is a feedback system. There will always be physical, mental, emotional, or even spiritual discomfort in our lives. It’s necessary and useful. It signals to us how we are interacting with our environment. It keeps us oriented. Sterling’s case is that we shouldn’t try to avoid it, we should embrace it – he recommends that we actively practice hunting discomfort. Once we find it and embrace it we work our way through it, and the result is personal growth. We get better.
First, face reality. The first discomfort Sterling outlines is facing reality. In business, we often say that it’s a great challenge to align the firm’s internal assessment of reality with what is actually going on in the external environment, especially in times of rapid change. We may just not see reality accurately. Our product may not be as well-liked by customers as our research tells us it is.
We can’t change reality, but we can change how we see it. We can change our belief structure. One way is to run many experiments where we can objectively and empirically measure results, and expand on what works and discard what doesn’t. We might find some things that work that we didn’t believe could. And we might find that we thought worked simply does not. Both represent valuable learning and provide us with a reality we can grasp.
Eliminate self-doubt. Self-doubt is mentally wrestling with questions and beliefs and insecurities. It’s the world of “I might” rather than “I will”. Sterling’s advice is that self-doubt can be a gift. It indicates an unwillingness or inability to commit. And yet commitment is often associated with entrepreneurial success. It’s part of what Professor Peter Klein calls entrepreneurial judgment: the capacity to choose which action to take and to follow through with it.
Choose your commitment as wisely as you can – which includes choosing those actions not to take. Sterling’s metaphor is Get A Tattoo. It’s an irreversible commitment everyone can see.
Some people find discomfort in exposure. If you commit, you might feel more exposure than you’re comfortable with. You might have to raise money, when it’s not your skill. You may have to make a presentation about which you’re not feeling 100& comfortable. You might be the only one expressing disagreement in a meeting full of groupthinkers.
Sterling’s recipe is to assemble a support group — he calls it your street gang. They’re supporters, subject matter experts, mentors. You’ll make your commitment to them, and they in turn will give you honest feedback, trust, and loyalty. You’ll still be committed but you won’t feel so exposed.
We take on greater and greater challenges — and that’s uncomfortable. As businesses take shape and grow, the challenges only get bigger. We might get to the point where we want to avoid some of the big challenges. But that’s the wrong viewpoint. The alternative is to turn challenges into an opportunity to find new ways to utilize our resources — to use them as a portal to advance from the status quo to a new reality. The method is reframing. What if you tried the opposite of the status quo solution? What if you looked at the challenge through someone else’s eyes, using their mental model rather than your own – what would they do? What if you change the assumptions about the way you’re addressing the challenge? There are many ways to reframe challenges, and reframing can release you and give you new energy.
The greatest discomfort is uncertainty. Economists talk endlessly about uncertainty in business. It’s a consequence of the unknowable future. But you own your own uncertainty — for entrepreneurs, it’s a feeling, not an economic concept. It’s subjective. We’re not only uncertain about outcomes, but about resources, about financing, about our capacity, about our partners. Uncertainty is multi-dimensional. It’s also guaranteed — we can’t avoid it.
Economists, therefore, say that entrepreneurs bear uncertainty. It’s what they do. It comes with the job. Sterling’s word is surrender: don’t fight or fear uncertainty, but accept it willingly as a cost. Give up resistance. Get into your discomfort zone. Entrepreneurs need to be doing hard things most of the time, however uncomfortable that might be.
Additional Resources Hunting Discomfort. How To Get Breakthrough Results In Life And Business No Matter What by Sterling Hawkins: Mises.org/E4B_174_Book
Visit SterlingHawkins.com
How do we change others’ behavior? In business, it’s a challenge we face every moment. Can we persuade a customer to switch to our brand or service? Can we get the board or the C-Suite to approve our proposal? Can we convince a VC to fund our startup? The common denominator across all these tasks is influence. How do we make the case with sufficient influence? The solution lies in using tools informed by Neuroscience. Economics For Business talks with Rene Rodriguez about his book Amplify Your Influence (Mises.org/E4B_173_Book), and his research into the neuroscience behind influential interpersonal communication.
Key Takeaways and Actionable Insights. Influence is a determinant of business success. In the past, there was a classification distinction between “soft skills” in business management and the more highly respected quantitative capabilities of finance and strategic planning. Today, that is no longer the case. The ability to harness communication to change others’ behavior is fundamental to making progress in the business world, and an inability in this area means an executive or manager will be perceived as ineffective. Setting out a vision that no-one follows is fatal.
Influence is also the way to help people make better choices for themselves. Influence can be considered by some to be manipulation, but there is absolutely no need for that perspective. Influence may be exerted to help people better evaluate the choices and options open to them. Influence is providing information that may not otherwise have been available to the audience, or that had not been considered in the most appropriate light. Influence unleashes what Rene Rodriguez terms “voluntary energy”; they are pleased and delighted to be offered a better decision-making path.
There is hard science behind the soft skills of influence. Influence is applied neuroscience. Neuroscience explains how and why humans resist change. It’s a threat. The first reaction to any new information is often resistance. We don’t like to question what we believe we know, or abandon the guidelines on which we’ve been operating, or change the heuristics we use. It’s a common, shared trait.
That’s why influence is the “how” of leadership: influencing behavior change when the natural response is to resist it. It’s also the goal of marketing, teaching, managing, selling, and communicating.
It pays to learn a little bit about neuroscience for each of these actions.
The power to influence can be amplified by using three techniques. As with any business tool, there are techniques that can be perfected to improve the performance in use. Rene highlighted three:
Sequencing: The brain processes information in certain sequences. First, it looks for threats (like “change” or “new ideas”) in order to sort between danger and safety. If it perceives a threat, it shuts down – no influential communication will get through, Next it seeks value – feelings of being valued, being engaged, being inspired. The right sequence of message delivery starts with a communication of positive value (so that the brain can believe it is in a safe place), followed by communication of caring, active engagement and inspiration.
Framing: people perceive their own reality through their own framing. If your frame of reference for pizza is high calories, excessive cheesy fat and too many carbohydrates, it doesn’t matter how delicious the pizza recipe Pizza Hut presents to you, you are going to be unreceptive. In the battle for attention and shared meaning, an influencer must set and claim the frame in advance of any message presentation. Communicators and innovators practice framing and reframing to improve their skills. For example, creative innovators always create the frame of solving a problem for others, requiring them to see the problem as others see it and experience it, and enabling the future communication of the solution as a relief of unease or removal of dissatisfaction or discomfort. Framing is based on empathy - seeing from others’ perspectives and aligning with their values. That’s why the Economics For Business value proposition design tool starts from “Who is the customer?” and “What is their need?”.
The tie-down: There needs to be a close. Our target audience’s brains are flooded with information from all directions at all times. We need to make our message stick. The tie-down is a tool to make sure the audience has the chance to understand what our information will mean to them, what value it can add to their lives, and how it will help them achieve their goals.
To ensure execution of the tie-down, Rene recommends that we all have an Influence Objective in mind: the specific action, thought or behavior we are aiming to influence. The tie-down is often a summary or emphasis of benefits, or a powerful takeaway or a “magic phrase”. It ties down our message in the audience’s brain.
The art of influence lies in storytelling. Brain scans show that when we are caught up in a story told by a skilled storyteller, we stop daydreaming and become fully present. We become focused. We narrow our attention to what the storyteller is saying. There’s a response in positive brain chemistry, as well as empathy and trust — a neural coupling between the storyteller and the audience.
Stories help us organize data, discern value, and make better decisions. Influencers work hard at becoming good storytellers. Rene left us with a 10-step guide, which we provide as a free pdf.
Additional Resources Amplify Your Influence: Transform How You Communicate and Lead by Rene Rodriguez: Mises.org/E4B_173_Book
"10 Steps to Amplify Your Influence" (PDF): Mises.org/E4B_173_PDF
A strange strand of thought has emerged in European political economy circles that has been given the name of The Entrepreneurial State. The headline claim is that the state (i.e., nation state governments) can and should intervene in the economy to bring about innovation, and that, indeed, it is absolutely necessary for grand, mission-driven undertakings such as climate change amelioration and the commercial development of next-generation technologies. Economics For Business talked to Christian Sandström, co-editor with Karl Wennberg, of Questioning The Entrepreneurial State (see Mises.org/E4B_172_Book), a compendium of analysis by thirty-two leading economists (including friends of E4B such as Peter G. Klein, Samuele Murtinu, and Saras Sarasvathy) to demonstrate the fallacies of the case for an entrepreneurial state. There’s a lot of sound economics to be learned from Professor Sandström’s book.
Key Takeaways and Actionable Insights There’s a warm climate in Europe for government solutions to perceived economic problems. “The entrepreneurial state” is one of the forms these solutions take. Entrepreneurship is well-developed in Europe, and recognized as a growth accelerator. Nevertheless, since 2008-9, country-level growth rates have been below expectations.
Professor Mariana Mazzucato originated the concept of “the entrepreneurial state”, telling fellow economists that they were all wrong in expecting growth to come from private entrepreneurship. Only government has the scope and scale to act entrepreneurially at the level of lifting the growth rate of the whole economy, overcoming the barriers to the introduction and commercialization of new technologies, and tackling the great missions such as climate change amelioration. Historically, she claims, this precedence has always applied: the state leads innovation and private entrepreneurs follow to fine tune the details of marketplace adoption and implementation.
The ongoing failure of Green Deals represents just one illustration of the errors of the entrepreneurial state. One essay in Professor Sandström’s book spotlights what he calls Green Deals: directed investments in various technologies aiming at so-called sustainable development. Public funds distort incentives in the market, making it “rational” for firms to pursue technologies without long-term potential.
One of his examples is a municipality in northern Sweden that accumulated billions of Swedish Krona in debt investing in industrial plant aiming to create car fuel from cellulose, with the ambition of creating an environmentally friendly substitute for gasoline, which would also result in new jobs and a regional resurgence in competitiveness. The process of extracting ethanol from cellulose proved to be more difficult than promised, and no technological breakthroughs occurred. The 2008 recession resulted in falling prices for ethanol, yet more public money was poured in. The end result has been a high debt burden on the municipality, no new jobs, and no reindustrialization for the region.
As Professor Sandström and his co-author Carl Alm conclude, this case and other similar cases stand in stark contrast to ideas about an entrepreneurial state successfully taking on risk and pursuing new technological opportunities.
There are fundamental reasons why governments can’t act entrepreneurially. First, governments don’t operate in markets and they are not subject to market tests, like going out of business if they fail to meet customer needs. They bear no genuine entrepreneurial risk. They have no competitors and so no process of competitive refinement and improvement. Their entrepreneurial actions can’t be evaluated. In effect, they want to achieve innovation without entrepreneurship, which is an impossibility.
Governments lack the required competence for the tasks they claim to be able to undertake. Peter Klein, Samuele Murtinu and Nicolai Foss introduce and explain the economic concept of ownership competence. Entrepreneurs operating in competitive markets have strong incentives (i.e., their own property and their own funds) to allocate resources that they own or control to the most productive applications and to generating the value that the market prizes most highly. Knowing what to own, when to own it (or dispose of it), and how to create value through ownership, all under conditions of uncertainty, requires a skill set that bureaucrats and public actors don’t have and can’t exercise. Public employees can’t exercise the ultimate responsibility that comes with ownership.
Bureaucrats can’t reproduce the human factors of entrepreneurship. Saras Sarasvathy introduced us to the entrepreneurial method of business innovation in episode #131 (Mises.org/E4B_131). Entrepreneurs self-select into the role of uncertainty-bearing, and then initiate projects and advance through a process of market co-creation, making commitments and then adjusting those commitments based on feedback loops and customer responses. They develop a lived experience that enables them to identify new goals to pursue and new means for pursuing them along the pathway. Creativity and adaptability are more relevant to success than investing acumen and planning.
Governments can’t operate in this way. They place big bets, with quantitative goals and illusions of predictability of outcomes, and they pay with other people’s money. They are not capable of finding the serendipity that guides the entrepreneur.
Governments don’t understand the innovative generativity of new technologies. Professor Sandström’s book includes quite extensive examination of what is identified as the Digital Platform Economy (DPE) — the digital entrepreneurial ecosystem of platform access to markets, data, algorithms, and cloud computing capacity (There’s a useful report on the DPE provided in the book at Mises.org/E4B_172_PDF). Digital platforms are enablers for entrepreneurial creativity and business building as a consequence of the access that they give to new business tools and the interconnections to resources, both human and material. The platforms are provided by private companies, and the resulting value creation is user and customer co-generated.
Governments misunderstand the Digital Platform Economy. They see platform providers as monopolistic owners of excessive market power to be regulated and taxed, and totally miss the value generation of hyper-connectivity between buyers and sellers, the complementarity of firms on both sides of the platform, the open access and the lowered transaction costs.
These digital platforms will do much more to encourage entrepreneurial growth than any government ever could.
Governments’ errors are repeated because there is no genuine evaluation of their activities, initiatives, and “missions”. Professor Sandström investigated the way that the results of government innovation expenditures and initiatives are assessed. He found that most evaluations are conducted by consultants, paid by the hour and mindful of the opportunity for future business if their work is well-received by the government that employs them. Some other assessments are conducted by the government departments themselves.
Perhaps unsurprisingly, Professor Sandström could find only 5% of these assessments that were critical in any way (mostly simply to say that the desired results were not achieved).
Moreover, the assessments were economically incomplete. There was no identification or discussion of opportunity costs (what better uses could the funds have been put to) or of administrative costs, which are high since bureaucratic infrastructure grows with each new initiative.
The government’s best role is to remove itself as a barrier, and possibly to help remove additional barriers (for which it often bears responsibility in the first place). Is there such a thing as innovation policy? Professor Sandström says no. He does point out that, in the Austrian tradition, removing barriers to entrepreneurship can help to create the type of environment in which innovation can flourish. This might involve the elimination of legislation and regulation that gets in the way. It could also include nurturing educational institutions to bring the right kinds of thinking and learned skills into the marketplace.
Any such initiative should be general and non-selective. Picking winners should be left to markets.
Additional Resources Questioning the Entrepreneurial State: Status-quo, Pitfalls, and the Need for Credible Innovation Policy, edited by Karl Wennberg and Chris Sandström (PDF and ePub): Mises.org/E4B_172_Book
"The Digital Platform Economy Index" (PDF): Mises.org/E4B_172_PDF
Chris Sandström on Twitter: @ChrisSandstrom
How do businesses actually manage — rather than plan for — continuous change? The increasing adoption of systems thinking in business tells us that the world is changing very fast, and companies need to change at least as fast as their environment in order to thrive. It’s comfortable to talk about but hard and uncomfortable to do. Most people prefer to continue to do what they’re used to rather than embrace change and constant experimentation.
There’s a lot to be learned from the military where special forces are trained to specialize in rapid reaction in chaotic or VUCA (volatile, uncertain, complex and ambiguous) worlds. They face an ever-changing environment (often described as kinetic). They have a very pure evolutionary process: what wins, survives. While the military organization is hierarchical, military operations are flat so that tactical decisions can be made by the people on the ground.
While we are anti-war, we can nevertheless recognize that the military has experience and expertise in managing and organizing for continuous change. We can learn from it.
There are significant barriers to overcome to implement rapid change management in business. Certainly, the time scales are different. Companies change at an intergenerational pace, one generation of managers (or managerial techniques) learning from the last one. In hierarchical organizations, people reach managerial and executive positions by accumulating experience. By the time they get to their high position in the hierarchy, they have locked in an old mental model. They miss the signals of change and fall back on preconceived ideas and notions and methods.
In addition, there is considerable inertia to overcome — a resistance to change that acts as a blocker to agility. It’s human nature to resist change. Once a company has established a niche or a market share, it’s genuinely hard to abandon the strategy or the tooling or the products and services and the marketing that got them there.
To put it in military terms, change is a constant battle.
Situational awareness is a set of tools that are transferable from military to business to improve management of change. Situational awareness governs how well your understanding of the world maps to reality. It operates along two perspectives and 3 time frames.
Internal situational awareness concerns the orientation of your firm, resources, capacity, the capabilities of your team, morale and so on. External situational awareness concerns markets, competitors, customers, trends, technologies, and all the environmental factors that are subject to change.
The three timeframes in military terminology are tactical, operational, and strategic.
The tactical timeframe concerns people on the ground in contact with the environment. In business, this can be the sales team or customer service or engineers in direct contact with customers. They’re doing implementation work but they are also the sensing mechanism. They may have daily or even hourly cycles for intention to change, making the change, learning from the consequences of the change and moving forward to the next change. They must be empowered, trained and equipped, and confident about their freedom of action and adaptation.
The strategic timeframe is the macroeconomic scale of what the firm is trying to achieve for the customer. This frame may be months or years, and dictates how to organize, how to invest, and where to allocate resources.
The operational timeframe is between the other two. How does the firm integrate short term implementational excellence with long term strategic engagement with a changing environment? How does the firm integrate all the hourly and daily information coming from the front line with the long-term investments and resource allocation projects? In a software business for example, there may be a trade-off between building new tooling, which takes time, and rapidly delivering products from established tooling.
How to apply situational awareness. Actively use the 6-box framework (internal /external perspectives, tactical/ operational/ strategic timeframes.
To achieve better alignment of internal / external timeframes, look for mismatches across boundaries in the firm. Do the people working on the front line have the same understanding of the importance of the work as the managers and executives. Does getting thing done seem more difficult than it should be? Are the feedback loops fast? Is the information in the feedback loops spread throughout the firm, through multiple teams, divisions and silos? What’s the gap between perceived ideals and actual experience?
To implement across three time frames is an exercise in portfolio balancing and active discovery, with a high premium on sensing skills.
How much time and resource effort should a firm spend on refining its tooling (the operational timeframe) so that every produced end-product is exactly the same (the tactical timeframe) while keeping an eye out for environmental change, when a future competitor might introduce a faster cheaper product (the strategic timeframe)?
As Austrian economics always stresses, there’s no objective answer, just subjective learning from experience. For example, Netflix was part of the strategic timeframe that Blockbuster failed to manage. Blockbuster was operating its stores in a proven fashion (tactical) and adding new stores (operational), while rejecting the implications of the Netflix model. Today (May 2021), Netflix shows signs of missing some strategic signals. They made content their focus (tactical) and built original production capability (operational) but may be finding that customer tastes are changing and the appeal of their produced content is in decline (strategic).
Similarly, for the last few years, funding has been easy for startups (tactical) and so they have focused on long term market development (strategic) without hitting profit and cash flow milestones (operational). Now that funding is drying up, they are having to shore up their operational capabilities.
There are a couple of techniques that are helpful. One is Horizon Scanning: allocating some resources to identifying and picking out future external scenarios that represent potential change or strategic threats and building a response in advance. Another is red team thinking: mapping out future internal failure modes and then working backwards from them to identify the trip wires to look out for, and to nip emerging issues in the bud.
The after action review (AAR) is an important element of situational awareness. The AAR is applied not just in the military but in fast change business environments such as agile software development. It’s a tool to separate the quality of the decision you made from the outcome of the action that you took. We tend to get attached to our decisions, even if they were based on poor principles.
The components of an AAR include:
What was expected to happen?What actually happened?What went well and why?What can be improved and how? The discussion must be open and honest without hierarchy or blame. As far as possible, everyone on the team should participate so that all perspectives can be included. The focus is on results and dentification of ways to sustain what was done well as well as the development of recommendations on ways to overcome obstacles. It’s really important to identify with high fidelity what happened, because only then is there a good chance to identify new opportunities or trends with equal fidelity. In situations of uncertainty, it’s important to identify “what happened” accurately, in order to be able to identify what it means and what it implies for future actions.
AAR becomes part of disciplined execution. The Economics For Business community is familiar with the explore/expand method of managing business complexity: explore many options through experimentation and expand (by allocating more resources) those that show good results. Annika Steiber in episode 170 (Mises.org/E4B_170) called this capability “ambidexterity” — combining two logics of business in consistent and reliable execution on one hand and openness to change and exploration on the other.
Ben expands this thinking into the concept of disciplined execution. Once a process is proven and is producing reliable results, map it out carefully and then take individual steps or parts of the process and see if they can be further improved, e.g., by automation, without changing the outputs. Processes thus become more resource efficient in producing their output. Always be trying to improve what you already do well.
Similarly, once an “explore” project starts to become productive, apply the same continuous improvement standard. Map the process, examine parts that can be improved, and do so part by part so production is maintained and efficiency is increased.
All of this change dynamic should be driven from the bottom up. Process improvements, fast responses to feedback loops, experimentation and rapid change are all insurgencies — the established hierarchy and mental models will often find them hard to embrace. Insurgency is a bottom-up dynamic. When transformation is pushed from the top down, it often happens that the territory changes before the consultants have drawn the new map. The hierarchy’s role is to provide strong alignment with the orientation of the firm and its culture and vision-mission, alongside loose control of front-line action.
Additional Resources "Apply Situational Awareness To Manage Change" (PDF): Mises.org/E4B_171_PDF
Ben Ford’s website, where you’ll find his Mission Control services: MissionCtrl.dev
Ben Ford’s LinkedIn page, with a lot of presentations and recordings to learn from: Mises.org/E4B_171_LinkedIn
Innovation in organization is at least equal in importance to technological innovation and product / service innovation. It tends to get less attention, which is a great opportunity for imaginative entrepreneurs to implement change for competitive advantage. Dr. Annika Steiber has studied organizational innovation for over twenty years and is a global authority. She shares her insights with Economics For Business, including her analysis of the most dramatic organizational innovation of all, Rendanheyi.
Professor Steiber’s most recent book is Leadership For A Digital World (Mises.org/E4B_170_Book1), and is her most comprehensive guide yet for business management in the digital age. She’s the author of eleven books, including The Google Model (Mises.org/E4B_170_Book2) and The Silicon Valley Model (Mises.org/E4B_170_Book3).
Her Menlo College Rendanheyi Silicon Valley webinars are available at Menlo.edu/Webinars.
Key Takeaways and Actionable Insights Organizational innovation doesn’t get the attention it merits, even though it can contribute greatly to customer value generation. Innovation thinking tends to focus on technology innovation and product/service innovation, with the definition of innovation as the successful introduction of new customer value to markets. Organizational innovation is not often seen through that lens. But it should be. We can reframe the problem this way: does bad organizational structure subtract from the customer value experience? We can all think of ways in which it might do so: for example, poor customer service when customer-facing employees are not empowered, and layers of bureaucracy that impede responsiveness to customer needs. In those cases, organizational innovation could readily generate improved customer experiences and enhanced customer value.
Dr. Steiber had made organizational innovation her research focus for over two decades.
There are a small number of organizational innovators, and a lot of imitators. Google has been one of the originators of new organizational models. Many organizational innovations are pre-packaged — LEAN is an example — and implementers are following someone else’s lead. Others are long drawn out evolutions of incremental improvement without a great burst of innovation.
One example of what Dr. Steiber calls "an entirely new animal" in organizational innovation can be found in the early years of Google, which she studied first hand — she was embedded in Google as an independent researcher. She observed a different management model than anything she had seen before anywhere in the world. From this research, Professor Steiber developed six new management principles, published in her book The Google Model, and summarized in our free PDF (Mises.org/E4B_170_PDF).
Silicon Valley companies employed and expanded on the Google Model. Dr. Steiber studies the peers of Google in Silicon Valley and found that they all adopted the Google Model and its six principles, some more slowly than others. Interestingly, her research pointed to a DNA advantage for Silicon Valley going back to the gold rush: it was a location that attracted and was populated by innovative and entrepreneurial people who were capable of building businesses and new institutions from scratch in the late 19th Century, and in the 20th Century, it was the place where Information Technology emerged, was expanded and accelerated and first put to use in business. Knowledge and knowledge flow replaced management structures and face-to-face administration, including at early pioneers such as Hewlett-Packard.
Read "The HP Way"—an early Silicon Valley organizational innovation manifesto (Mises.org/E4B_170_PDF2).
The six management principles Dr. Steiber describes are:
Dynamic capabilities. Ability to integrate, develop, and reconfigure internal and external competencies in order to meet rapidly changing surroundings.
A continuously changing organization. Instead of waiting and springing into action after needs become pressing, a company should ensure that its organization is permeated with a proactive approach to change.
A people-centric approach. People-centric, focusing on the individual and liberating their innovative power and providing them with a setting in which they can express their creativity.
An ambidextrous organization. Two different forms of organizational logic within the same organization: daily production, which works best with a conventional planning-and-control approach, and innovation, which requires greater freedom, flexibility, and a more open attitude toward experimentation. An ambidextrous organization must successfully handle and utilize the energy inherent in the contrast between these two forms of logic.
An open organization that networks with its surroundings. Permeable boundaries and a constant and conscious exchange of information with the surroundings. Long-term survival requires that companies develop into more open networking systems.
A systems approach. A holistic view of the system and understanding that the system can spontaneously develop new characteristics that can be difficult to predict. These new characteristics can be positive, negative or a combination of the two, creating a demand for additional measures, such as decreasing the fallout from unexpected negative system effects.
We highlighted a couple of these new management principles.
A continuously changing organization The most successful companies are designed for constant renewal. They expect change all the time, and they lead its development. They aim for excellence on every dimension, applying three layers of expertise:
Be proactive: Search for change internally and externally. Embrace it and practice it.Experimentation culture: Try every initiative assuming that it could be a new opportunity. Mobilize fast.Don’t follow. Take the lead, change the standard, be disruptive rather than disrupted, practice creative destruction. These companies never lose external focus, continuously monitoring developments and competitors that could disrupt them, and constantly market-testing new initiatives. They have highly developed sensing capabilities.
An ambidextrous organization Combining the two logics of flawless daily execution for known established businesses and exploratory experimentation seeking unknown new business innovation is an organizational breakthrough. It’s a systemic view of an organization combining different kinds of leadership for the two styles, different cultural signals, different milestones, different incentives, and different evaluation criteria. One system is designed for stability and one for change.
Rendanheyi: the most radically entrepreneurial organizational innovation. True organizational innovation is very rare, but there is a new one that Professor Steiber described for E4B called Rendanheyi.
Rendanheyi is an organizational innovation for the network age in which a large company (Haier, the Chinese company that first instituted the model has 70,000 employees) splits itself into hundreds of microenterprises of averagely 60-70 people — but could be as low as 10 or so - each enterprise performing as its own entrepreneurial business with its own P&L, its own customer base, and control over hiring, budget, and distribution of profit, and over its own value-adding line of business. Defining characteristics include:
No bureaucracy, hierarchy, or pyramid forms of organization; no managers.Employees are not referred to as such — everyone can be an entrepreneur is the mantra; they choose which microenterprise to work in. The focus is on the customer or end-user and not on pleasing the manager above. Incentive systems reward all employees for value creation, and all individual employees are constantly trying to understand how to increase value for customers. Increased value creation is rewarded, and so wealth generation is democratized.Zero distance to the end-user: this is a Rendanheyi principle that brings the consumer or customer inside the microenterprise to co-create new value in the form of new products and services and solutions. Wholesalers and retailers, for example, can inject distance between a Haier micro-enterprise and its users; the enterprise might look to digital solutions to eliminate that distance. Generally, they seek to identify barriers to zero distance to the users and get rid of them.End-user is a general term, so that those micro-enterprises that are serving other businesses rather than consumers can nevertheless practice the zero distance principle. For example, there may be a marketing micro-enterprise within Haier that serves a manufacturing micro-enterprise and a sales micro-enterprise. All can be aligned with zero distance and can work to fulfill end-users’ needs.Paid-by-user. This principle focuses micro-enterprises on end-user value by emphasizing that all businesses live or die based on whether the end-user pays them for value perceived, or not. It’s Austrian customer sovereignty in action. The general tendency in paid-by-user is away from transactional relationships to extended relationships across multiple purchases in ecosystems and via subscriptions and memberships. Relationships are an important focus, and the focus is on creating life-time users.
A sports team on the playing field is a sound analogy for Rendanheyi. There is no central control, each team member is collaborating and combining specialized skills for a team result.
There is only limited call for corporate functions at the center of the Rendanheyi organization. There is a role for developing and furthering vision that crosses multiple micro-enterprises, and for portfolio decision-making as to where to invest resources. Some orchestration functions can be assigned to the center — for example, furthering ecosystem thinking whereby micro-enterprises serving a consumer domain such as the kitchen can develop multiple services including information services and integration services across multiple appliances, tasks, and problems for the kitchen ecosystem.
The result of the Rendanheyi model is the animation of a living system, a superorganism. Rendanheyi provides a genuinely new and different perspective on entrepreneurial organization at scale.
Additional Resources "Six Organizational Principles for Adaptive Entrepreneurial Models" (PDF): Mises.org/E4B_170_PDF
Rendanheyi Silicon Valley Center: Mises.org/E4B_170_Rendanheyi
Menlo College Rendanheyi Silicon Valley Webinars: Menlo.edu/Webinars
Menlo College Digital Management Courses and Webinars: Executive.Menlo.edu
Is there any industry a passionate entrepreneur can’t improve and enhance by elevating the customer experience? The answer is clearly no. Economics For Business talks to Jeff Arnold, who finds insurance fun, exciting, and a source of inspiration, and who is advancing profitably towards the new future he’s imagining, where buying insurance is so enjoyable that customers will stop shopping on price and clamor for the new experience he is designing.
Key Takeaways and Actionable Insights Passionate, creative entrepreneurs can deliver profitable innovation to any industry, no matter how static and rigid it may seem. Jeff Arnold loves insurance. He told us he finds it fun, awesome, and exciting. Studying the intricacies of contractually trading and transferring risk for payment generated a lifetime interest and passion in him. He’s turned that passion into revenue and profit by delivering new value to customers in aspect of their life or their business that is extremely important to them.
As a good Austrian, Jeff Arnold views his industry first from the customer’s perspective. Customer-first. That’s the Austrian way of business. When Jeff thinks about insurance, he thinks from the consumers’ perspective. They pay hundreds of thousands of dollars over a lifetime for insurance of many kinds: house, automobile, business, medical care, and more. Do they know exactly what they are buying — or, perhaps more importantly, not buying because of exclusions buried deep in the small type of the appendices to an insurance policy agreement? How do they feel about the customer interface, including call center phone trees and hard-to-decipher policy documents?
From this perspective, he is able to develop design principles for an insurance business with a better customer experience:
Help customers to think about a systematic lifetime plan for all their insurances;Help them develop the knowledge required to properly understand insurance offers and alternative policies;Give them the opportunity to customize insurance products for their needs as opposed to buying a commoditized vanilla product;Help them to get the exchange value from the purchase that is right for them.Give them an interpersonal experience that’s much better than the industry norm. Jeff focuses his customers on value, not price. Most often, buyers approach an insurance purchase with a transactional frame of mind: how can I pay the lowest price. They’ll shop around to find it. Jeff wants to put an end to “price shopping”, to be replaced with a value calculation: what coverage do I need, how did I get it, and who is the best provider?
The value calculation often entails discovering and eliminating exclusions — coverages that are excluded in the fine print of the contract. These exclusions occur in home insurance (which is especially hard to read and understand) auto insurance (there are 12-14 exclusions to look for according to Jeff) and commercial or business insurance (where many coverages are automatically excluded and must be built back in item by item, with careful attention to detail).
The value solution lies in the integration of technology and personal service. Jeff’s latest business, RightSure, aims to get individuals the right insurance by using A.I. in combination with “famously friendly humans”, i.e., staff carefully selected and trained to deliver knowledge and service in an amenable way. The A.I. can provide a preliminary phone interface, a chatbot interface on the website, and can do an excellent job of matching customer needs to the right policies. Famously friendly people can patiently explain all the policy options, point out what’s covered and what’s excluded, answer customer questions, and help them to make informed decisions. They’re good at listening, exhibit high empathy, and can help customers navigate from suspicion to trust.
The combination of A.I. and famously friendly humans delivers a superior customer experience while also achieving high levels of efficiency. The return on investment in human capital is as high as the return on technology capital. The combination generates brand uniqueness.
Jeff represents entrepreneurship in action in the insurance industry. Jeff Arnold is a quintessential entrepreneur. He’s driven by a passion for his industry, where he spent a career in multiple roles before launching his current business. He gathered knowledge he learned from others and from his own experience in those various roles. He innovates by having a more highly developed customer focus than others, and commits to a better experience for his customers than they can expect elsewhere. And he knows how to combine and recombine assets and resources in new ways to deliver that better experience. He continuously monitors the customer experience and customer sentiment to keep improving.
His primary skill are empathy and imagination — understanding the experience customers prefer and designing it in his mind before bringing it to life. He doesn’t need technology expertise to bring his vision to life; he can buy that on the market. It is the human factors of empathy and imagination that lie behind his superior product.
Imagining the future drives product and service innovation. After a lifetime in the insurance industry and informed by hundreds and thousands of conversations with consumers, Jeff can accurately identify current dissatisfactions and easily imagine future products and services to address some of those satisfactions. Some of the ones he mentioned in our conversation were:
The macro policy: Why do customers have to buy home and auto and business and medical insurance I separate policies and separate transactions. What if there could be one macro policy for a family, adjustable to new needs as life goes on yet still a “one policy” solution for managing all the risks a family faces?
Expanding liability coverage: It seems like lawmakers and courts are continuously finding new things the rest of us are guilty of, like saying bad things on social media. Liabilities are expanding — Jeff called it social inflation. What if our policies could keep up without us having to adjust them in new transactions?
New payment systems: What if we bought automobile insurance by the mile instead of in a lump? Or what if we got refunds based on good driving habits (which is beginning to happen with telematics)? Generally, the payment system of lump sums for coverage over a time period can be replaced by behavioral measures of consumption.
These are the kinds of innovation Jeff is imagining, and working hard on bringing to market. Entrepreneurs make the world a better place.
Additional Resources Jeff Arnold’s author page on Amazon.com: Mises.org/E4B_169_Author
Jeff’s website, Ambassador For The Insurance Industry: JeffArnold.com
The Art Of The Insurance Deal by Jeff Arnold: Mises.org/E4B_169_Book
RightSure.com
Markets are marvelous. They’re the poetry of economics. They are one of the most remarkable technologies humans have ever built. Beautiful businesses develop new markets both outside and inside the firm. We discuss markets with Anthony J. Evans, a business school professor who teaches that all businesspeople must become economists.
Key Takeaways and Actionable Insights A business economist is an Austrian who looks at the fields of economics and business to see how one is best applied to the other. Aim to be a good economist and a good business practitioner. Managerial economics is the application of the economic way of thinking and the insights of economics to the managerial task of creating value. It was Shlomo Maital who wrote, “Managers can’t just employ economists, they must become economists” (Mises.org/E4B_168_Book). Anthony Evans follows that direction and teaches his students at ESCP Business School that they’ll be more productive and more capable as businesspeople as a result of learning and applying economics.
Market system economics provides businesses with the best toolkit for success. Businesses are participants in the market system. Managerial economists study markets in order to find ways for businesses to use market insights, harness market mechanisms and understand the signals and information that markets provide. It’s easy for firms to overestimate their ability to affect the markets in which they are participating, and don’t sometimes they don’t fully understand or properly analyze what market prices are telling them.
Prices are the most important market signals, and they can transmit information about potential futures. They can guide firms on understanding how much value they are creating relative to competitors. They can provide signals about how to increase revenue by moving process higher or lower. They can help businesses understand opportunity costs and transaction costs.
Markets are decentralized experimentation, and if some new experiments by disruptive competitors are commanding purchases from actual buyers today, that may signal more buyers and more transactions in the future especially after prices adjust to higher transaction volumes. Monitoring prices and reading the signals must be a core managerial skill.
Market tests should be applied whenever feasible. Technology can help. Businesses should run a market test for every question that a market can answer: is this offering or initiative valued, is it preferred, can we put a price on it, will varying the price change the level of demand or acceptance, is the benefit greater than the cost, do some customers prefer a competitive offer? Run a market test — A/B test, pilot program, prototype evaluation, survey with customers, whatever is feasible.
Today’s technology provides tremendous help with low-cost digital testing methods, fast feedback loops, and efficient data processing. In fact, more and more, technology can relieve managers of the task of formulating their own understanding by automating the test procedures and the analytics and recommendations.
Markets can be brought inside the firm to improve business performance. Markets stimulate innovation, lower costs, and efficiency because customers always want better, cheaper, and faster and competing entrepreneurial firms always want to provide those benefits in the search for profits. The same effects of the market order can be sought inside the firm. What is the market value and the right price for marketing services from the marketing department, or HR services or IT services? What’s the marginal cost versus marginal benefit analysis for one more HR staff member, or the opportunity cost of one more IT system installation versus one more sales campaign? What’s the value of the knowledge flowing through the firm?
These are the kinds of questions that the market order can answer, and managers should always be asking them. Prices can be the metric for all learning.
Market economics can also guide organizational design and processes. Markets are dynamic and ever changing. Businesses must reflect and emulate this dynamism. Organizational design and structures must be flexible enough to enable dynamism and not erect barriers to change and adaptation. What are the forces that make markets grow and decline, and what are the forces that have this effect on firms? Organization should harness the forces of market growth.
Professor Evans’ suggestion is a constitutional view of the firm. Let simple rules of conduct emerge from a shared sense of vision and mission, codify them, and then let decentralized teams run the experiments that feel constitutionally right to them given their reading of market signals.
Subjective value is immeasurable, but can be gauged in market tests. The purpose of a firm is to generate subjective value, which is created by customers through their own experiences and co-created by the firms and brands and services that facilitate those experiences. Subjective value is intangible and immeasurable. But exchange value — what customers actually pay in an exchange transaction — can be a proxy in some cases.
Subjective value is a hard concept to grasp for those who have been educated or trained to think of value in objective terms, as something inherent in a product. Professor Evans finds his students, when asked to describe the value of an offering or an idea, instinctively gravitate to the product-based view, citing attributes, features and performance benefits.
Taking the customer perspective is very hard, and perhaps unnatural. The economic point of view is always to put the producer in the shoes of the customer, to take the customer’s view and identify the customer’s mental model for processing information and observation. It’s hard to do, and requires significant cognitive effort. But done well, it’s key to marketing, innovation, product improvement and competitive positioning. Empathically diagnosing subjective value is one of the greatest insights economics can give to business.
Entrepreneurs thrive in markets. Markets are the place where entrepreneurs ply their skills, and the entrepreneurial role will never diminish. Their imagination of the future and anticipation of future demand – even under conditions of uncertainty – their creativity and their judgment will always be important in the context of dynamic interactions of multiple players, offerings, and institutions within markets. The human factor is the most important.
Entrepreneurship is not an academic matter to be debated for the distinction of different nuances, but a practical matter of working and succeeding in markets. It concerns the identification of a profit opportunity via some kind of new product, service, method, or recombination of capital, and the ability to introduce this novelty into the marketplace, actively making decisions about resource allocation, cost, investment, communications and all the other elements of a business, overcoming obstacles and resolving difficult challenges. It is, as Professor Evans stated it, both ideational and implementational. Ambidextrous.
And the common backdrop for all entrepreneurs and businesses of all kinds is continuous change. In his book Economics: A Complete Guide For Business (Mises.org/E4B_168_Book), Prof Evans states that, “Economic change will disintegrate existing combinations (of capital goods) and force entrepreneurs to find new ones”. This action, which Prof Evans refers to as “recalculation”, is core to the dynamics and agility of entrepreneurs in markets. Recalculation is the creative pulse that provides the energy for generating new capital structures out of old ones.
Austrian economists have always been acutely aware of change as an economic factor. Perhaps the business world is catching up, but Austrians have always been ahead. It’s the perspective that entrepreneurs and businesses can co-ordinate with each other fruitfully in markets where change is so pervasive and so fast that no-one has complete knowledge and yet must be able to act. Austrian economics demonstrates that good outcomes are possible, even in these conditions of bounded knowledge, for everyone participating in the market, so long as entrepreneurs are free to do their work without intervention. It's a very powerful message.
People in business can be proud of acting as value generators and not feel any imposed need to “give back” or sacrifice themselves to artificially constructed restraints.
Additional Resources Economics: A Complete Guide For Business by Anthony J. Evans: Mises.org/E4B_168_Book
AnthonyJEvans.com
There’s a lot of speculation about the future of work — what form it will take, where it will be done, and who will do it (including the robots versus humans debate). We talk to Mo Hamzian, an entrepreneur who is not only theorizing about the future of work, but building newly imagined workspaces that combine spatial design with technology and custom services, making elite workspaces available to everyone.
Entrepreneurship is now both an economic and societal trend, opening up business opportunities of its own. Entrepreneurship is now, as our guest Mo Hamzian styles it, “a thing”. It’s in the forefront of culture, it’s always in the news, it’s a lifestyle choice as well as a business choice, it’s a career, it’s a source of new heroes for our time.
Institutions of entrepreneurship are growing: schools are teaching entrepreneurship, media are covering entrepreneurship, technology is supporting entrepreneurship.Standards are emerging: tools like our own value learning process and 4 Vs value generation model, as well as processes like the Business Model Canvas are becoming standards of the entrepreneurial method.The sharing of entrepreneurial knowledge in a community is expanding via mentoring by experienced entrepreneurs. As a consequence, we see the emergence of new societal norms. An entrepreneurial society favors self-reliance over dependency, resourcefulness over entitlement, breakout achievement versus structured conformity, and creativity over formula. Entrepreneurship is understood as a journey that is never completed, and may adaptively follow many diversions in pursuit of evolving goals, rather than a predictable climb up the hierarchical ladder of the corporation. Keep thinking rather than keep climbing.
Even inside the corporation, structure is giving way to small self-organizing teams and corporate procedures are being replaced by adaptiveness and agility.
One of the implications of the growth of entrepreneurship is the trend that gets the name “The Future Of Work”. Entrepreneurship brings many significant social changes, including flexibility of time and place and methods of work. And the government’s pandemic policies of shutting down office and work spaces and encouraging work-from-home accelerated those changes. Now it is clear, more than ever, that, in the digital age, there is no need whatsoever to commute through grey suburbs on jammed roads or overcrowded trains to get to a dull and depressing cubicle farm just so that you can be in the same building with the other sad souls who are your colleagues.
Cities will empty out, commercial office markets will enter a period of secular decline, and individuals will feel liberated and empowered to do their best work in the physical location and surroundings of their choice.
One way to seize the opportunity represented by the future of work is via real estate itself — repurposed and re-imagined. Mo Hamzian is an entrepreneur who sees the opportunity in real estate for work where many might see only decline. He looks at it through a different lens, as entrepreneurs do. Can real estate provide the multi-purpose flexibility and adaptiveness required for today’s and tomorrow’s work patterns? It can if looked at creatively.
The creative lens is the customer-first lens: everyone deserves the best workplace. Business thinking that prioritizes customer sovereignty can often solve the most challenging problems. Mo Hamzian translates the unmet needs of today’s distributed workforce as seeking the best space from which to work — comfortable, well-equipped, good acoustics and conferencing technology, a place that “recognizes you” and your needs.
He developed his ideas, in part, by studying the workspaces of the business elites — the top bankers, tech executives and corporate CEO’s. These are immersive, high tech, high comfort, high style ecosystems you never want to leave. They’re available to a very few. What if they were made available to a much wider audience? This is the way many markets evolve — first, affordable at great expense only for a few, then quickly expanded to a mass audience.
This is the idea behind VEL — Mo Hamzian’s startup to bring elite workspaces to a wide audience of users on demand.
Do your best work: the VEL concept is aimed at personal productivity, encouraging the individual to achieve high quality output in a temporary workspace. This implies, of course, some responsibility and commitment on the part of the user.Achieve flow: the ultimate level of individual work is characterized by the feeling of flow — the fulfilment of experiencing how good you are and how much you are improving while doing your work. VEL’s workspace and technology are designed to support flow.Elite environment for everyone: Mo Hamzian’s study of immersive elite workplaces enables designs that bring the same experience to a temporary workspace.Technology: From wi-fi telecommunications and conferencing to (in the future) A.I. and VR and holography, there’s a lot that technology can do to support high quality and high productivity work, and VEL can provide it on demand at variable cost and affordable pricing.Flexible access: customers can rent VEL space and technology by the hour or by the day, in whatever configuration they prefer.Democratization and decentralization: VEL workspaces are available to all, with an aim to distribute them across the country for wide availability, whether urban, suburban, or rural, wherever work can be done.Customization and recognition: Ultimately, the high-tech VEL workspace will recognize the individual when they walk in and configure to their customized set of needs. The VEL concept removes frictions and barriers that might otherwise stand in the way of the future of work and the future of distributed entrepreneurship. As we advance towards a more entrepreneurial future across the entire business landscape, from big corporations operated by flexible, agile teams to individual practitioners, gig workers and small, highly specialized and highly networked companies, concepts like VEL will be an important part of the enabling infrastructure.
Additional Resources Mo’s LinkedIn page: LinkedIn.com/in/MoHamzian
Mentioned by Mo as a worthwhile mentoring site: GrowthMentor.com
VEL website: MyVEL.com
To what extent should entrepreneurial businesspeople concern themselves with macro-economic variables? At E4B, our point of view is: not much. We don’t believe you can fully trust the data, we don’t believe you should put much credence in the interpretations of it, and we encourage businesses to concentrate on serving customers and generating value.
We made an exception this week to discuss the phenomenon of the inverted yield curve, because it might, conceivably, have some immediate effect on businesses and their customers. We talked with Dr. Murray Sabrin, author of Navigating the Boom/Bust Cycle: An Entrepreneur’s Survival Guide.
Key Takeaways and Actionable Insights The yield curve inverted. What does that mean? Technically, the yield curve inversion refers to short term interest rates on the 2-year treasury note doing above the interest rate on the 10-year treasury note.
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The reason this is of interest is that, historically, it’s a signal that the countdown to a recession has begun. At the human level, it means that market participants expect tighter short-term borrowing conditions, potentially making financing business activity more expensive and more difficult.
In reality, there’s no way to be certain of future conditions, and there are so many variables, from inflation to unpredictable Federal Reserve activities, that prediction is inevitably inaccurate.
Moreover, on their own terms, the Federal Reserve interest rate data are not consistent. The 3-month treasury rate remains 2% below the 10-year rate — no inversion there.
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Therefore, predictions of a recession should be taken with the proverbial grain of salt. It may be different this time.
What matters is what entrepreneurs do in the face of this uncertainty. Dr. Sabrin has a number of ideas and pieces of advice for businesses.
Examine conditions in your own sector rather than in macro-economic variables. Economic conditions and trends and outcomes vary significantly by sector. What’s happening in automobiles, housing, energy, and retailing is sector specific.
Look especially for those sectors where free markets are allowed to operate; there may be different trends there. For example, deflation (a continuous trend towards lower prices) might be anticipated from the technology sector as result of innovation and competitive striving, rather than the price inflation we are being promised from other sectors.
Similarly, pay greatest attention to your most relevant geography: neighborhood, city, and state. Economic conditions in Florida are a lot different than in California. Manhattan is different than San Diego. Your neighborhood might be different. Maybe your business operates internationally. Think about your relevant geography and not about the macro-economic headlines.
Focus first on your supply chain. Dr. Sabrin’s extensive research into the longitudinal success of entrepreneurial businesses emphasizes the important of reliable inputs. In risky economic periods, the supply chain may need bolstering — extra inventory coverage, additional suppliers in case of disruptions. This may be expensive and more expensive to finance amidst rising rates, but guarding against supply chain disruption is a primary concern. Don’t risk disappointing your customers because your supply chain breaks.
Maintain your most important lending relationships. If financing is a concern, look to bolster and strengthen lending relationships. Secure a line of credit. Nurture the relationship with your bank. And explore the newly emerging landscape of fintech lending — another example of free markets expanding the range of options and possibilities for entrepreneurs.
Here’s a financial landscape map from an earlier E4B podcast — use it to become familiar with the latest financing options: Mises.org/E4B_166_PDF
Your individual cost curve is not the same as that of the market. The current pervasive concern is with higher interest rates and higher costs. These are macro-economic variables. But the cost curve for your business does not have to be the same. Many suppliers will be lowering prices and offering promotions or special terms to maintain their business flow. You can take advantage by shopping around, rebidding contracts, and seeking out the most eager suppliers. Your micro-economics can be different than the headline macro trends.
Most importantly, seek opportunities within changing economic circumstances. An inverted yield curve is just another instance of continuous change, and change is the condition under which entrepreneurs thrive. They find opportunities in change. There are always growth sectors, there are always customers with needs, and there are always new openings, even when some doors are closing. The agile entrepreneur is alert to new possibilities.
Additional Resources Navigating the Boom/Bust Cycle: An Entrepreneur’s Survival Guide by Murray Sabrin: Mises.org/E4B_166_Book
"Financial Capital Options For Businesses at All Stages" (PDF): Mises.org/E4B_166_PDF
What drives customer behavior and customer choices? It’s the existential question for business; you’ve got to know the answer. But it’s a mystery, hard to unlock. The solution to this answer lies in what market researchers call insights, based on the Austrian deductive method that we summarized in episode #164 with Per Bylund (Mises.org/E4B_164). In episode #165, we talk to Darshan Mehta, a lifelong professional in the field, an advisor to global and local brands, an originator of insights technology, and a deep thinker in the field.
Key Takeaways and Actionable Insights Insights mark the road to innovation and differentiation and give businesses a competitive advantage. By definition, an insight is a deep understanding of the motivation of an individual: why they do what they do, choose what they choose, and stop doing what they used to do? What guides their behaviors, what they do with their time, and how they find betterment and ease?
These individual motivations can sometimes be exhibited as technology trends, social trends and cultural shifts. Insights help businesses understand the drivers of these shifts in the landscape, as well as how these shifts, in turn, change individual behavior. Causality works in both directions.
Insights are multi-dimensional, and businesses need to install multi-dimensional systems to generate insights. No single method and no single information or data source will deliver the deep and rich insights businesses need. Darshan Mehta recommends a multi-dimensional approach.
Conversations with customers This is the number one source of data for insights generation: deep, rich, personal, subjective, and revealing. It requires some skill development to be good at customer conversations. Empathy is a key ingredient — what Darshan calls “being a people person”, interested in how people feel, and with the curiosity to learn and the humility to understand that a lot of what is important to customer decision-making resides in the sub-conscious and is difficult to articulate. In fact, conversation helps people to learn how to describe their feelings and motivations, if the interviewer lets the conversation develop slowly and with time for self-reflection to dawn. The human-to-human connection factor is important, whether in a one-on-one conversation, a group setting (such as a focus group) or an online chat.
Whether your business is present in the conversation or not, customers are having those conversations, so it’s important to listen and take part.
There are tools on the econ4business.com website to frame in-depth interviews:
Contextual In-Depth Interview Method: Mises.org/E4B_165_Contextual and for listening with empathy:
Episode 33 "Isabel Aneyba: Listening From the Heart and the Techniques of Empathy": Mises.org/E4E_33 Behavior observation The Austrian deductive method comes into play when the data is in the form of behavior that we can actually observe — accompanied shopping, ethnography, buying data, shopping data, video data, eye-tracking, A/B testing. All of these give us information about behavior. The next step in insight generation is to deduce the drivers of the behavior. Sometimes we may have some conversational data or sentiment data (such as from surveys) to combine with the behavioral data, sometimes not.
The process of working backwards from behavior to motivation uses the question, “Why?” Why did they act that way? Why did they reject an alternative? What could possibly be behind the behavior? If they acted unexpectedly, or out-of-pattern, or differently than last time, why was that? The standard of 5 Why’s is often invoked to get to the deepest understanding. But it’s not the repetitive 5 Why’s of the child asking mom why they can’t have a piece of candy. The Why’s must be deeply thought-out, probing, significant Why’s to get to the next level of understanding.
Data analytics Analysis of so-called big data can make a contribution to multi-dimensional insights generation, especially if the data relates to behavior such as buying patterns, clickstreams, and cultural shifts in behavior (like Tik-Tok usage). Data can’t reveal drivers or deeply felt dissatisfactions, but it can reveal trends and even suggest some preferences (e.g., shifts in usage from one brand of social media to another). Data analysis algorithms don’t ask why, they ask what — especially what data patterns and pattern shifts can be observed. Bear this in mind when integrating data analytics into your multi-dimensional insights generation process.
Learn the language of dissatisfaction. The drivers of customer choice are always derived from dissatisfaction. Because they are seeking betterment, they must, logically, be dissatisfied with current conditions. It’s very tricky to identify dissatisfactions because the language of articulation is subjective and personal. Researchers and engineers and designers talk about “pain points”, but customers probably don’t. They may talk about what makes them “crazy”, or “upset”, or “frustrated”. Relative satisfaction / dissatisfaction could be revealed by brand-switching. Installing feedback loops for activation immediately after the customer’s product or service experience can help gather relevant data, especially if you can gather the feedback in the customer’s language rather than your own.
Insights are built through combination, recombination, and synthesis. “Insights lie where worlds collide” is a quote from Darshan’s book (Getting To Aha! Why Today’s Insight Are Tomorrow’s Facts). What he means by that is it’s a combination and recombination of conversational data and analytical data and trend observations and cultural shifts that ultimately generate the insight.
Blending and mixing and putting elements together to reveal new possibilities beats logic in the process of insights generation. Call it synthesis. And before synthesis can take place, the ability to break down wholes into component parts in a creative way is required. Analysis and synthesis, destruction and creation.
Ultimately, human emotion lies behind all insights and all innovation: experiences are feelings. Technically, the drivers of customer behavior change can be tracked to functional factors such as speed (faster), cost (cheaper), and / or convenience (easier). But beyond these lies emotion — the feeling that an experience is, was, or can be great. Customers buy experiences, not goods or services. A solution that evokes emotion results in (according to Darshan) a response that’s 12X stronger than one based on just faster/cheaper/easier. Therefore, an insight that evinces emotion — reveals it, brings it to light — is the most valuable of all.
It's important to understand the language of positive emotion, as well as the language of dissatisfaction. An experience evokes emotion when customers call it amazing or super-cool or use superlatives of that kind.
Customers bond most strongly to businesses that can align with their highest values. Beyond even the strongest emotional benefits lie highest values: lifetime values for which customers are always striving. Examples include family security — always a goal and never entirely realized — a sense of achievement — there’s always more to achieve — and a world of peace — we know today how elusive that is.
Brands that can associate themselves with these highest values — purpose-driven brands — or help customers attain them for themselves will be especially prized and loved in today’s markets. Humanizing brands in a digital world is a difficult standard to attain, and making the emotional connection with the customer on the subject of their highest and most strongly held values is the pathway.
Listen to the Economics For Business Podcast (Mises.org/E4BPod) on the role of highest values in business.
It's a modern expression of customer sovereignty that brand buyers are so active in evaluating products and services based on their assessment of the values exhibited by the corporations behind them, and that they seek to change the world through buying and not buying.
Better insights can help led us to a better world by identifying dissatisfactions and pointing to new solutions. Insights are visions of what makes us human, improving what connects us and unites us.
Additional Resources Getting To Aha! Why Today’s Insights Are Tomorrow’s Facts by Darshan Mehta: Mises.org/E4B_165_Book
iResearch.com
Think better, think Austrian is the mantra we have adopted for our Economics For Business project. Economics is a way of thinking. It’s conceptual, and its concepts can help businesses to make better decisions. The most important business decisions are those that pertain to the generation of value for customers, since that is the purpose of the firm. We talk with economist Dr. Per Bylund about exactly how the Austrian way of thinking helps businesspeople in every role to think better, and the business benefits that ensue.
Key takeaways and Actionable Insights. “Think Better, Think Austrian” means starting from first principles. Businesses are concerned with behavior — with action. The most important behavior is that of customers . Do they buy, or do they not buy?
The Austrian economics framework places people, and the effort to understand what they are trying to do, in the center of its analysis. First principles in Austrian economics teach us that people act to improve their circumstances—to somehow make things better for themselves. We recognize that people have a purpose in mind, and they make choices that lead them to attaining what they want or need.
It is from this first principle that business owners and entrepreneurs can work backwards to understand the motivations behind the actions of our prospective customers. We can ask why. And we should.
Thinking backwards reveals new understanding. If customers act in a way we don’t understand, or differently from the way we expect them to act, or hope they will act, we can work backwards from what we’ve learned without judgment and instead exercise empathy. They might do something “crazy” — like using a product in a very unexpected way, or buying a competitive product that we know to be “inferior” in some sense. We know that their action made sense to them, and that they believed they would be better off compared to alternative choices or actions. Working backwards from this understanding enables us to deduce their motivation, and what value they were seeking. We can learn from their “crazy” action and rethink our offering. We can choose to take their feedback, even if it doesn’t make sense to us, and offer them an alternative.
Thinking better requires a relationship with the customer. Successful business owners and entrepreneurs must develop a deep enough relationship with their customers to understand how they think, how they feel, and how they perceive things. Additionally, we must learn the context in which they are making their choices—there’s no such thing as a non-contextual choice. Per Bylund makes this clear when he explains that ice cream in summer is a different product choice than ice cream in winter, and clothes for business wear at the office are a different choice than clothes for working from home. Consider this: Whom does the consumer believe is observing and judging them and what standards are being applied? Those are important contextual factors to be taken into account.
The Austrian thinker considers all these influences on the customer and uses them to build and nurture relationships
We know that the ultimate purpose for customer action is the relief of some unease. How do consumers and customers decide what they want to spend their money on? Rather than asking ourselves what people want to buy, we can ask ourselves what decisions people make in pursuit of better circumstances. They start from a position of dissatisfaction. They feel unhappy, or disappointed, or feel let down or lacking in some way. Contented people don’t act. People whose every comfort has been seen to, and who lack nothing—people who aren’t experiencing any unease—don’t buy. Discontented people do. This never-fully-satisfied feeling of discontent on the part of the customer is the universal resource for the entrepreneur. It is never exhausted because people are never fully content or fully satisfied in all of their many needs.
Customers use this heuristic to calculate potential value, even though they likely have no idea they are doing it. They think, to what degree do I expect my choice to relieve my discontent? Satisfaction is achieved not so much via the benefit that products and services promise, but via the burdens that are taken away: less work, less difficulty, less effort, less cost to get to a feeling of less discontent or less fear or less concern or less stress.
Often, of course, customers’ concerns are social. How do others see me, how do I appear to them, how do I compare to others in appearance or competence or achievement? The relief of unease is always subjective and often the subjectivity comes in the form of the customer comparing themselves to others, or to their own assessment of others’ judgment of them.
The entrepreneur listens carefully to what customers say, and observes their actual behavior, then uses empathy to understand what process the customer is using to define their unease and ways to relieve it.
Additional Resources "Think Better, Think Austrian" How-To Guide (PDF): Mises.org/E4B_164_PDF
"Per Bylund on Opportunity Costs": Mises.org/E4E7
The medical care industry is so restrictive of individual freedoms — those of both of doctors and patients — that we can legitimately classify it as tyrannical. As is always the case, the solution will come from entrepreneurship, the creative and innovative response of individuals, doctors and teams and firms and their new business models to the dissatisfactions of patients and users of today’s system.
Joe Matarese is one of those innovative individuals. In episode #162 of the Economics for Business podcast, he described the nature and cause of the problem. In episode #163, he surveys the entrepreneurial solutions, some of which are beginning to emerge and some of which still lie in the future.
Key Takeaways and Actionable Insights As with all entrepreneurial solutions, the consumer is in the driving seat. The consumer — in this case, the patient — are clear in what they want, and what they don’t always get: quality care, accessible and convenient, at an affordable price.
Their definition of quality includes the alignment of interests between medical professionals and patients. Accessibility and convenience result from timely response to patient needs as opposed to lines, waiting rooms and delays. Affordable prices will arise when pricing is open as opposed to hidden behind the veil of insurance, co-pays, and healthcare-as-a-benefit rather than as an economic good.
Direct Primary Care is the business model that aligns doctor and patient interests. The new emerging model of membership-based primary care (see BigTreeMedical.com) is a doctor or a small team of doctors setting up an independent practice and recruiting a customer base of subscription-paying patients. In return for a monthly or annual subscription, the patient enjoys access, and one-on-one consultations on demand (usually via tele-medicine visits). The doctor is often networked into a pharmacy (or the practice obtain a pharmacy license) so the patients access to drugs is facilitated, and the prices of drugs to the patient can be lowered.
Most importantly, the patients are able to build a strong relationship with their primary care doctor. Health monitoring can be closer and more personalized, and early treatment — one of the most important variables in medical care efficacy — can be facilitated.
The direct primary care practice is networked into specialists and treatment centers so that the doctor and patient together can choose the treatment pathway that is best for the individual — tailored to individual circumstances and needs.
Personalized technology supplements the Direct Primary Care model, greatly enhancing the health outcome benefits for the patient. The direct primary care model and one-on-one patient-physician relationship provide the ideal conditions for the deployment of modern personalized technologies. Condition-monitoring watches and wristbands and other wearable or portable consumer electronics can provide the doctor with monitoring data and send an alert for any change in condition or abnormal reading. The doctor or patient can call for an immediate diagnostic consultation.
A direct primary care practice can be networked into an imaging center and a testing center for supplemental data acquisition — many of the new devices are mobile and can come to the patient, rather than vice versa, or can provide more immediate and convenient accessibility.
Personalized networked tech provides a new infrastructure for patient-directed monitoring and analysis (whereas the Obamacare “standard of practice” protocol predetermines what tests and diagnostics a patient can access, locked behind a bureaucratic gateway).
An entrepreneurial ecosystem of services will emerge to support the Direct Primary Care model. The opportunities for entrepreneurs in the new medical care ecosystem are, to use Joe Matarese’s word, endless. He cited, as an example, the Surgery Center Of Oklahoma (SurgeryCenterOK.com), which posts cash prices for surgeries online (no hidden fees), and can usually provide service within 24 hours. They take no insurance and patients pay cash. On a broader geographic scale, medical tourism destinations with open pricing give patients the opportunity to find best pricing and provide the latest equipment and top doctors.
There are cost sharing services such as Sedera (Sedera.com) that offer new ways for patients to pay for healthcare in a peer-to-peer sharing of large unexpected medical costs. Sedera’s Cash Pay Directory provides educational resources and shopping tools to “help members become savvy healthcare shoppers”.
There are negotiation vendors who help patients to get fair pricing on medical bills from the big hospital conglomerates. There are online pharmacy vendors, like Mark Cuban’s Cost Plus Drug Company (CostPlusDrugs.com), to help patients shop for the best drug values.
There are entrepreneurial services like Freedom Health Works (FreedomHealthWorks.com) to help Direct Primary Care doctors with billing systems, office tech and the business infrastructure for a modern practice.
In the entrepreneurial world of healthcare, entrepreneurs compete to provide the best and most affordable services ecosystem so that patients can enjoy the best healthcare.
Open pricing and cash payments are an important component of the new system. A big problem, perhaps the biggest problem, with the current medical care system is that the price system is not able to work in the way that it works in free markets. As Joe put it in episode #161, medical care system is “price-less”. Because payments are made by a third-party payer and not by the individual consumer, pricing becomes opaque to the user and economic calculation is rendered impossible. The third-party payment veil has resulted in price escalation and price manipulation and multiple prices for the same procedure at the same facility depending on whether the payments are immediate or deferred and the degree of bureaucratic and regulatory involvement.
If patients were to pay cash for treatments, they could make better decisions about exchange value. Catastrophic insurance for unexpected and rare events would make the use of insurance more like its application in car insurance and fire insurance — a properly priced optional spreading of risk for unexpected future events.
Consumers and physicians will collaborate in the creation of a parallel system for medical care. Joe Matarese believes the status quo medical care edifice is too rigid and entangled to reform. The solution lies in a parallel system. If consumers activate their demand for improvements in quality, accessibility, convenience and payments systems, entrepreneurs will respond with new market-based offerings. Customers will flock to them because of the benefits they perceive in contrast to the current system. Market feedback loops of satisfaction and dissatisfaction will rapidly fine-tune the new parallel system to a higher level of value and acceptance. Joe estimates that to will take only 5-10 years for the new system to take over.
Additional Resource "Entrepreneurial Solutions to Medical Tyranny" (PDF): Mises.org/E4B_163_PDF
Medicus Healthcare Solutions: MedicusHCS.com
Medical care in the US exemplifies how the perverse effects of accumulated, self-reinforcing economic errors can render a system dysfunctional for consumers. As CEO of Medicus Healthcare Solutions, Joe Matarese has seen the current system from the inside — working and interacting with thousands of hospitals and thousands of providers, primarily doctors, around the country, dealing with processes, bureaucracies, government reimbursement procedures, and the full gamut of the producer side of the medical care system. In Part 1 of a two-part podcast series, he gives us the informed insider’s view.
Key Takeaways and Actionable Insights Many forces combine and interact to produce the medical care system we experience today. Politics: As in almost all cases of market destruction, politicians are highly responsible. They have decided that the medical care of individual citizens is an appropriate field for their interventions, and they meddle in their usual ignorant and incompetent fashion. Dr. Scott Atlas of Stamford University was one who documented some of this glaring incompetence and its resultant creation of the crisis response to the COVID-19 pandemic in his book A Plague Upon Our House. The impact of political incompetence on individuals’ experience of medical care is not limited to COVID-19, but Atlas’ book provides one excellent example.
Regulation: Politicians don’t just meddle; they legislate and regulate. The Affordable Care Act of 2011 is a particularly significant milestone. It created a regulatory environment in which it became virtually impossible for independent physician groups to function. Smaller and rural hospitals could not survive the regulatory burdens imposed, and many closed or were acquired by larger hospital groups. The resultant consolidation and anti-decentralization led to centralized decision-making (particularly evident in the COVID-19 pandemic, but much more broadly impactful than just that event) to the effect that individual doctors are told how to practice and how to treat their patients. The one-on-one doctor-patient relationship that flexibly exercises the experience of the doctor on behalf of the individual needs of the patient and their particular condition Is no longer operative. Doctors now apply a centrally designed pre-determined “standard of care” (and are even told by the AMA what “woke” language to use when interacting with their patients).
Bureaucracy: With regulation comes bureaucracy. Central to the medical care system is the CMS bureaucracy — The Centers For Medicare And Medicaid Services. (You can visit the behemoth at cms.gov — it’s instructive to see the breadth and depth of its reach.) This is the home, for example, of the code lists that govern medical care billing and payment policies. Every doctor must code every patient interaction and every procedure, and the code triggers a specific billing amount. The care that doctors can give patients is governed by these codes and standard-of-care protocols rather than the heuristics an experienced doctor uses to treat individual patients in individual circumstances.
Perverse incentives: Out of the regulatory bureaucracy comes a cascade of perverse incentives. The billing code system leads to one of them: hospitals and doctors will lean towards treatments and billing codes that result in the best billing and revenue outcome for them, rather than what is best for the patient. Similarly, with the fee-for-service model of the Affordable Health Care Act, there’s always the incentive to provide the service or procedure that generates the best fee.
Financial Engineering: The worst financial engineering of the medical care system is the tying of health insurance to employment, and the general misuse, misunderstanding and mispricing of insurance that results. Insurance is appropriate for classes of events (like car accidents or house fires) which are known to have distributed incidence but unknown in terms of where and when they will take place. Individuals pay into an insurance pool that can be drawn on when an unlucky individual encounters an incident; we all hope we will never have to draw on it. In health care insurance, individuals pay for coverage which they know they will draw on. They expect insurance to pay for routine things they should really pay for out of individual income or savings. Medical insurance coverage is appropriate for rare or catastrophic events, but not for everyday health maintenance. In fact, insurance totally obscures the market for health care.
The combined result of all these forces is the elimination of economics from medical care. No free market: Medical care is the epitome of interventionism. There are no unregulated voluntary exchanges between buyer and seller, in this case patient and doctor. Every interaction is regulated, bureaucratized, coded, and distorted by financial engineering. Most importantly, there is no free market pricing. Prices are the indispensable signaling and information exchange mechanisms of markets; when they are suppressed, markets can’t function. The medical care system is, as Joe Matarese puts it, price-less.
No entrepreneurship: The function that solves consumer problems in markets is entrepreneurship. Entrepreneurs identify customer dissatisfactions and devise and present solutions for consumers to choose from. Entrepreneurship can’t operate in regulated healthcare. It is suppressed. Joe pointed out that, in the few corners where an entrepreneurial breakout has occurred — he mentioned medical tourism, Lasik eye surgery, cosmetic surgery, and The Surgery Center Of Oklahoma (SurgeryCenterOK.com) — prices have been lowered, quality increased and value spread wider and wider in the market, reaching more and more consumers.
Repressed Innovation: A major output of freely priced entrepreneurial markets is innovation. Entrepreneurs bring improvement in the form of new services and offerings, improved processes, and the application of new scientific discoveries. The innovation process is highly repressed in US Health Care, as in, for example, the FDA’s long and arduous bureaucratic process for approving new drugs resulting in delays in their adoption costing millions of lives.
Replacing the free market is an edifice of massive, plodding, constraining entities. The top of the monstrous pile can probably be assigned to Big Pharma. The massive amount of funds flowing through the pharmaceutical companies empowers their commandeering of the medical community. Government healthcare agencies such as CMS, FDA and VA take up their entwined cronyist positions related to Big Pharma and Big Hospitals. Big Insurance is the financial engineering for the edifice. The bureaucracy regulates them all, but from a position of having been captured through the lobbying process. The patient sits at the bottom of this stack, squeezed by its weight, restricted by its rules, and constrained from receiving individualized care even though doctors and nurses are capable of providing it.
The COVID-19 experience was an instance of the negative consequences of regulated, bureaucratic, perversely incentivized and politicized medical care. The standard four pillars of a medical response to the COVID-19 pandemic would have been:
mitigationearly outpatient treatmenthospital treatmentvaccination Instead, we were bureaucratically and politically accelerated towards a mass vaccine solution, satisfying the perverse incentives of Big Pharma.
Mitigation could have embraced healthy lifestyles, nutraceuticals, and some stratifying of risk by patient age. Instead, it was botched with ridiculous and useless mask mandates and pointless (and damaging) lockdowns.
Early outpatient treatment for those infected would have recognized the “golden window” of outpatient treatment in the first two or three days of the case to reduce the need for later hospitalization, as documented by Dr. Serafino Fazio and others in a published paper (see Mises.org/E4B_162_Paper), with drugs like ivermectin and hydroxychloroquine, but these were ridiculed, and their use repressed. By the time hospital treatment is needed, the condition has changed from one of inflammation and clotting to pneumonia and lung infection, with potentially worse outcomes. The use of remdesivir was centrally authorized, and this drug is much more expensive and risks worse side effects than the early treatment drugs.
The four pillars were abandoned for the centrally planned decision of mass vaccination.
There is a pathway out of medical tyranny. Principles of Austrian economics can help us find the way out of the current situation. Some of the principles we might apply include:
Let free markets operate: The medical care edifice refutes and represses free markets and market pricing. The first step in a solution is to restore markets to medical care.
Customer sovereignty: Markets are built around the consumer as “the captain of the ship”, determining the purpose and direction of the voyage. Consumers would exercise their sovereignty in a one-on-one relationship with their primary care physician.
Decentralization: Decisions in markets are made close to the customer and not via centralized bureaucracies.
Network versus hierarchy: Austrian economics views markets as networks of specialized nodes connected by 2-way information flows and provider-consumer interactions. The medical care edifice is a hierarchy not network.
In Part 2 of "Entrepreneurial Solutions to Medical Tyranny," Joe Materese will identify some specific ways that we can build a parallel system outside the edifice to bring back consumer sovereignty and free markets.
Additional Resource "Entrepreneurial Solutions to Medical Tyranny" (PDF): Mises.org/E4B_162_PDF
Medicus Healthcare Solutions: MedicusHCS.com
Your individual experience is a business asset. Life is teaching us more than we sometimes realize. An insightful analysis of what we’ve experienced, combined with purposeful translation, can generate unique intellectual property on which to base a unique approach to business. Connie Whitman joins Economics For Business to share her experience and her development of a thriving, resilient, and adaptive coaching and training service.
Key Takeaways and Actionable Insights Experience is an asset that reveals our business superpowers. Life teaches us whether we fully realize it or not. While climbing the job ladder at a firm may seem like the pursuit of credentials and titles, it’s better understood as an accumulation of knowledge and learning that can be applied in the future in entrepreneurship.
Connie Whitman enjoyed a 20-year career in financial services up to the SVP level. It was her customers who pointed out to her what “superpowers” she was developing — a distinctive capacity to assist all parties in a complex collaborative contract to fully understand the benefits accruing to each one of them individually and all of them collectively.
We all can have these superpowers, but we don’t always realize them until a third party points them out, through asking for input or advice or seeking us out or praising us. It’s important to learn the right kind of self-assessment — and to learn to listen to others’ assessment of us — so as to be able to understand our own superpowers.
We can translate our experience into intellectual property that forms the basis for an entrepreneurial business.
Connie Whitman transformed her experience into both a brand philosophy and a scalable methodology. Connie knew from her experience in business that the function entitled “sales” is often viewed negatively: sales activities and salespeople might be accused of rapaciousness and avarice, however unjustified such accusations may be. She intended to develop a service in coaching and training in the sales field, and so it was important to distance herself from these misperceptions. Her counter was selling from a place of love: relationship selling based on love, respect, and integrity. Selling is the construction of an “everybody wins” proposition. It’s an honorable implementation of the entrepreneur’s ethic of service. Anyone using Connie’s techniques would evoke for themselves a feeling of pride and self-respect that the critics of the sales function try to deny.
She crafted a methodology for selling from a place of love in the form of a seven-step selling process. It is replete with Austrian principles of subjectiveness, empathy, and customer sovereignty.
Preparedness: Planning in advance to assemble all the knowledge and understanding available to make you informed and ready; anticipating what the customer will want to know and is likely to ask.
Connecting: Using empathy to connect on the basis of what’s important to the customer in order to establish credibility.
Exploring: Asking questions to learn as much as possible about the customer’s needs and preferences in the context of their current circumstances.
Active Listening: Connie’s phrase is “be present” — listen intently and indicate that you have heard accurately by asking follow up questions to further explore customer needs.
Presenting Solutions: Framing all value propositions as a solution — reliving customer unease.
Confirming: The process of closing the sale, actively asking the customer for their business.
Following up: Consistent, persistent, and respectful (CPR) follow up to confirm satisfaction and potentially extend the relationship.
Connie’s method has evolved and improved over the years — nothing is ever fixed, and all businesses adapt and learn. Yet this intellectual property developed from experience has proven to be solid capital generating both revenue flows and client satisfaction, not to mention word-of-mouth recommendations and references.
Business-building is a function of your network — another piece of intellectual property born of experience. You meet many people in your professional career and you make many connections. Your network is another IP asset. It’s one you should groom and keep fresh and active, turning it into another business asset.
An IP business can be lasting, but you may have to refresh the infrastructure. Connie’s in-person, face-to-face business model was challenged during the COVID pandemic. When business travel stopped, and a lot of sales training budgets were cut. The IP remained valid. The market signal was for her to digitize the business. She took classes and hired consultants to learn how to achieve domain authority. She educated herself on the technology required for digitization of her individual business model, and the processes for digital engagement that were consistent with her 7-step process and principles. The result has been further growth, and the continued fulfillment of pursuing her business goals, and realizing new ones.
Your entrepreneurial IP business can become your most fulfilling experience. Connie describes her entrepreneurial experience as immensely fulfilling — the most rewarding thing she has done in her life. It’s the realization of the value accumulated over a career, and the new value shared with clients in providing service to them. It has been tremendously hard work, of course, and has required some challenging resource allocation decisions — of both time and money — but the reward greatly exceeds the sacrifice.
Additional Resources "Connie Whitman’s Seven-Step Sales Loop" (PDF): Mises.org/E4B_161_PDF
ESP—Easy Sales Process by Connie Whitman: Mises.org/E4B_161_Book
Connie’s website: WhitmanAssoc.com
Changing The Sales Game podcast: Mises.org/E4B_161_Pod
Entrepreneurs can realize their goal to think better, think Austrian by taking a systems thinking approach. We can ditch linearity and hierarchies in favor of distributed networks and webs of causality and create better knowledge – more aligned with the real world — and better mental models. Professors Laura and Derek Cabrera of Cabrera Research Lab and Cornell University — leading authorities on systems thinking — speak to Economic For Business on the application of systems thinking for entrepreneurs, and everyone.
Key Takeaways and Actionable Insights There’s a crisis in thinking in the business world. Laura and Derek Cabrera have conducted deep research in the field of business thinking, and they’ve identified both the problems and the solution. The problems include reductionism (we’re taught to think about parts of systems instead of the system as a whole); hierarchical organization of thinking (versus complex distributed networks); thinking in categories versus breaking down part-whole groupings; thinking in terms of liner cause-and-effect versus webs of causality; and the prevalence of bivalent logic (right/wrong, black/white) rather than the multi-valent logic of many right answers.
This way of thinking is not well-aligned with the realities around us. The solution is systems thinking — the thinking of complex adaptive systems.
Systems thinking aligns with how the real world works. Our mantra at Economics for Business is Think Better, Think Austrian. Systems thinking is better thinking (and Austrian economics fully embraces complex adaptive thinking — what Mises called constant flux and Hayek called spontaneous order and Lachmann called the market as a process of combination and recombination).
Systems thinking defines complex adaptive systems in this way:
Autonomous agents follow simple rules based on what’s happening locally around them, the collective dynamics of which lead to the emergence of the complex dynamics we see.
This description is actually a mental model of a complex adaptive system. The products of systems thinking are mental models. None are perfect representations of reality, but they help us when they are better representations of reality.
Four simple rules of systems thinking produce better mental models. By following 4 simple rules, over and over again, anyone can become a practiced and adept systems thinker. The rules are captured in the acronym DSRP.
D is for Distinctions. Systems thinkers make distinctions between different things and different ideas. We can make distinctions between different customers, different costs, different sales channels, different suppliers, different employees. We identify boundaries, what’s inside and what’s outside. We differentiate, compare, and contrast.
S is for organizing ideas into systems of parts and wholes. Every thing is a system because it contains parts. Every e-mail contains words which contain letters which are made up of pixels. We construct meaning when we organize different ideas into part-whole configurations. We split things up or lump them together in systems of context. We group, we sort, we classify, we assemble.
R is for identifying relationships between and among ideas. We can’t understand much about anything without understanding the relationships between or among the ideas or components. Relationships include causal, correlation, feedback, inputs/outputs, influence, etc. Fundamentally, relationships are action and reaction. We live in an infinite network of interactions, including between our own thoughts, feelings, and motivations. We connect, interconnect, associate and join.
P is for looking at things from different perspectives. When we make a distinction or identify parts and wholes or identify a relationship, we are always doing so from one particular perspective, made up of the point from which we are viewing and the thing or things in view. Being aware of the perspectives we take is paramount to understanding ourselves and the world around us. If we change the way we look at things, the things we look at change. We frame, we interpret, we empathize, and we negotiate from a perspective.
Systems thinking is not a set of steps but a set of rules, and from the interplay of these rules emerges the dynamics of systemic thought.
There are four types of action for systems thinkers applying the DSRP rules. 1) See Information and structure. To construct meaning and mental models, we take in information and structure it. It’s important to recognize the difference between the information and how we structure it. A good way to do this is visualization: use whiteboards or sticky notes or software to map out systems and parts (e.g., boxes within boxes on a chart) and relationships (lines between the boxes). This physical manifestation of a system can help create new knowledge and point to solutions.
Laura and Derek told the story of a large conglomerate business that, by visualizing its divisions and functions and the information flows between them, was able to identify redundancies, see where communications and information was lacking or blocked off, and design a new and improved structure.
2) Use common patterns in the structure of mental models. Laura and Derek use the term cognitive jigs: forms of information structuring that can be used again and again. A list is one type of cognitive jig. It can be used to order priorities or structure wholes into parts. Similes and metaphors are jigs. There’s another called a relationship distinction system (RDS) that can help solve silo problems in organizational design by identifying required relationships and the people responsible for them, and the resources required to operate the relationship. Excel spreadsheets and tables are jigs. Look for useful cognitive jigs and use them over and over again. They increase the efficiency and speed of thought.
3) Make structural predictions. Austrians are wary of predictions because we know the future is uncertain. Here, we are not talking about predicting the future, but predicting the possibility of new knowledge existing after restructuring information. For example, a new relationship opportunity could emerge if we change our perspective. A new understanding could emerge if we break something that we were treating as a whole into its parts. We can identify gaps in our current thinking and make a bet that there’s something positive in changing that thinking. We can create new knowledge.
4) Embrace the logic of and/both. We are taught bivalent logic: there’s right and wrong, there’s black and white, there’s X and Y. There’s an alternative: multivalent logic. There can be more than one right answer. There can be a continuum rather than fixed points.
One example of multivalent logic applies in the analysis of what customers want. They have a variety of preferences, ordered in different ways at different times and in different contexts. They are continuously learning what to want, and always making trade-offs. Bivalent logic won’t help entrepreneurs understand customers’ choices or decision-making processes.
Another example of bivalent versus multivalent logic is cause and effect compared to a web of causality. We tend to think of cause and effect as neighbors on a timeline. The cue ball of cause strikes the colored ball of effect and moves it in a designated direction. But it’s more realistic to think of the events of our lives or our business having multiple causal factors. There are so many mediating factors and external and internal variables that lead us to be more systematic in our thinking about them. Purposely look for webs of causality rather than shoehorn observed phenomena into a linear causal model that doesn’t match the reality of the world.
Systems thinking includes the recognition of individual subjective purpose and intent. The perspective of methodological individualism leads Austrians to worry about whether systems thinking is well-aligned with Austrian thinking. I asked Laura and Derek this question. The response: “I would say that’s precisely what systems thinking entails — the notion that each individual agent is following simple interaction rules with other agents, and that those interaction rules are leading to the system and its emergent properties.
An example of an interaction rule from Austrian economics: humans act in order to improve their circumstances. Another is that they use their own subjective value system to determine what is an improvement. The action axiom, subjective value, opportunity cost in choosing between alternatives, profit and loss and the context of constant change are the simple rules of Austrian economics.
Practice, practice, practice. Systems thinking is something everyone should be able to do. It can be practiced. Our brains are already building mental models about the world. It’s already in us and so it pays to be aware of it.
It’s like any exercise: more reps make us stronger. Look at anything through the DSRP lens when you are feeding your dogs or driving down the highway observing billboard advertisements. Make the neuronal pathways of DSRP second nature.
This can occur at the level of individual learning or of organizational learning. In episode #152 (Mises.org/E4B_152), we discussed the organizational model of VMCL — an organization using learning to acquire the capacity to do its mission every day to achieve its vision.
Additional Resources "How to Become A Systems Thinker" (PDF): Mises.org/E4B_160_PDF1
"Practical Systems Thinking Actions and Behaviors" (PDF): Mises.org/E4B_160_PDF2
Systems Thinking Made Simple: New Hope for Solving Wicked Problems by Derek and Laura Cabrera: Mises.org/E4B_160_Book
Cabrera Research Lab: CabreraResearch.org
Rory Sutherland, Vice-Chairman Ogilvy UK, is a peerless marketing authority, revered throughout the business world. He published a blogpost with the title Wanted — an Austrian School of Marketing. In praxeology, subjective value theory, customer sovereignty, and ordinal value stacks, he identified the building blocks of a marketing approach for our digital age. We talk about it in Economics For Business #159.
Key Takeaways and Actionable Insights Mainstream economics has the wrong narrative about capitalism and, consequently, a misconception about marketing. Mainstream economics fetishizes efficiency, and regards marketing as a cost and an add-on business activity rather than fundamental and essential. There are multiple erroneous assumptions about consumer behavior such as adhering consistently to transitive preferences, perfect trust, and knowing to the penny how much utility will be derived from every transaction. Utility is defined in a circular fashion (consumers act to maximize utility / how do economists know what utility is / it’s the value that consumers try to maximize).
The influence of mainstream economics on business is to favor a focus on what Rory terms “instrumental objective means of business growth”, such as lower prices, and wider distribution. Business becomes obsessed with quantification, and, because value is not quantifiable, looks for other outcomes that can be quantified and used to justify investments. This approach misses the key point: that the marketing tournament is played out not in the objective arena, but in the subjectivity of the consumer’s mind.
Ludwig von Mises developed the science of understanding human behavior, and provided a unique economic underpinning for marketing. Mises introduced the new method of praxeology, making Austrian economics an entirely different science than mathematics-based economics. It’s the science of human behavior, of action, and can be combined with psychology and evolutionary biology in the development of a superior mental template for understanding business.
For marketers, the most telling understanding from praxeology is the consumer’s drive to relieve uneasiness. Mises phrases it: “The incentive that impels a man to act is always some uneasiness.” Note the terms “impels” and “always”. These are powerful insights for marketers. But more is required for action: “the expectation that purposeful behavior has the power to remove ….the felt uneasiness”. This is the task of marketing: to create such an expectation.
The relief of unease is the consumer’s primary drive, and therefore the proper focus of marketing. There is no need, as Rory phrases it, for marketers to “ladle on the positives” in their communications. Removal of unease works differently. It creates the expectation that uneasiness can be removed by actions the consumer takes.
Reputation, for example, is a reassurance to customers that they won’t be disappointed, and that promises made can, with some confidence, be expected to be kept.
A strong brand is a special form of such reputational reassurance.
Investment in a costly advertising campaign with high production quality can remove unease about the credibility of a seller — someone willing to invest in advertising must be confident that there will be widespread acceptance of what they’re offering, giving the buyer a corresponding confidence of not only quality but also social endorsement.
Guarantees, samples, and easy return policies are examples of widely used and effective unease-reducing marketing initiatives.
In fact, anything that reduces the work that customers need to do to enjoy the product or service (such as, for example, home delivery) can relieve unease and increase the value experience. Economists might call this reduced opportunity cost or transaction cost. Whatever the terminology, the unease-reduction approach is the most powerful marketing method.
One example Rory cited was that of zoom. While the technology has been well-established for some time, zoom was bedeviled by the problem of social unease in the early phases of its establishment. Is an electronic meeting as effective as an in-person meeting? Will a client think less of a service provider who doesn’t fly to see them, irrespective of the quality of the remote, technology-enhanced communication?
The analysis of unease — especially the socially-contextual unease inherent in a service like zoom — is a really important element in the understanding of value generation through marketing. Austrian school marketers can develop a special understanding by asking more questions about how best to reduce unease rather than how to increase desirability. Rory used the example of range anxiety for potential buyers of electric vehicles. Their anxiety about possibly running out of power before finding a charging station might be irrational based on their physical environment and infrastructure, but the anxiety nevertheless governs purchase and usage and demands relief.
Marketing is built on an Austrian understanding of customers and their subjective heuristics of value perception. Customers’ perception of the potential for the relief of unease is subjective and emotional. The appreciation of goods and services is not merely a product of their objective characteristics. Value for consumers can be created through psychology, not just through production. Value is a consumer experience, an emotional response driven by a subjective sense of what matters to them, embedded in context, story and meaning.
Changing consumer behavior is not a function of the objective reality of product and price. Marketers who focus just on these elements are “playing with a limited deck”, in Rory’s words. The presentation of a good or service to customers is fundamental to the value proposition. It’s not an add-on or an optional extra for business. Marketing can change customer’s minds through reframing, through changing the social context, or through any one of many, many more ways to change how they look at things.
Consumers evaluate through heuristics rather than rational calculations of economic benefits and costs. The marketing power of brand or reputation is a customer heuristic: a firm that has invested in its reputation through quality and service, reliability, and consistency in keeping its marketing promises, as well as cultivating its online ratings, will be rewarded in the marketplace. Customer disappointment — resulting from a failure to consistently keep promises — will be punished. Reputation and disappointment, of course, are subjectively perceived.
Austrian marketers thrive on the feedback loops. As Rory puts it, some people like plain white bread and some will pay $10 for a sourdough olive focaccia loaf. Marketers explore all the possibilities in a market — they embrace the messiness of customer preferences and the whimsy of their choices. Perfect competition deprives customers of these whimsical choices; it commodifies what’s offered by suppliers.
If markets were designed by suppliers there’d be less variance but also less resilience (fewer options). Markets are designed by consumers and value is created in customer-initiated experiences, facilitated by suppliers who listen and respond well. Consumers get what they want via feedback loops, sending signals back to the marketer about what they want and don’t want, and what they’ll buy and won’t buy.
Brands especially welcome market feedback so that they can align more and more tightly with consumer preferences, and customize the branded experience to an ever-greater extent, reinforcing the brand-consumer bond. It is the consumer feedback loop that drives innovation. Marketing is the listening and alignment function. It’s essential to the workings of capitalism. It is the tool for synthesis of value through the imaginative redefinition of what people value, based on their signals.
It is the Austrian perspective that deals so well with the unpredictability of marketing successes. Another limitation of conventional economics and quantification-obsessed businesses is the search for one right answer. Such restricted models of reality are dangerous. What capitalism and marketing are good at is coming up with multiple answers — increasing the potential solution space for problems, and increasing the number of ways to relieve unease.
The answer to any customer demand is never one thing, it’s multiple options for different value-uncertain customers to choose from. Sometimes there are what Rory calls “opposite things” (Red Bull and Coca-Cola) or sometimes multiple different things (a wide range of single serve beverages for a wide range of consumers in a wide range of situations).
Rory is an expert on unpredictable marketing successes. In his book Alchemy, he describes the “magic” of marketing and some of its unpredictable outcomes. One of the notable ones was the success of Red bull, a beverage brand that, according to research among its own consumers, “tastes kind of disgusting”. The testing agency had never seen a worse reaction to any new product. Why is there such unpredictability? As Rory puts it:
Models of human behavior devised and promoted by (mainstream) economists and other conventionally rational people are wholly inadequate at predicting human behavior.
Red Bull “hacks the human unconscious”. It has potent associations with risk taking behavior, with myths about the power of caffeine and taurine, with perceived signaling effects, and with several more psychological placebos. These have nothing to do with product and price, and make the success of Red Bull unpredictable.
Another way to say this is to call Red Bull’s success an emergent property. The future is unpredictable, but so is the past (we can’t really explain Red Bull’s success), even though we attempt to post-rationalize. It’s just one of several possible outcomes and we don’t truly know the story and how it happened.
Austrians’ embrace of emergent outcomes in free markets with freedom of choice makes marketers perfectly comfortable with unpredicted outcomes.
Much of business success is luck, instantiated by entrepreneurship and enabled by marketing. As a consequence of this unpredictability, extraordinary business success is a function of luck and timing. Business outcomes are largely probabilistic rather than deterministic. Sadly, 80% of the effort in business is applied to pretending that it is deterministic — in the form of planning and strategy activities for example.
The time and place of “take off” for new innovations and marketing campaigns is entirely unpredictable. There are two influences that can bring a little more certainty. One is the role of the entrepreneur, who is likely to be more single-mindedly focused and more persistent in betting on a single innovation than a larger corporation that has a portfolio and a risk-averse bureaucracy.
The second is marketing, which has the capability to change customer psychology and change their frame of reference, transforming a bleeding edge concept into something inevitable and compelling. Early-stage adopters are often seen as somewhat crazy (i.e., there is limited socially contextual acceptance for the innovation), and marketing can accelerate the adoption curve by reducing or eliminating the value uncertainty of more customers more quickly.
Importantly for marketers, Austrian economics takes a process view of markets, in which people and their preferences and their individual and social behavior are constantly changing. This “constant flux”, as Mises worded it, gives energy to marketing as a stimulus for innovation, improvement, and promises of better alternatives.
Additional Resources "The Austrian School Of Marketing" (PDF): Mises.org/E4B_159_PDF
Rory Sutherland's blog post: "Wanted — an Austrian School Of Marketing": Mises.org/E4B_159_Blog
Alchemy: The Dark Art and Curious Science of Creating Magic in Brands, Business, and Life: Mises.org/E4B_159_Book
Rory Sutherland on YouTube: "Praxeology: Time To Rediscover A Lost Science" (There’s a special frame at 8:10): Mises.org/E4B_159_Video
Entrepreneurship-as-design is brought to life in a wonderful conversation with Mark Romera, who conceived, designed and brought to market a values-driven vision of kids having fun playing in their backyards, via an impeccably crafted brand named Spimbey.
Key Takeaways and Actionable Insights. Entrepreneurs can identify innovation opportunities even in the most established fundamental routines of everyday family life. What’s more basic than kids playing with physical toys in the family back yard, running round, having fun, connecting with others? It’s fundamental to family life in the neighborhood. Yet, kids don’t get that experience so much these days. How to bring it back? That’s an entrepreneurial question that Mark Romera answered with Spimbey, a brand new playset product he designed and launched though his company, Spimba.
First, choose your customer. Mark chose Mom. Kids are users, but Mom’s the customer. She’s part of a family with target-age kids and some backyard space. She wants her kids to have fun, play safely outside, play with others, and develop themselves physically and mentally. She worries about how much time kids spend on their digital screens, and how that affects their development.
How does an entrepreneur develop the requisite deep knowledge about Mom? Talk to her; engage her in conversation. Go where the play takes place — the back yard.
Distill a complex need into a simple solution. Already, there’s a lot of complexity. Mom, kids, families, playthings and the materials they’re made with. This brings in safety considerations and regulations, as well as design and manufacturing needs and marketing and distribution needs. The best way to get started is work backwards from the simple solution — the concept of a finished playset, easily assembled by Mom or Dad in a suburban backyard. It needs to be simple for Mom to understand and picture in her mind, and all her questions (like safety and ease of assembly and sustainability) must have simple answers.
From this simple vision, entrepreneurs work backwards in a disassembly process to identify everything they’ll need and the network design to bring it all together.
Design and assemble a flexibly networked internal and external team. Mark was a sole founder. First, he assembled his team in answer to the questions, who can help me with this journey? He also had flexibility for when and where he needed team members. For the “internal” team (not necessarily employees but performing functional management roles) he looked for process development, product development, brand development and web development. He made careful decisions about types of people, level of experience and the ability to take responsibility in an agile process. Most important was brand alignment — a premium, high quality, high integrity brand presentation requires team members of an appropriate caliber who understand reputation building and high consumer trust.
Next, he focused on assembling the external support team: design, safety experts, materials experts, testing labs and safety certifiers aligned with the appropriate regulatory regimes, manufacturing partners, external sales and customer service experts, logistics, freight and delivery partners. The entire value network must be linked, and scheduled for the right inputs at the right time, all working backwards in the calendar from the critical date, which is the high season for retail sales of playsets. Co-ordination of value network nodes and information flows with process inputs, sequences and handoffs is a complex exercise which must be programmed before any work commences.
The design process is a combination of creativity, rigor, networking and collaborative integration. As we’ve learned, much of entrepreneurship is a design process, to get from a concept that’s generated internally to a completed product or project that can meet the rigorous demands of the external world, including Mom and the safety regulators, and the guardians of the distribution channels.
The design concept must take a form that everyone involved in the design process can see and understand in an appropriate way, without contradictions or misunderstandings. Then the appropriate design parameters must be assigned: safety, durability, ease of assembly and ease of use, manufacturability, regulatory compliance, freight and packaging constraints. Many of these design inputs must be outsourced — to computer design shops, materials specialists, manufacturers who can impose their own restrictions, warehousers and freight carriers who have specific requirements.
There is a lot of iteration, adjustment, change management and process orchestration to be managed as the design concept advances towards the market and becomes more and more solid, complete and comprehensively detailed. Mark emphasizes meticulous planning, and a calm demeanor with clear communications to keep the network aligned and on the same page.
Branding is a critical element. The product is physical, but the benefits are psychological. This includes the sense of fun and easiness for the kids, and the feeling of satisfaction and safety for parents. These psychic benefits must be captured in the brand presentation, both online and in physical elements like design and color and packaging. For Mark, his brand is his philosophy, captured in communication, presentation, design, production and delivery.
Mark Romera’s personal entrepreneurial journey passed through various business roles and experiences before branching into entrepreneurship. Mark worked in growth marketing, business intelligence, new business development and as an independent consultant solving strategic problems for business clients. As his responsibilities increased, he often felt like an entrepreneur inside the corporation. In growth marketing, he learned the power of testing supported by data. Test everything, without waiting for too much discussion about the pros and cons of an idea or concept. If it works, scale it up, if it doesn’t, try to understand why based on the data you’ve collected. Testing and experimentation produce data, and data reduces uncertainty. The data cycle requires speed for success, and not conventional structures or decision-making processes that slow things down.
Entrepreneurship brings unique psychic rewards. With his growth hacking and exploit-and-expand experience, Mark felt ready and eager to step into entrepreneurship. He told us he wanted something more, because something was missing. He wanted the freedom to develop his own ideas from scratch and to create something new and cool. The psychic reward from entrepreneurship is special. It combines the challenge of immediate implementation and a successful sales season with the long term vision of building a global brand, extending a product line, and gaining acceptance in markets worldwide.
The entrepreneurial journey for Mark is immediately highly rewarding with the long term prospect of increasing achievement and success.
Additional Resources Mark Romera’s "Entrepreneurial Journey as a Design Process" (PDF): Mises.org/E4B_158_PDF
See the completion of the journey: Spimbey.com
The terminology of complex adaptive systems sounds academic and abstruse, but the subject is not: it’s about the real-life, in-your-face problems and challenges that face a business every day. The secret to solving the challenges of complexity is adaptation. Luca Dellanna, a business expert on the subject, joins Economics For Business to explain how any firm and all management teams can harness the power of adaptation.
Key Takeaways and Actionable Insights Complex systems are a business’s everyday environment, and every business behavior is an adaptation. Every action a manager or leader takes should be aimed not just at its direct outcome but also for the adaptations triggered in your team, i.e. the longer term, second order future behaviors that are made more likely as a consequence of the immediate action. Take motivation as an example. Motivation results less from direct efforts (such as a “motivational speech”) but rather from the establishment of an environment in which good effort is recognized and rewarded. Your system action could be as simple as checking back with employees regarding assignments very quicky and providing feedback. This shows that their behavior is observed, appreciated and valued — a motivational environment to which they will adapt positively. A different environment can be demotivating, with negative long term consequences.
Fast, tight feedback loops are the engines of adaptive systems. Feedback is the energy of adaptive systems, and Luca urges that the feedback loops must be fast and tight. After-action feedback should be as close to immediate as possible, so that there is no uncertainty about whether action is praiseworthy or not. Dashboards and end-of-period bonuses are too delayed for motivational purposes. Similarly, feedback should be highly specific to the action in question, as opposed to a general — and, even worse, vague or unclear - evaluation. These “motivational moments” or “mission moments” can contribute to the sense of a shared mission and vision.
The opposite case can generate “motivational losses”. When a team member or colleague shifts from motivated and engaged to unmotivated and disengaged — ready to quit perhaps — it’s a motivational loss. These can be avoided. Treat these occasions as incidents, to be investigated and addressed. Usually, the best solution is productive clarity, because motivational losses usually occur in the event of unclear objectives or unclear directions. The solution to lack of clarity is to make it impossible to be misunderstood, and to do so from the very outset, so that there is never a need to be remedial.
People have mental contracts, and it’s important to understand and empathize with them. We all have two contracts, the one we sign, and the one in our mind which includes a host of intangibles that are unexpressed in the written contract. We might expect to receive promotion after an appropriate period of hard work, even though there’s nothing in the written contract to that effect, nor has anyone made us that promise. It’s an implicit contract. It’s important to identify and understand these mental contracts, and to end, through clear communications that can’t be misunderstood, all misconceptions that can lead to unfulfilled expectations.
Signaling must be clear and costly. Leadership behaviors act as signals to the rest of the organization. The signals must be clear and unambiguous. Words can be misunderstood or can be perceived as self-contradicting when there is inconsistency. Behaviors can be more clear and more consistent. Luca gave a safety example: instead of instructing individuals to wear helmets in unsafe areas, managers should go to wear the work is being done, and demonstrate the behavior. The more “costly” the signaling behavior to the manager, the more clear the signal. Luca gave the example of the founder of the Dupont explosives businesses living with his family at the factory where explosives were made. He put “skin in the game” to demonstrate the importance of safety in a notoriously unsafe industry — a costly signal, and one that had the desired effect.
How to become a systems thinker: practice adaptive thinking and apply it to yourself. Adaptive thinking can be practiced. It can become an expertise. Think through every reality to determine how other individuals are adapting to behaviors of others that concern them or affect their work. How do people adapt to the words that are spoken to them, or the instructions that are given to them? What are the likely second and third order effects? Always ask yourself, how is the system adapting?
Then apply adaptive principles to yourself. Fashion tight and specific feedback loops for yourself so that your actions generate immediate feedback. How are people adapting to your actions? Make sure you are using the right mental models. Check your assumptions.
Additional Resources Luca-Dellanna.com
"Managing Adaptive Systems" (PDF): Mises.org/E4B_157_PDF
The Power of Adaptation: A Guide to Bottom-up Growth that Lasts by Luca Dellanna: Mises.org/E4B_157_Book
Teams Are Adaptive Systems: 12 Principles For Effective Management by Luca Dellanna: Mises.org/E4B_157_Book2
Antifragile: Things That Gain from Disorder by Nassim Nicholas Taleb: Mises.org/E4B_157_Book3
Business success is a function of knowledge — the right knowledge at the right time applied in the right way. But knowledge is always scarce and incomplete and sometimes wrong. It is best to regard knowledge as a process: continually gathering changing knowledge from a wide range of sources to integrate into decision-making and action. Austrian economics can provide that integration, helping businesspeople with sense-making in a complex, ever-changing world of knowledge. Yousif Almoayyed joins Economics For Business to share his knowledge journey and the ways in which Austrian Economics provided him with the required integrating theory.
Key Takeaways and Actionable Insights Business knowledge is gathered from multiple sources and multiple disciplines. Gathering knowledge that’s relevant for business success is a process, a journey, and an exploration. It’s not limited to business subjects. A rounded businessperson studies economics, of course, but also history, psychology, languages, culture, computer science, political science. Why are these all relevant? Because business is a social science, concerned with how people think and perceive and interact, and how they adapt to new knowledge and changes in context and changes in choices. All the knowledge disciplines impact business.
There’s an exploratory phase in every knowledge journey, where we cast our knowledge net wide. Yousif Almoayyed describes how his early years of schooling included multiple schools both in his native Bahrain and in the US and other countries. He started to gather comparative knowledge of different countries and cultures. He decided to continue the process by traveling to and studying in China. He developed an elevated capacity for the critical business skill of empathy: seeing things as others see them, through others’ eyes, or rather, through others’ mental models. People who grow up with a different cultural and philosophical and religious and linguistic and institutional background develop different mental models. The facility to discern, analyze and understand those mental models helps businesspeople in their interactions with customers, competitors, employees, partners, and suppliers.
The exploratory phase of knowledge gathering doesn’t require us to think about applying that knowledge in business at the time of gathering. It’s building up a knowledge inventory.
Different fields of knowledge can yield different business skills. Yousif told us how he studied computer science and developed a deeper understanding of the clarifying explanatory power of logic. Via the discipline of computer programming, which requires efficient navigation to an answer that is both right and elegant, he was able to gather principles of logical reasoning that are highly applicable across disciplines.
He studied history and — by combining these studies with empirical observations in China and Cambodia and Africa as well as the Middle East — he was able to develop his skills in causal reasoning. What causes can be credibly and realistically and logically linked to what outcomes? What he observed on the ground did not always comport with what is taught in history books, since historians may use flawed or biased logic or incomplete knowledge. Best to construct your own reasoning chain and your own web of causality. This skill is highly applicable in business.
Linguistics helps with understanding the meaning that people intend when they speak. It helps with nuance and idiom, and with assessing people through their spoken words — another critical business skill.
Austrian economics is the system of thought and logic and insight that can integrate all this knowledge into a cogent way of understanding and explaining the business world. Yousif felt that, even with his wide range of multidisciplinary knowledge and multicultural experiences, he still did not understand people and their decision making sufficiently for business. Yousif discovered Austrian economics by reading its definitive treatise, Human Action by Ludwig von Mises.
He told us that he found the insights in Human Action, derived from theory, were highly confirmable in the real world via observation. Anyone can make the same discovery. Over time, for example, you will be able to build more and more confidence in your understanding of how people make their decisions, as well as in your own decision-making about the future. By understanding how individuals’ value systems drive economic decision making, you will be able to interpret and anticipate their economic choices. You’ll deduce the theories or mental models through which people see the world, and analyze their actions that way.
Value systems are at work in firms, also. When a firm has a value system of trust and collaboration, there will be an alignment of interests among everyone who works there, and with suppliers and partners. If you take such a firm as a customer, you can apply the same values-based approach to building a strong business relationship.
Running your own business is an original and customized application of principles of Austrian economics. You can’t read a book about how to run your own business, Yousif told us. Your analysis, using the principles, must be original. He gave the example of applying price theory in his domestic market of Bahrain. It’s an island, so it’s possible to track price fluctuations in inbound commodities — a special economic case. There are unique seasonal business patterns. Trading in oil has a disproportionate effect on economic conditions, and the oil industry is government controlled, so oil prices affect government spending. Boom and bust cycles are very real, and there is observable monetary distortion of firm-level accounts.
Yousif is able to plug these real and highly specialized data into his command of Austrian price theory to arrive at not only price decisions, but a wider range of decisions about when to build inventory and when to deplete it, and when and how to refresh his capital base, replacing older high-maintenance machines with new high-reliability upgrades. Theory is applied in practice in a very real way and in very real decisions. The results have been impressive: a turnaround of a firm to become a growth business and a market leader.
This is our aim at Economics for Business: applying economic principles to help you to improve and accelerate your business.
We all seek progress: at the individual level, the team level, and the company level. Flow is the term for the experience that we feel when we are making progress on challenging activities through our own actions. Flow is high productivity and high achievement. It is the sensation you have when making progress is “winning” over being distracted or frustrated. Organizational structure is often a barrier to flow. Bart Vanderhaegen tells Economics For Business how to transcend the barrier.
Key Takeaways and Actionable Insights Learning and change are good for people and organizations, but very hard to implement. Management books, management gurus and consultants are all for change to established ways of doing things. But the business landscape is littered with failed change and transformation projects. It’s not people who resist change, it’s processes and established practices and organizational structure. In many ways, structure is the biggest barrier to change, and the enemy of learning. Even when change projects re-make a business’s structure, it’s still there, just in a different configuration.
What if it were possible to transcend structure?
The secret lies in motivation. Austrian economics reveals the secret of motivation: every individual seeks better circumstances for themselves, trading one set of conditions that’s unsatisfactory for another set that they prefer. That’s an intrinsic motivation — it comes from inside the individual.
Most business systems rely on extrinsic motivations, what Bart Vanderhaegen calls carrot and stick. The firm metes out rewards in the form of awards and bonuses and promotions for behavior it wants to encourage, and withholds them when there is unapproved behavior. The firm takes a positivist or behaviorist view of the world: people can be “nudged” into approved behavior patterns.
Rewards have many flaws. They rely on predictions — setting future targets — that can never be reliable. These predictions are often fixed, unresponsive to changes in the environment, and usually set without much discussion with the individual who is to be motivated by the target. If the target is met or not, the individual finds it hard to know exactly how their actions contributed to the result.
There is a third kind of motivation: FLOW. It is possible to harness a third kind of motivation that is neither carrot nor stick, and relies on neither reward nor punishment. It can provide autonomy and freedom to individuals to pursue what they find valuable. They can see their own activity as a contribution to a greater end or purpose for themselves. This kind of motivation comes from FLOW.
FLOW is your absorption into an activity performed well. It’s the enjoyment of performing an activity to the extent that you are actually experiencing that you are good at it, while you ae doing it. The activity itself creates the motivation for it. FLOW easily wins the internal competition between getting distracted or diverted versus making progress on the activity.
We are progress-seeking creatures, and FLOW gives us the greatest sense of progress.
FLOW is practical, and can be harnessed, practiced, and linked to work and organization. There are three conditions for being in FLOW, or getting back to FLOW when you fall out of it.
1) A clear and specific goal for the activity.
This is not to be confused with aspirational goals like a corporate vision, or target goals like the year-end sales volume target. This goal is at the level of action. For the specific activity, what represents completion? In what time specific frame? What problem will have been solved when the action is complete?
2) Capture immediate feedback from the activity.
The activity tells you if you are making progress. Measurement is in the activity itself — there is no outside judge. If you’re not making progress, the activity can steer you back to it. Bart Vanderhaegen uses a tennis analogy: if your shots are going in, you’re making progress; if not, you can adjust your action.
3) The activity must have a challenging but solvable level of difficulty.
To make progress requires taking on challenges that can elevate our skills. FLOW requires overcoming difficulties (an insight that is contrary to the old adage of “keep it simple”).
For those who are quantitatively minded, Mihaly Csikszentmihalyi, the founder of FLOW studies, measured the appropriate degree of difficulty as 10-12% harder than one’s current ability — a kind of Goldilocks number of not too hard and not too easy.
This has profound implications for organizations engaged in motivation. They must present ever-increasing levels of difficulty to their employees and teams, as they learn to perform better and better in the flow of taking on challenging tasks.
4) Organizational structure is a barrier to FLOW and to its power to solve complex business problems.
FLOW can solve complex problems. When the overarching problem to solve is how to deliver customer value — which is a problem that cuts across all elements of corporate structure — a FLOWing team can succeed, because value is a clear goal, and learning by taking on difficult challenges provides a pathway to the goal. The customer doesn’t care how the firm is structured.
Internal structures of departments and functions and conflicting goals and rules can present a major barrier to FLOW and to customer value generation. A problem-solving team representing many departments and focused on the goal of customer value can transcend the barrier, and transcend corporate structure.
Therefore, Bart Vanderhaegen recommends not to spend time and effort creating a new structure when the current one is problematic. Create FLOW over structure.
5) How to put FLOW into action.
Like everything that has value, FLOW is a subjective experience. But there are some application actions that can help to generate team FLOW.
Organize a problem-solving network on top of the structural layer.
It’s an organic network that crosses departments and regions and functions and all other structural boundaries.
Give each team in the network a mandate.
A mandate is a problem to solve without specific direction on how to solve it. The team figures out what the solution will look like and how to get there.
Make the problems as open as possible.
The problem may be to define what are the most important problems to solve.
Create transparency (via a software platform) on the problems, ideas and progress.
Everyone “taking the pen” themselves.
Make sure the goals are linked to actions.
For the most open problems, goals can be set for a small number of steps: let’s get to the next milestone in 30 days (e.g., generating a first set of preliminary ideas).
Through criticism and testing, teams will be able to FLOW to new levels of comfort in solving the most difficult of problems. They become more and more capable. And the problem-solving network is scalable: it can become bigger and bigger and solve harder and harder problems.
Additional Resources "The Value-Creating FLOW Process for Business Problem-Solving" (PDF): Mises.org/E4B_155_PDF
Bart Vanderhaegen’s TED Talk: Mises.org/E4B_155_Video
PactifyManagement.com
The Pactify Podcast: Anchor.fm/Pactify
FLOW: The Psychology of Optimal Experience by Mihalyi Csikszentmihalyi: Mises.org/E4B_155_Book1
Creativity: Flow and the Psychology of Discovery and Invention by Mihalyi Csikszentmihalyi: Mises.org/E4B_155_Book2
For entrepreneurs, design is not just lines and shapes and colors and decoration, and it’s not just the look and functioning of a website or a building or another object. It’s a process of advancing from an idea or concept to marketplace realization as a customer-desired new service PR product. In fact, according to Professor Henrik Berglund, entrepreneurship is design.
Key Takeaways and Actionable Insights Entrepreneurs advance from idea to implementation via a process of design. How do entrepreneurs exercise judgment? How do they advance from an imagined idea or business concept or anticipated value to implementing their project in the marketplace and making sales to customers?
It’s a creative process. Some call the domain design science, although we Austrians would think of it in a more subjective framework as human design. In general terms, design provides the bridge from the internal environment of the firm (its capital, its capacity, its skills, its resources, etc.) to the external world of customers and the marketplace. Design facilitates the fit between the two. It’s a goal-driven process of getting to the right design: a value proposition design that attracts customers, an effective value network design for assembling all the components, a business model designed to deliver the value, and pricing and cost choices that result in profit.
The steps in the design process take the form of design artifacts. Design is not abstract. It’s action. The action takes the form of constructing design artifacts: things like sketches and flow chart diagrams and network maps and templated value propositions and business model designs and business plan spreadsheets, prototypes, landing pages and A/B tests.
There is a design pathway from more abstract and conceptual to more substantial and closer and closer to a marketable product, service, or business. The artifacts are not arranged in any specific order, but they are characterized by the progress from abstract to functional and detailed.
Most importantly, the design artifacts are measurable and testable, so that entrepreneurs can get more and more information about how well the design fits with the real world — customer assessments and feedback, simulations, beta tests and other feedback loops serve to make the design more substantial and the entrepreneur’s level of confidence higher.
Experimentation is one kind of design pathway. Professor Berglund described experimentation as a design interaction with an existing real-world situation, where the testing process is to assess how well the entrepreneurial vision works in that world. Is there demand? Will customers find the proposition useful, and will they buy? Through repeated and experimental testing, entrepreneurs measure their way to the best-fit adaptation of their concept to the market.
He used as an example of experimentation an early step in the development of Dropbox, in the form of a video that carefully described its function and benefits, and sought feedback from the market in the form of requests to join a beta test. The video was successful in attracting a beta test audience, reassuring the designers of the potential use case.
Transformation requires a different kind of design approach. Transformative ideas do not have an existing market — a “real world” — in which to experiment. There is no identifiable demand at the outset. The process is co-creation, with potential users and customers, of a new world or a transformed world. The design path is not the use of carefully constructed measurable artifacts, but of another kind, which Prof Berglund describes as mutable and transformable.
He used the example of the iPhone, transforming from the functionality of a phone — with a use case of intermittent 2-way communication events - to the concept of a handheld device with continuous use for a multiplicity of purposes aided by integration with software apps and internet connectivity. The vision was never precise, as it can be with experimentation. Apple outlined a more vague vision of possibilities and soft boundaries, and invited individuals and communities of software developers to join, collaborate, make specialized local contributions, and synthesize a new, emergent system over time.
Firms will typically employ a mixture of experimentation and transformation in a portfolio of projects. Experimentation and transformation are “ideal types” of design, not always as clearly differentiated in the real world as they are in theory. Nevertheless, it’s important for entrepreneurs to differentiate between them, and to maintain a portfolio of projects that instantiates both types.
Professor Berglund and Chalmers are engaged in a new synthesis of entrepreneurial theory and practice. Prof Berglund observes in a book chapter called "The Artifacts of Entrepreneurial Practice," that entrepreneurship scholarship has not always been very useful or helpful to practicing entrepreneurs. Now this is changing as researchers move closer to "the real time doings and sayings of practitioners involved in entrepreneurship". In the spirit of transformation, there’s a new synthesis of theory and practice that is being co-created. That synthesis is one of our guides at Economics For Business; we hope to gather from business entrepreneurs their evaluations about which elements of theory and research are of most use in practice.
Additional Resources "Opportunities as Artifacts and Entrepreneurship as Design" by Henrik Berglund, Marouane Bousfiha, and Yashar Mansoori (PDF): Mises.org/E4B_154_Paper1
"The Artifacts of Entrepreneurial Practice" by Henrik Berglund and Vern L. Glaser (PDF): Mises.org/E4B_154_Paper2
HenrikBerglund.com
Chalmers.se
Design & Assembly is the second pin (after Imagination) in the Economics For Business GPS system — the toolset to help entrepreneurs navigate their business environment. We talk to Brett Lindell, CEO of Pantheon Holdings (which includes Aegis Exteriors and Fortress Roofing) about his Design & Assembly approach that has helped him build a fast-growing business from scratch in the crowded, competitive, and demanding field of regional house construction. His advice: there are plenty of resources available; if you assemble the right resources to fit a system of assuring and delivering the best customer service, there’s a lot of growth to be harvested, whatever the industry.
Key Takeaways and Actionable Insights The entrepreneurial method uses currently available means to create the possibility of new future outcomes. The entrepreneurial method is not to try to control outcomes but to put available resources to use to explore possibilities. Brett Lindell used the method for his business launching pad:
Who am I? Experienced as a US Marine, a college student and a corporate executive in learning, planning, doing, and relationship building.
What do I know? A lot. How Marine Corps plan complex missions, and how they train inexperienced young people to implement amidst on-the-ground chaos. How the system of a global corporation puts the highly engineered products of a worldwide manufacturing web in the hands of construction site workers equipped with nothing more than hammers to produce sturdy and beautiful houses. How sandy beaches and a good climate attract residents who want to buy homes.
Whom do I know? There are companies in the construction industry craving nothing more than simple, reliable good service — which is scarce. There are young people graduating college in my region with limited job prospects who are enthusiastic and highly trainable.
Controlled downside: The entrepreneurial method controls downsides, and doesn’t pretend to control outcomes. Brett’s controlled downside was public commitment to starting, with the consequent specter of public shame if he didn’t succeed, knowing he hated the very possibility of shame.
Design is the series of steps from idea to a working system. Brett Lindell set out to design and assemble a system of systems to achieve his mission.
Geography/Market system: A magnet for homeowners (beaches, ocean, climate, beauty, great place to live) and therefore for developers and builders. Not dominated by cities and so the construction market is highly dispersed.
Labor resource system: Young people graduating college in the area face limited employment opportunities combined with high enthusiasm to stay in the area.
Organizational system: Integrate geography and labor resources via decentralized command that locates tools and decision-making autonomy in the hands of front-line customer-facing employees.
Service system: Basic research (talking to potential customers) revealed that the addressable market is for reliable service: answer the phone when they call, be on time for deliveries and appointments, keep the promises you make. Brett’s system is classic system design of simple rules: employees must (1) tell the truth, (2) pick up the phone when it rings, (3) return all phone calls, (4) customers in all directions — i.e., treat everyone like a customer and serve them as they want to be served whether they’re suppliers, colleagues, or anyone else in the system. (And for Brett, his employees are his most important customers.)
Rich knowledge encoding: Brett believes in handbooks — a belief he learned from the Marines. Handbooks encode all the knowledge of the firm on how to follow every process and implement every task. Every employee can thereby benefit from all the accumulated knowledge and experience in the firm, and the handbooks are continuously updated via new experiences and new knowledge.
Tech systems: In a relatively low-tech industry, Brett’s firm is a high-tech leader because he is always looking for and evaluating the latest technology for automation, work-reduction, and control. The technology can be in the form of apps or software or hardware, and is especially valuable when it can all be integrated together in end-to-end systems or sub-systems such as inquiry-to-order and order-to-cash. Technology integration for these sub-systems speeds up cash flow, reduces labor costs, and increases transparency, thereby enabling quick fixes and improvements. Brett would rather have too much technology than too little.
A plan: While planning can never predict or control the future, it can be an integrating theme for system design. Brett’s plans are a brief and compressed (one page) set of numbers, and those numbers are shorthand for a lot of detail. For example, if Brett’s company is to have the capacity to provide construction components and services for 50 homes in the current year and 500 the next year, then systems of procurement, logistics, sales and marketing, finance and technology must be designed to scale to handle more volume and more complexity without impeding growth. Time, resources, and personnel must be deployed appropriately.
Assembly embraces and harnesses the human element of the business system. A system combined with the right people, suitably trained, and equipped, and with the right mindset, produces the right results. When individual employees are oriented to independent problem solving and autonomous goal-driven creativity rather than central planning, the firm can cope with — and, in fact, generate — dynamic change.
Brett has injected as much humanity as he possibly can. Seeing his hires get promoted and take leadership and realize personal goals is his greatest reward. He has created a family-friendly firm where people can get home to their kids before they go to bed, and take the family on vacation without worrying about the office or the job site, knowing that the system will manage the absence. He creates jobs and makes people’s lives better. That’s the entrepreneurial society.
Additional Resources "Designing and Assembling a System for Entrepreneurial Growth" (PDF): Mises.org/E4B_153_PDF1
"The Entrepreneurial Method" (PDF): Mises.org/E4B_153_PDF2
Reach Brett at brett@aegisext.com
Why do entrepreneurs start businesses in the first place? They have a vision for the future and seek to work with other people to bring it about. Those other people may be colleagues and employees, directors and investors, suppliers, and customers. Organizing this multivalent work is hard. Thinking of your organization as a complex adaptive system yields new understanding and a new approach to organizing that results in improved goal achievement.
Laura and Derek Cabrera of Cabrera Research Lab are dedicated to sharing research findings that enhance the capability of any organization to reach business goals. They join the Economics For Business podcast to do some sharing with the E4B community.
Key Takeaways and Actionable Insights Systems Thinking resolves the mismatch between the way the real world works and the way firms think it works. World hunger is a wicked problem, yet there is enough food to feed the world. We don’t have the right mental model to account for all the social, economic, political, motivational, and cultural issues that shape the problem.
In the same vein, systems thinking in business is about building mental models that better align with the real world. Laura and Derek Cabrera provide an introduction in Systems Thinking Made Simple, and they mentioned some of the important changes in thinking that businesses must embrace to enter the new world of possibilities that systems thinking opens up. The first step is to recognize that LAMO thinking is inappropriate for a VUCA world.
The real world is agnostic about human endeavors
VUCA World
LAMO Thinking
The real world is non-linear
but we think in linear ways.
yet we tend to look sat things through a human-centered (anthropocentric) lens.
yet we tend to look sat things through a human-centered (anthropocentric) lens.The real world is adaptive and organic
yet we tend to think mechanistically and the metaphors we use reference machines (e.g., a universe like clockwork; mind is a computer).
The real world is networked and complex with a sprinkling of randomness
yet we think of things in ordered categories and hierarchies.
All businesses are complex adaptive systems. We have no choice in the matter. An organization is a living, breathing thing, organic — lots of individuals dynamically making decisions that roll up into the complex system. It’s not a machine.
An implication is that business executives and managers can’t operate on outcomes directly (e.g., via business “planning” or business “strategy”). Outcomes are emergent from the system and can be worked on only indirectly.
The traditional mental model for business organization is flawed. Laura and Derek capture the traditional mental model for organizational management in the acronym PCCU: Plan, Command, Control, Utilize.
Plan: Businesses create plans for the future, often in great detail, with rigorous discipline, and lots of numbers and projections. But the real world is changing too fast, and outlining detailed steps to reach a goal amidst rapid change introduces biases that can occlude opportunities for rapid and profitable adaptation to change.
Command: Hierarchical organization designs assume a military metaphor of command. Organizations are much more organic in the real world, tempered by social influence, compliance, resistance, and rebellion. Better to think of then organization as a network and a culture.
Control: Management likes to feel like it is in control, but the control paradigm is both unrealistic and unresponsive to organic change.
Utilize: The most detrimental organizational construct is the Human Resources department. Treating people like resources to be utilized is unsustainable. People are independent agents in the system who wish to co-evolve to a place where their individual goals and those of the organization are well-aligned.
The mental model for how complex adaptive systems work is Simple Rules. The great insight from complex adaptive systems thinking is that organizational behavior isn’t directed by leaders, but driven by followers. What are they following? Simple rules.
We can think of an organization as a superorganism. It self-organizes by following simple rules that guide the actions of individual agents in variable contexts. Autonomous agents follow simple rules based on what’s happening locally (that is, around them), the collective dynamics of which lead to the emergence of the complex, system-level behavior we observe: adaptiveness and robustness.
The simple rules for successful adaptive organizations are summed up as V-M-C-L. Vision: A seeing thing. Something we all see in the future, where we are headed. Not a tagline, not a statement on a website, not a corporate word salad. A vision is a shared mental model that everyone in the organization can see and articulate and align with. It’s in their hearts and minds. It gets employees excited and connected.
Mission: A doing thing. A mission is something that you do repeatedly over and over again to bring about the vision. It directs the work in the organization, with clarity about who does what. It’s clear, concise, easily understood and measurable.
Capacity: The organization must have the capacity to do the mission: the energy, the resources, the skills. Capacity is a system of systems all connected and working together, focused on, and directed towards doing the mission.
Learning: Learning is critical to expand capacity, reinforce mission and refine vision. It is the adaptive function. Organizations must love learning – seeking unvarnished feedback from the outside world as input into making the changes that are needed for improvement. This means loving reality and being brutally honest about the current state. Learning means improving mental models, and embracing the possibility that your current model is wrong.
In their book Flock Not Clock (see Mises.org/E4B_152_Book), where there is a detailed exposition and explanation of V-M-C-L, Laura and Derek cite the example of the app My Fitness Pal.
Vision: Healthy living is the new normal
Mission: Facilitate and motivate healthy behavior choices
Capacity: Build mission-critical systems: design, engineering, R&D, sales, and marketing, etc.
Learning: Feedback on whether living healthy is getting easier, whether more people are making healthy choices, whether more people are feeling joyful and powerful as a result.
Think of the elements of V-M-C-L as a pyramid you can construct from first principles: Thinking drives Learning, which drives Capacity, which drives Mission, which brings about Vision.
The emergent result of V-M-C-L is culture. Laura and Derek talk about training people to think in order to be able to learn. The first step is often unlearning the misleading mental models we’ve been taught to believe. When people start to think about mental models, they can recognize their own and those of others, and make comparisons, make changes, and find common ground.
If your mental model about your current situation is real — "brutally honest," as Derek put it — then the chance of changing that situation for the better is good. You’ll be able to identify a path out.
Culture can be built around the simple rules of vision, mission, capacity, and learning, by purposely constructing the four mental models of V-M-C-L. There is enormous organizational and economic power in the new understanding of complex adaptive systems and how they work in getting a group of disparate people to work together towards a goal as if they are a single unified organism.
Additional Resources Sign up for Laura and Derek’s Vision-Mission Bootcamp: Go.CabreraResearch.org/VMBootcamp
Visit Cabrera Research Lab online at CabreraResearch.org and on LinkedIn (Mises.org/E4B_152_LinkedIn).
"20-Point V-M-C-L Checklist" (PDF): Mises.org/E4B_152_PDF1
"Constructing the VMCL System" (PDF): Mises.org/E4B_152_PDF2
Flock Not Clock: Align People, Processes and Systems to Achieve Your Vision by Derek and Laura Cabrera: Mises.org/E4B_152_Book
Imagination is the first stage of any value generation journey — starting a development project, enhancing the customer experience, embarking on innovation, or building a business for the next year or the next decade. Imagination might sound like a fuzzy concept, but it’s a robust business tool, the engine of the entrepreneurial design process. Mark Packard joins the E4B podcast to put imagination into a business context and describe the possibilities it opens up.
Key Takeaways and Actionable Insights Imagination is central to entrepreneurs and entrepreneurship, and to innovation and advance in all aspects of business. We see business through mental models, as a kind of a movie our minds play for us. In this movie, we remember result and experiences from the past (which requires imagination) and we create images of what might have been, or, in the future, what might be. We know these images are not real, but they play through our mental model of business reality. They inform our plans and projects. We imagine cause-and-effect relationships between imagined concepts and ideas, and between actions and outcomes.
From new product development to efficient administrative processes, every aspect of business involves — and requires — imagination.
We can use imagination in simulating possible results. Not only do we employ imagination in our regular business activity, we also use it for advanced complex modeling. We add new inputs to what we have constructed in our imagination — in the form of “what if” queries - to create a new mental model that’s different from the current one: a prospective reality that we can plan for and try to achieve.
As we try to achieve that prospective reality, we receive feedback in various forms, which we use adaptively to further adjust and improve the mental model we hold in our imagination. Imagination is dynamic, always changing.
Customers are also imagining, and entrepreneurs must imagine what they are imagining. We’ve highlighted in earlier episodes, the Value Learning Cycle that customers complete in the process of learning what to want and what to value (see Mises.org/E4E_44). The cycle begins with predictive valuation — consumers predicting to themselves how much value they’ll experience from the product or service a business is pitching to them. That’s imagination at work. If they buy and consume, value is an experience that results — and experience is a mental representation that includes imagination. Then in their post-experience valuation, customers adjust their mental model based on their new value knowledge. Future predictive valuations will be imagined with this updated knowledge.
Imagination is central to customer expectations of value and to customers’ decision-making.
Businesses use three kinds of imagination to make a value proposition. Businesses develop value propositions for customers, utilizing 3 kinds of imagination: creative imagination (imagining the design of a future product or service that will deliver a valued customer experience); empathic imagination (imagining how the customer will feel as a result of the experience); and predictive simulation (imagining what the world will be like after pursuing the contemplated action).
Creative imagination is a combination of needs knowledge (what customers want) and technical knowledge (what can be produced with available resources). In both cases, more knowledge is an aid to the imaginative process.
Similarly, empathic imagination can benefit from more knowledge about the customer’s mental model, developed through relationships and conversations.
Predictive simulation is aided by rapid learning from testing and prototyping and developing design artifacts (like landing pages and A/B tests) that enable interim simulations of customer responses.
Imagination can’t be shared but visions can. When we work on a team or in a firm, it’s productive to be aligned on the imagined future at which the group is aiming and is working towards. Strictly speaking, we can’t share imagination. Everyone’s imagination is subjective and individual. You can’t imagine what I’m imagining.
What can be shared is a vision, because it can be described in words developed from a shared language. Of course, every individual may interpret the meaning of the words differently, but with repetition, explanation and persuasive presentation, the group can get closer and closer to shared meaning. The vision becomes a cultural artifact — how we think in this firm, what we aim for in this firm, how we see the future in (and of) this firm.
Similarly, in selling value propositions to customers, businesses are trying to get those customers to share a vision. We persuade them with storytelling, whether it’s in the form of advertising, or PR or social media or the words printed on a package.
Rhetorical skills — being able to communicate in a way that enable other people to see and share a vision, and to adapt it to their own vision — are key to successful entrepreneurship.
Some people are better at imagination than others — but you can work on the skill set. Many business icons are or have been symbols of great imagination at work, such as Steve Jobs in the past and Elon Musk today. They’re better at seeing the future than others.
But everyone who understands imagination at the foundational level, as Mark Packard explained it in the podcast, can get better at it, and train others to get better at it, too.
Imagination is a simulation run through our mental model based on knowledge we possess. One important step is to improve the knowledge set available for the simulation — better quality knowledge, more accurate knowledge, more detailed or intimate knowledge.
More needs knowledge and more technical knowledge will improve creative imagination. Keep up with new technologies and with consumer trends and marketplace developments.
More customer knowledge will enhance empathic imagination. Spend more time with customers. Use qualitative research (such as the E4B contextual in-depth interview: Mises.org/E4B_151_PDF) to understand their mental model better, so that the empathic simulations you run through that mental model will improve.
Predictive simulation is an act of imagination that improves with learning about what works and what doesn’t. Run more tests and new kinds of explorations. Explore, explore, and explore more. Don’t take your own predictions too seriously; rather, expect to be wrong in ways you never imagined. Be humble, be adaptive, be agile, and recognize that you do have to predict in order to act. Triangulate with what others are doing because they’re imagining too, and they may have more and better knowledge than you. Try to reconstruct their mental models and assess whether they’d be helpful for you.
Additional Resources Elon Musk’s Imagination (Video): Mises.org/E4B_151_Video
"Subjective Value in Entrepreneurship" by Mark Packard and Per Bylund (PDF): Mises.org/E4B_151_Paper
"Empathy for Entrepreneurs: How to Understand and Identify Customer Needs and Wants from Their Perspective" (PDF): Mises.org/E4B_151_PDF
"Mark Packard on The Value Learning Process" (Episode): Mises.org/E4E_44
We’re highlighting six of our 2021 podcasts that have special value for value creators. We invite you to listen to the special year-end podcast, and to sample each of those we’ve highlighted here, review the Key Takeaways we provide as a summary for each one, and download the free tools that accompany each podcast.
Per Bylund explains that all successful entrepreneurs are Austrians.Episode #143: Mises.org/E4B_143Resource: "Explore and Realize (and Keep Exploring): How Austrian Entrepreneurs Generate Value on the Path to Business Success" (PowerPoint): Mises.org/E4B_143_PPT
Mark Packard joins Per Bylund to explain how Austrian Value theory enables entrepreneurs to radically re-shape business thinking for greater value generation.Episode #108: Mises.org/E4B_108Resource: "The Value Generation Business Model" (Video) Mises.org/E4B_108_Video
Matt McCaffrey outlines the Austrian approach to business strategy: emergent not planned.Episode #127: Mises.org/E4B_127Resource: "Emergent Strategy Process Map" (PDF) Mises.org/E4B_127_PDF
Mark McGrath orients entrepreneurs to purposeful adaptation to emergence via the OODA loop.Episode #138: Mises.org/E4B_138Resource: John Boyd's "OODA Loop Graphic" (PPT) Mises.org/E4B_138_PPT
Ulrich Moeller provides the organization design model for the adaptive entrepreneurial firm: it’s boss-less.Episode #133: Mises.org/E4B_133Resource: "The Future Of Organization Design" (PDF) Mises.org/E4B_133_PDF
Saras Sarasvathy pulls it all together in the form of The Entrepreneurial Method.Episode #131: Mises.org/E4B_131Resource: "Better Lives and a Better Society" (PDF) Mises.org/E4B_131_PDF
Entrepreneurship is fulfilling and exciting and inspiring. It’s fun. It’s learning. It’s a sense of achievement. It’s a journey. Economics For Business loves to spotlight individual journeys to illustrate what’s possible, provide learning about how to create and grow opportunities, and to inspire new entrepreneurship. This week, we are joined by Victor Chor, who leads us on a journey from a hobby of flipping on eBay to creating a brand and orchestrating a high-energy global value generation community.
Key Takeaways and Actionable Insights The journey starts with action — develop your “doing skills”. Victor Chor started his journey via “flipping” on eBay: sourcing items to offer for sale, and using sales feedback (what sells, what doesn’t) to determine future offerings. He developed the “doing skill” (as opposed to a “knowing skill” that comes from formal business education) as he made more and more sales. Flipping was a hobby that became a business.
What’s the benefit? Well, it’s fun. There’s money profit. There’s a sense of achievement. And there’s learning.
Experimentation is at the heart of entrepreneurial success. How do you find out what works? You experiment. Try this, try that. Learning results. Victor learned the products that sell best. He learned scaling, as a repeatable process yielding increasing returns. He learned the best feedback loops for adaptiveness — in his case inventory management and how to keep it low through accelerated sales.
Experimentation is a learning loop: experiment, gather feedback, learn, improve, run more experiments.
Adopting customer centricity is a further advance on the journey. To a large extent, Amazon, with its “customer obsession”, led the way in making customer centricity the norm for e-commerce and internet selling. They not only continuously raise the bar for customer service excellence in terms of quality, speed, convenience, availability, and range of choice, they also introduced wide ranging competition between 3rd party sellers on their platform. Competition is a virtuous circle for customer satisfaction: if one firm establishes an advantage or a superior offering to which customers flock, then competitors must improve their offering even more to re-qualify for customer acceptability.
In this environment, entrepreneurs learn about continuous improvement and the need to create a unique customer experience that can establish some sustainable advantage. The ability to grow in sales revenues morphs into the design of unique customer experiences.
A further advance in the mastery of customer centricity is to engage customers in product and service development — what we’ve been calling co-creation of value. Through surveys and e-mail marketing and just hanging out and talking with customers, Victor’s team has developed an acute understanding of customer wants, needs and preferences.
And the technology field lets us all think like customers. Victor points out that he and his team are all customers for the products they take to market. They’re all looking for quality and convenience and technological excellence, all experiencing what inconveniences customers, and therefore even better able to serve their market.
The next level of advance on the journey is brand building — imagining, designing, assembling, and marketing a differentiated branded offering. There is a transition point where a project can become a brand. A project to develop and deliver a high-function technology product can cross into the branded perception and branded experience area. Branding is the ultimate power in delivering uniqueness. A brand can establish a sustainable and unassailable perception.
Victor Chor advanced into brand building through building his community. The people he hired into his growing business has ideas for establishing and growing a brand. Wholesaling and distribution and manufacturing partners contributed both ideas and capacity. Victor developed a very original concept of a brand as a representation of all the people involved together in the venture. His image for a brand is that “it’s a ballroom”: set it up and throw a party in which many can participate and all are welcome to help shape new products and the future of the brand.
Infinacore is the brand name around which Victor and his team have assembled their community. It’s focused on wireless charging and related high-tech convenience: the brand mission refers to “making the wonderful world we live in as simple as plug and play”. This is a brand platform with unlimited future potential, based on how customers define simplicity and plug-and-play in the future, and how they judge what they find to be wonderful.
Reaching out more and more widely expands opportunity and opens up new avenues. Early in his journey, Victor utilized the services offered via Alibaba. He made contacts, built up a buddy list, engaged in chat on the platform, and used the network to source products. Many of his contacts in manufacturing and trading companies stayed in touch over time. Some of them started their own venture and their own factories. Long term relationships developed, and links to capability and capacity multiplied and grew stronger.
Everyone in this network is on their own journey, feeling what Victor called the “shared vibe” of connection and collaboration.
Alibaba proved to be a catalyst for learning — for example, learning a shared language, learning to negotiate, learning to communicate, and learning working practices like minimum order quantities — and an opening of new avenues, such as contacts with factories that could provide white labeling opportunities and technology improvements for original products.
Ultimately, Victor was able to develop a leadership skill in entrepreneurial orchestration: pulling together and integrating resources, people and processes in a value network dedicated to the shared pursuit of high-tech brand building.
The journey is arriving at a new peak, but never ends. There’s a new product / wireless charging system launch coming up for Infinacore. It represents a new peak in both technology and brand, a unique original design with new benefits. The Infinacore community has advanced to a new higher level.
The company has refined its vision and mission, not simply as communication, but as a picture of the future around which everyone in the community can gather and in which all can invest their effort and emotional energy. It’s ingrained. There‘s shared passion and shared emotion.
This is the step that removes the anxiety of uncertainty. When the vision is shared and the mission — what the community does repeatedly every day to make progress towards the vision — is clear, then the future is not a scary unknown, but a goal towards which there is continuous advance. There’s no fear.
Additional Resources "The Evolution Of A Global High-Tech Brand" (PDF): Mises.org/E4B_149_PDF
Visit Infinacore.com
Follow Infinacore on Instagram: @Infinacore
Human action lies at the core of the application of Austrian economics to business: how do people act and how can we develop the best understanding of why they act that way. We apply that thinking to customers, and we can also apply it to business organizations. If we are able to answer these questions well, we can develop a profitable business model and an effective management model. Our guest Diana Jones has a distinctive perspective about the management model that’s based on understanding people’s personal and private experiences rather than their place in the hierarchy or their formal role in the process.
Key Takeaways and Actionable Insights Relationships are fundamental to all systems thinking, and to all business management. Sociometry is a tool to measure relationships. Sociometry measures relationships between people and within groups. The unit of measure is distance. People can feel close to each other and other group members, and this closeness results in certain types of behavior. People can feel distant from each other, resulting in a different kind of behavior. They can also feel close or distant to concepts, like the company mission or the annual plan, and to institutions, like the Board of Directors or the HR department or a firm’s way of pursuing innovation. They can feel close or distant to colleagues in a meeting, or to the meeting purpose and agenda. Measuring and understanding relationship distance contribute directly to performance management.
Sociometry reveals the disproportionate importance of informal structures over formal structures. It’s easy to think of the formal organization chart as the model for managing a firm. Planning descends from higher levels to lower levels, along with instructions on how to implement and what to do. It’s not how companies function in reality.
What makes companies work is relationships. People form bonds with each other, and the bonds they form shape the work that they do and how they do it. The bonds are often forged via sharing of knowledge and experiences that are private and personal rather than business and process knowledge. Productivity comes from people connecting on shared experiences, so that these personal and private relationships become more relevant to business operations than the formal structures, such as hierarchy. When relationships change, behaviors change, and vice versa. When relationships shift, the whole business system shifts.
Formal structures don’t work, at least not in the way top management thinks. And the titles associated with hierarchical position can be alienating and toxic to relationships, symbolizing and reinforcing distance rather than closeness.
Sociometry helps to focus on these informal relationships and especially on the most important ones that make a big difference: for example, to improve customer service.
There’s a role for leadership in this system of informal relationships, but it’s not the one that generally taught or written about. Leadership can emerge amidst informal relationships, but it doesn’t come from authority. Leadership is not to be confused with position in the hierarchy. Leadership entails the communication of vision and helping people understand it, share it, and do the right things to achieve it.
The informal structure and its relationships make the formal structure work. The formal structure produces cynicism, anxiety, and reactionary behavior. The informal structure can eliminate these negative tendencies, unleashing untapped talent and enabling and refreshing the firm.
Leaders help people as guardians of these informal relationships: monitoring, empathizing, and nurturing.
Many people need help working in groups. It’s typical practice in business management to assign people to groups: agile teams, project teams, product development teams, functional teams, and so on. It’s seldom questioned whether or not individuals understand how to work in groups. Usually, they don’t. They’re unsure whether to speak up or be compliant, or whether conflict is valued to arrive at consensus or is to be avoided.
This is one more element of Diana Jones’ thinking and method that tells us that the traditional thinking of business organization and management process is mostly wrong. Hierarchy and formal organizational models don’t work, titles and authoritative roles are counter-productive, and reporting relationships are irrelevant when compared to relationship distance / closeness. There’s a lot of the traditional management model blueprint we need to scrap.
The better route to exceptional team participation and team results is via empathy. In Economics For Business, which is the application of the principles of Austrian economics to business management, we allocate great importance to the use of empathy as a tool, usually in the relationship between a business or brand and its customer. For example, we use empathic diagnosis to understand a customer’s dissatisfactions and unmet wants.
In Diana Jones’s model, empathy is an internal organizational tool. She deploys it in a sophisticated way that identifies four different types of application.
Cognitive empathy: imagining and understanding how a person feels and what they might be thinking.Emotional empathy: accurately reading and sharing the feelings of another person, and reflecting on those feelings in a way that helps everyone involved.Compassionate empathy: going beyond understanding to taking action that helps people deal practically with difficult situations about which they’re emotional.Group empathy: the capacity to read the emotional tone of a group that’s sharing a challenging experience. The core competency is the ability to read people and their emotional tone or state. Diana Jones gives the skill a name: interpersonal perception. It’s a skill that can be developed in a learning loop of experience, experimentation, curiosity, and intuition.
Additional Resources "Trust-Distance Matrix: Assessing the Cost of Distance in Business Relationships" (PDF): Mises.org/E4B_148_PDF
Leadership Levers: Releasing The Power Of Relationships For Exceptional Participation, Alignment, and Team Results by Diana Jones: Mises.org/E4B_148_Book
Diana-Jones.com
Strategic management theories and entrepreneurship theories have diverged in academia. One perspective can’t recognize the other. Yet the most promising and successful new business approaches demonstrate an agile combination of both sets of theories. Professor Mohammad Keyhani joins Economics For Business to explain this phenomenon and help us point the way to the future of strategic entrepreneurship.
Key Takeaways and Actionable Insights. In business school thinking, there is a dichotomy between strategic management and entrepreneurship. In management scholarship, strategic management and entrepreneurship are distinct fields of study. Professor Keyhani calls them “two logics” of business.
Both logics have gained legitimacy from their origins in economics. As business theories, they base their arguments on models from the field of economics, which, of course, is older and more mature. By importing thinking from economics, these business disciplines are able to construct generalizable theories (as opposed to, for example, a case study approach). The most famous generalizable theory in strategic management is Michael Porter’s five forces framework, which borrowed from industrial organization economics. Most strategic management theories have been based on general equilibrium models of neo-classical economics. Strategic management became a theory of structures and constraints, and of imperfections in equilibrium (such as the concept of competitive advantage).
The entrepreneurship discipline has been more varied and diverse and less dominated by economic models. Entrepreneurship scholars look to Austrian economics, which is based on verbal logic rather than mathematical models. But Professor Keyhani, in his Ph.D. dissertation, found an integration route between strategic management and entrepreneurship using the framework of game theory, adding elements of time and dynamics (both critical in Austrian theory) and adding the innovation of computer simulation (to which more and more Austrian economists are open as a way of adding computable algorithmic rigor to verbal logic).
He established a way for strategic management and entrepreneurship to communicate with each other.
Strategic management is a theory of competitive structures. Strategic management models are based on models of competition among players with similar value propositions, maybe with slightly different cost structures and other small differences, but all considered as competitors to each other. The models look at the nature of the competition, the structure of the competition, and seek insights into why some companies may have advantages over others.
Strategy becomes an approach of identifying and building on strengths, about sustaining and managing an existing system, about operations rather than innovation, and about control and prediction.
The consequence is a series of blind spots, mostly to do with the dynamics of action over time, the uncertainty that accompanies action, and the learning that results.
Entrepreneurship is a theory of dynamic value creation. The question in entrepreneurship is how to create value and how to build a value creation system in the first place. The entrepreneur faces the questions, “Am I creating any value at all? Is anyone going to pay for this innovation and be happy with it? And will I be able to get more customers?” These questions precede the models that strategy and strategic management theory have been based on. Those models start off with the entrepreneur’s questions having been answered, so they are not useful at the value creation stage.
Based on Austrian economics, the entrepreneurship literature has provided mental tools and mental models for entrepreneurial thinking and an entrepreneurial approach to business. These include the emphasis on subjective value and customer sovereignty, and on uncertainty and unpredictability in business. There is value in action in the face of uncertainty, because it creates new information, which can support better decision-making. That mechanism is totally lacking in the equilibrium models of strategy.
Theories of entrepreneurial action to generate learning are useful not only for startups but also for larger companies, to help them think and act more entrepreneurially, and to counter the defensive and anti-innovative thinking of building on strengths and defending position. Managing an existing value generation system can result in losing the long-term perspective of innovation, adding new product lines, taking advantage of opportunities, and potentially building new strengths.
“Do both!” The best approach combines strategy and entrepreneurship. Professor Keyhani argues that, ideally, firms think strategically and act entrepreneurially, and he recognizes that, in the real world of practitioners, this is what businesses do.
He uses blockchain as an example. No company can say that they have an existing strength in blockchain because it’s a new technology and the business concepts that utilize it are only just emerging. It’s a level playing field.
Are there any advantages a company could have? Maybe a company has a lot of computer scientists and mathematicians. That might be a slight strength. But getting into blockchain businesses is an entrepreneurial action, largely different than building on strengths.
The approach to innovation we support here at Economics For Business is “Explore And Expand”, and Professor Keyhani sees a good match between the explore-expand dichotomy and the entrepreneurship-strategy dichotomy. Exploration is a blind spot in strategic management theory and modeling — there is pretty much no exploration in the five forces framework or the RBV (resource-based view) framework. Exploration — acting for the learning value to open up options for more things that can be done in the future — is the entrepreneurial way of thinking.
Effectuation (covered in episode #131: Mises.org/E4B_131) is another form of entrepreneurial logic. It recognizes that the entrepreneur faces so much uncertainty that it may not be possible to set specific objectives. But the entrepreneur knows that they want to do something, that they have knowledge and resources and relationships, and that they may be able to create some value from them. Effectuation is the “fuzzy front end” of value creation.
Another way to combine entrepreneurship and strategy is speed of learning. The general capability to be more adaptive than competition, to go through the learning cycle faster, is a dynamic capability that can be strategic.
Competitive moats in the software world. Is the structure-and-constraints approach of strategic management useless in the digital era we live in? Sustainable competitive advantage seems to be inapplicable when anyone can write software (or download it from Github), and access hosting and storage at scale from AWS.
But in fact, software entrepreneurs do think in terms of competitive advantage. The modern term for it is “moats”. Venture capitalists look favorably on businesses that can surround themselves with a moat to keep out competition.
The most discussed moat is network effects. This concept did not come from the neo-classical economics equilibrium models, but from the dynamic analysis of more users coming in to join existing users. The five forces framework suggests that advantages lie either in cost or differentiation, but a network effects advantage can be both.
Two-sided platforms with two-sided network effects add even more complexity. It’s strategic to achieve that status, but the theory did not emanate from traditional strategic management thinking.
Professor Keyhani introduces the next entrepreneurial strategy breakthrough: generativity. We talked in episode #104 (see Mises.org/E4B_104) about the new phenomenon of digital businesses identified by Professor Keyhani: generativity. Achieving generativity confers significant competitive advantage for any entrepreneurial firms who can develop it through technology. It’s an advantage that is not identified by existing strategy theories.
Generativity can be thought of as the automation of open innovation. Products and services can be designed to offer features that enable outsiders to innovate with them, and these outside innovations benefit the company. For example, the Google Pixel smartphone and the Apple iPhone are generative products or generative systems. With the tools these firms provide in the phones, outside developers can create new apps, that they offer on the Pixel or iPhone platform for other outsiders to use. The app developers make money, and so do Google and Apple, both from sales of outsider-developed apps in their app stores, and from in-app purchases. Google and Apple are not utilizing their own knowledge — they don’t know the problem the app is solving, or even who developed it or where they are. They don’t have to make the solution, don’t have to take the risk, and don’t have to pay salaries or development costs. Yet they profit from the innovation. It’s a huge competitive advantage for these two entrepreneurial companies.
Additional Resources "The Strategic Management Model versus the Entrepreneurial Model" (PDF): Mises.org/E4B_147_PDF
"The Logic Of Strategic Entrepreneurship" by Mohammad Keyhani: Mises.org/E4B_147_Paper1
"Was Hayek an ACE?" by Nicolaas J. Vriend: Mises.org/E4B_147_Paper2
The ultimate list of tools for entrepreneurs—"Entrepreneur Tools" by Mohammad Keyhani: Mises.org/E4B_147_Tools
Ceaseless flux. Those are words Ludwig von Mises used to describe the perpetual change in business conditions that entrepreneurs experience. The consequent need, he told us, is for a process of constant adjustment. The current word for that process is adaptation. Economics For Business talks to Luca Dellanna, a leading business expert who advises companies of all sizes on managing the challenge of continuous adaptation.
Key Takeaways and Actionable Insights Adaptation is a necessary capacity of all businesses. Adaptation is a necessity. The marketplace changes, customers change, technology changes. Change is the norm. Firms that don’t adapt will suffer and potentially die, so adaptation must become the norm for business. In complex systems theory, adaptation is the selection of strategies or actions that enhance survival or any other measure of success (or fitness, as its sometimes called) amidst swirling change. In business, adaptation means choosing your degree and pace of change.
Change will be externally imposed if it is not internally embraced. Businesses can influence the level of change impact. They can critically examine their mental models, and assess their products, processes, beliefs, and people, to evaluate their fitness for adapting to market change. To avoid change being imposed from outside the firm — to avoid negative natural selection, in the evolutionary metaphor – all layers of the firm must embrace change, and proactively adapt. Eliminate unfit products and processes, pursue the development of new ones that are better adapted, and upgrade people resources through thoughtful hiring and active learning.
Adaptation is different than responsiveness — it’s embracing harm. We talk a lot about a business’s responsiveness to customer wants and preferences, especially when those preferences are fluid and incompletely articulated and require interpretation. Responsiveness is critical — but it’s different from adaptation. It’s response to an external signal. Adaptiveness is embracing change inside the firm.
Luca Dellanna has a striking way of communicating this: he advises his clients to deliberately expose themselves to what he calls “harm” — new problems never before encountered. The exposure must not be to a problem that could overwhelm the firm, but one that can be addressed at a subsidiary level or component level or via adjustment in a shared mental model. Luca calls this “small harm” — specific problems (e.g., the price of a product or service compared to the customer’s willingness to pay). Proactively probe the problem, e.g., in a high pricing test, generate feedback and actively use the learning to adapt. Another word for “small harm” is stressors: situations that put stress on the firm. Set up systems to seek out these stressors so that adaptation is deliberate, and can be enculturated, rather than wait for a crisis that requires an emergency response.
Lack of discomfort is a problem to avoid.
Identify the leading indicators that describe the conditions that will change the future. Lagging indicators — such as revenue — are metrics that describe the past. There are leading indicators available such as number of customer contacts (describing what the pipeline might look like in the future), and satisfaction scores (describing future repeat sales). Luca recommends pairing one lagging indicator with one leading indicator to develop a metrics system.
This is not the same as popular consultant-proposed metrics systems such as OKR (Objectives and Key Results). Objectives are not leading indicators. The best leading indicators are behaviors, because these can be easily adjusted if observed to be in need of change. Falling behind on objectives does not yield an actionable response if not linked to a causal factor. Inadequate behaviors (e.g., conducting a sales call without following the proven process) can be addressed, especially if they are clearly linked to positive outcomes.
This is the same principle as Amazon’s focus on what they call controllable inputs, and Amazon knows a lot about driving business growth.
There are several strategies to pursue adaptation. Redundancy (having more than needed): A focus on efficiency and “no waste” can be detrimental to adaptation if it leaves no resources for experimentation and exploration. Employees need time to work on new things, not just on current tasks and issues.
Bottom-up initiatives: Central command and control can’t run everything, anticipate every harm, or plan every experiment. Ensure entrepreneurial empowerment of front-line employees and functions so that they can initiate learning.
Avoid game-over: In experimenting, calibrate the risk to ensure that a negative result is not overwhelming, and, in regular operations, be aware of any possibility of a major crisis — a Black Swan event — and be sure that it will not destroy the firm or deliver a setback from which it will be hard to recover.
Never stop exploring, in a culture of anti-fragility.
Nassim Nicholas Taleb famously coined the term “anti-fragile”. The company that has the most well-developed capacity to learn from problems and harm is the most anti-fragile. The culture of anti-fragility is always to surface problems when they are encountered and address them at the source. Luca stresses that culture is built when everyone in the company can see a consistent set of actions in which the trade-offs of addressing problems are consistent with the stated vision. For example, a culture of safe operations will be reinforced when safety precautions are taken even when the cost, in time or money or both, is high.
The leading indicator is that every individual and every operation and sub-operation is following safe practices, and that the company readily commits resources when a new safety procedure or installation is proven to be effective. If the trade-off is made that the new procedure is effective but too expensive to install, the culture will be punctured because the company has acted contrary to its declared vision.
Additional Resources "The Power Of Adaptation" (PDF): Mises.org/E4B_146_PDF
Read Luca Dellanna’s book, The Power Of Adaptation: Mises.org/E4B_146_Book
Another application of adaptation, Teams Are Adaptive Systems: 12 Principles For Effective Management by Luca Dellanna: Mises.org/E4B_146_Book2
Visit Luca Dellanna’s website to find more resources: Luca-Dellanna.com
E-mail Luca at luca@luca-dellanna.com
The field of medical care is so ripe for new entrepreneurial solutions. As is always the case, solution design begins with understanding subjective value, both for customers (patients) and providers (doctors) Christopher Habig of Freedom Healthworks (FreedomHealthworks.com) joins Economics For Business to explain how an Austrian, subjective-value focused approach is bringing market freedoms to medical care.
Key Takeaways and Actionable Insights Step 1: Like many entrepreneurs, Chris Habig started a revolutionary business from a place of familiarity and existing knowledge. The so-called effectual process in entrepreneurship begins with two straightforward questions: what do I know and who do I know? Chris Habig grew up in a family where both parents are physicians. This vantage point gave him the opportunity to observe the critical doctor-patient relationship first hand, as well as the way in which modern bureaucratized medicine imposes obstacles and complexities that strangle the value generation potential of that relationship.
Step 2: Assessing the subjective value gap. From his Austrian analytical perspective, Chris was able to identify the subjective value gap. For customers (patients) it is the loss of the positive feelings that they associate with the doctor-patient relationship. Chris summarizes them as advocacy, access and affordability: my doctor is on my side and looking out for me; my doctor is always available to me; I will not be excluded for economic reasons. These feelings are negated by bureaucratic medicine.
There’s a subjective value gap on the physician side, too. Research shows that doctors are stressed, and no longer find fulfilment in their work. Their mental health declines and there is an increasing rate of defection (leaving the industry) and even suicide. It’s a sign of a dysfunctional system to exert such an effect on its human capacity.
Step 3: Identifying the barriers to remove. Value generation often consists in the removal of barriers to the realization of the desired experience. Chris identified two major barriers: insurance and government. The current approach to medical insurance actually hampers the market for what customers truly desire, which is the positive feelings of the doctor-patient relationship. Now it’s a patient-insurer relationship: will my visit / test / procedure be covered? Will there be a big bill in the mail?
And, of course, the participation of government to enforce the current system through legislation and regulation perpetuates the barriers.
Step 4: The entrepreneurial solution. The solution is to free the system from its constraints through entrepreneurship. The physician is the entrepreneur on the supply side. Via a new business model called Direct Primary Care (DPC), the physician-entrepreneur creates a new value proposition for customers. Access is provided via a subscription model, and this financial innovation enables the thriving of a practice composed of a small number of patients to whom the physician can devote more time per visit, more attention, and more personal and individualized care. The physician is networked into a web of complementary secondary and specialist services that can be orchestrated for the individual patient’s need. All the associated business services are clustered around the DPC practice, and the physician does not need to be bound by a hospital system bureaucracy.
The new financial model enables the customer to take charge of their medical expenses, paying cash for current needs and reserving insurance for catastrophic events, which is the way it should be used. Consumer prices are lowered throughout the system.
Lives are improved on both sides of the doctor-patient relationship.
Step 5: The support system for the entrepreneurial model. We live in an age in which distributed entrepreneurship can be embedded in an enabling system of digital infrastructure. Part of the innovation that Freedom Healthworks brings to the renaissance of the doctor-patient relationship is the platform on which the DPC business model can run.
Chris has identified 158 steps for the set-up, operation, and maintenance of a DPC business model. These can all be hosted, enabled, and implemented on the physician’s behalf. Finance, technology, operations, marketing, and vendor relationships can all be systematized and partially or fully automated. The doctor can focus on the relationship component of interacting with patients.
Step 6: Scaling. Can entrepreneurs build out a fully-functioning cash-based direct care system to rival and ultimately replace the government-insurance company nexus? It’s already happening. As each DPC practice proves itself, more entrepreneurial physicians will make the transition and momentum will build.
DPC is an important example of the future of entrepreneurial economics.
Additional Resources "Enabling A Direct Primary Care Practice" (PDF): Mises.org/E4B_145_PDF1
"FreedomDoc Launch Process" (PDF): Mises.org/E4B_145_PDF2
Healthcare Americana podcast: Mises.org/E4B_145_Pod
Visit FreedomHealthworks.com and FreedomDoc.care
Every company starts as an innovation. Thereafter, the unceasing challenge is to keep innovating because the market continues to change, technology continues to advance and, crucially, customer expectations continue to rise. Economics For Business speaks with Joe Matarese, Executive Chairman of Medicus Healthcare Solutions, about how to build the culture of continuous innovation and overcome the countervailing forces of the status quo.
How to understand consumer expectations and build organizational culture that rewards continuous innovation: Mises.org/E4B_144_PDF.
Key Takeaways And Actionable Insights Every company starts as an innovation. The challenge is to continue — and ideally accelerate — innovation without pause. As Joe Matarese puts it, innovation gets you into the game. It’s how every company starts. There’s the identification of a gap in the marketplace and the operationalizing of a new innovation to fill the gap, better than any other competitor or rival entrant.
Innovation is seldom a great new invention or unprecedented leap. It’s more often the day-to-day incremental changes and improvements in products and processes to meet customers’ changing expectations.
The great challenge is to continue or even accelerate innovation as the company grows and expands.
Continuous innovation combines mindset, processes, technology, empathy, and organizational empowerment. The world is complex and ever-changing. Innovation is necessary for all businesses to keep up or even move ahead. Innovation is not simple, and it’s not easy — in fact it’s a continuous struggle against opposing forces. Joe Matarese has directed innovation from three vantage points: big corporate, startup, and large growth company. To achieve the goal of continuous innovation requires attention to multiple factors:
Mindset: Innovation must be the commitment for everyone in the company. That means always asking the question, “How can we do better?” Such a mindset requires both tolerance of discomfort — since there’s never any rest — and humility in the face of feedback. Innovative companies hire people with these characteristics and cultivate constant vigilance throughout the firm.
Processes: Things get done through the implementation of processes. Innovative are always seeking to improve their processes — make them faster, lower cost, and more efficient in their use of inputs, especially the use of people’s time. Innovation itself is a process, and process improvement is a form of innovation.
Technology: Irrespective of how innovative any one company may be, technology is progressing at an increasing rate of change with potential to render all processes faster, lower cost, and capable of higher quality and fewer errors. One way to ensure continuous innovation is the rapid adoption and early implementation of new technologies as they become available.
Empathy: Even more powerful than technology is the capacity to tap in to customers’ expectations. This is the source of knowledge about future requirements. Customers are experiencing new technology, are absorbing innovation from other firms in the market (whether they are firms that are competitive to yours or simply adjacent), are experiencing change, and their expectations are changing and becoming more demanding by the moment. By sensing their changing expectations, the innovative firm is in position to be a first responder or an innovator before the expectation has even hardened or matured. Being ahead of expectations is a powerful place to be.
Empowerment: People in front line sales and service functions are closest to customers and their expectations. Line operatives are closest to process implementation. Supply chain managers are closest to business partners and vendors. It is these front-line positions that are best placed to deliver information about expectations and what’s changing. They are also best placed to sense dissatisfaction and unease, and to make real-time changes and adjustments. If they are empowered to make changes and to both suggest and implement improvements — even if what they try doesn’t work — they will be more highly motivated and more likely to serve as an internal engine of innovation.
Tools: Joe shares how his company, Medicus, has developed tools for innovation. Internally, all employees have access to communications tools that ensure the customer data they collect, and the ideas they generate as a result, are widely circulated and responded to. Externally, doctor whom Medicus reimburses for services have access to a tool to record their time that is administratively simple and generates fast payment, addressing two measures of unease.
Our Econ4Business.com platform curates many tools for entrepreneurs. One example relevant to this episode is the "Continuous Customer Expectations Monitor" (see Mises.org/E4B_144_PDF2). It guides entrepreneurs through the continuous process of tracking and keeping up with changing customer expectations.
There is a constant counterforce to innovation that the innovative company must recognize and overcome. There is an innate human resistance to innovation and change. Consider this from a leading brain scientist and psychologist:
When information streams in through our sensory systems, it first stops off at our amygdalae, which are there to ask the question, “Am I safe?” We feel safe in the world when enough of the sensory stimulation coming in feels familiar. When something does not feel familiar, however, our amygdalae tend to label that unfamiliar thing as dangerous, and they respond by triggering our fight-flight-or-play-dead fear response. —Jill Bolte Taylor, Ph.D., Whole Brain Living (Mises.org/E4B_144_Book)
It’s natural in humans to resist change. It may not be safe. It may threaten my job, or my comfortable routine, or generate unwanted uncertainty. Fear of change is real. The function that exercises the fear response in companies is bureaucracy. Bureaucracy exists to ensure compliance with existing rules, and their consistent and uniform implementation. Bureaucracy is anti-innovation.
When a business leader commits to improving a product or process, he or she is undoing what someone else in the firm had championed and nurtured and maintained. It’s a constant battle that must be waged between change and the maintenance of the status quo.
The adoption of new technologies is an effective technique of innovation, but it can also trigger a fear response. Technology is the continuous innovator’s weapon. It advances at its own pace, as a form of evolutionary advance. Every technological innovation spurs new applications in the marketplace. The adoption of these new technology applications is a catalyst for continuous innovation in the firm, supporting both product and service improvements and the incremental efficiency of processes — faster, leaner, lower cost.
The fear mechanism exhibits itself as employees worrying about their jobs. Perhaps the application of technology will reduce the number of people supporting a particular process from 5 to 4 to 3 or 2 or even one or none. They fear that progress will punish them. They adopt a defensive mindset. The innovator’s goal is to change the mindset to one of anticipation of rewards for progress.
Basic economics tells us that resources which are no longer utilized in a process that is rendered more efficient are thereby released for higher and more productive uses. Innovation leaders can communicate that, and make sure employees know they will be rewarded for progress via new and better opportunities for them to contribute more through the higher productivity that innovation brings.
The greatest resource for continuous innovation comes from customer intimacy and empathy that senses customers’ escalating expectations. When we talk about a changing marketplace, we are really talking about customer expectations. Innovation elevates customer expectations and thereby triggers the next round of innovation in a never-ending cycle.
For example, now that many people carry iPhones and other smartphones, they’ve become used to unprecedented levels of convenience, interconnection, functionality, and intuitiveness. Their expectations for every other piece of technology they encounter, and every interface they navigate, are raised to a new level. There’s a marketplace of expectations and every new technology raises the bar.
The way to keep pace, and to have any chance of anticipating and meeting the next level of raised expectations is to get as close to the customer as possible, to be with them when they’re using your product or service or technology and listen and empathize when they express a wish (or expectation) that the experience could be easier, better, faster, less frustrating, more enabling. “I wish it were as easy as my iPhone” is the expression of an expectation that everything should be as easy as the iPhone.
Innovating firms build in mechanisms that make continuous innovation not only possible but likely. There’s a quote in the book Working Backward, about continuous innovation at amazon, to the effect that “Good intentions don’t work, mechanisms do”. The intent to improve a process or product is not enough; people already had good intentions in the first place. Mechanisms turn intentions into actions and achievements. Some of the mechanisms Joe Matarese recommended are:
Mechanisms for taking in data from and about customers: Customer intimacy has a mechanism, in the form of frictionless and unstructured data collection. Give front line employees and the technology they use the unfiltered capacity to gather customer information about their dissatisfactions and report it back.
Let people experiment: The E4B technique of explore and expand applies to everyone in the organization. Elevate experimentation over compliance. That’s the way learning happens.
Eliminate bureaucracy that is not mission-supportive: Every company eventually builds bureaucracies in order to support consistent application of business rules. Innovators differentiate between bureaucracy that is mission-supportive and bureaucracy that is mission-obstructive. HR is often a department where bureaucracy grows. If HR is helping to recruit talented people who will contribute to innovation, then the bureaucracy is mission-supportive. If HR imposes rules that unnecessarily impede innovation, then that part of the bureaucracy should be shut down. The goal is to liberate the value-generating creativity of everyone in the organization, and not to impede it.
Decentralization and entrepreneurial empowerment: Decentralization is a mechanism of innovation. The goal is for your organization to consist of hundreds of individuals thinking creatively and solving problems for customers. You want them all to think and to learn! They must know that the firm cheers them on for doing so.
Additional Resources "Designing An Organization For Continuous Innovation" (PDF): Mises.org/E4B_144_PDF
"Continuous Customer Expectations Monitor" (PDF): Mises.org/E4B_144_PDF2
Medicus Healthcare Solutions: MedicusHCS.com
Econ4Business.com
Whole Brain Living: The Anatomy of Choice and the Four Characters That Drive Our Life by Jill Bolte Taylor: Mises.org/E4B_144_Book
Successful entrepreneurs are Austrians, they just don’t know it yet. This is a famous assertion from Dr. Per Bylund, and we dissect its meaning in the latest Economics For Business podcast.
Key Takeaways and Actionable Insights Success starts from a deep understanding of subjective value (see Mises.org/E4B_143_PPT). What’s the value of a successfully completed Google search? What’s the value of the feeling of satisfaction that results from having cooked an excellent meal enjoyed by your family? What’s the value of the PowerPoint template you utilized to make a well-received boardroom presentation that may boost your corporate career?
Austrian entrepreneurs know not to ask the question in that form. First, value is not measurable; it’s a feeling or experience in the mental domain. It may have great intensity, it may have long duration, but it can’t be measured in dollars or with any other number.
Yet the generation of customer value is the entrepreneur’s goal. How can the goal be achieved when the understanding of value is so challenging and its measurement is impossible? This is the brilliant advantage of the Austrian entrepreneur.
The customer learns what a value experience feels like. A customer can’t describe the value they are seeking or what goods and services will deliver it. The value process is not one of demand and supply. As Ludwig von Mises understood, customers feel a sense of unease — “things could be better” — and begin to explore possible avenues to relieving their unease. Of course, this exploration takes place within a complex system of needs: individual and personal goals, family comfort and security, job success and economic status. Customers sort through possibilities with incomplete information and in the context of uncertainty. The gap between feeling unease and finding the best good or service to address it is large. They might try multiple potential solutions with varied cost/benefit profiles before they arrive at one that seems best, or better than alternatives. In other words, they learn: value is a learning process.
The entrepreneur helps their customers to learn. The customer’s value thinking is constrained: in the present, they can’t imagine a solution that they haven’t yet tried or that has not been available to them. The entrepreneur innovates around the constraint, by providing and communicating new means that the customer could utilize in the future.
Entrepreneurs can’t directly shape the customer’s choice. It’s a fallacy to believe that advertising or promotions or presentation of features and benefits can accomplish that. The customer’s context is too complex for such a simple mechanism to work. The entrepreneur creates a tomorrow in which the customer will feel better off, and provides the means to facilitate the experience, a means for the customer to learn what a better tomorrow feels like. They meet customers in a market that doesn’t yet exist.
Austrian entrepreneurs have a unique value generation tool. The complexity of the customer’s value system — all the components of value interacting and changing in time — can be simplified with the use of a key that Austrians call the hierarchy of values. Every individual has a set of goals or values they pursue in life. Some of these are more important than others — we call them the highest values. For example, people who engage in sport and athletic activities may have several values for doing so: for fitness and health, for social reasons, for self-improvement, and so on. One value may be the most important in their own individual hierarchy — for many people it is the sense of achievement. By improving their speed or time of running or bicycling, by winning a tournament or a league or playing on a winning team, the individual can experience a sense of personal achievement that is rare, valuable, and fulfilling.
It is a commercially strong behavior to appeal to this highest value among customers. Nike does this for example with its “Just do it” appeal. To simply undertake the athletic activity is achievement: you’ve done something. And, of course, Nike wearables help the process of experiencing the highest value.
All entrepreneurs can appeal to customers’ highest values, and the Austrian entrepreneur has deeper insight into this action.
Austrian humility is a success factor. So much of business success is projected as heroic implementation of superior strategy. Austrian entrepreneurs do not suffer from such hubris. They take a humble approach to business, understanding that the customer is often engaged in searching and learning without a clear outcome in mind, and that, therefore, the entrepreneurial business cannot be certain of any future results. Entrepreneurs humbly follow, letting the searching customer take the lead, and accepting the customer’s terms of service.
This is how entrepreneurs learn how to facilitate value — often from the harms they suffer from getting their value proposition out of alignment with the customer’s preferences. If the value proposition is wrong, or the price is too high, or the convenience not to the customer’s liking, then no transaction is made, and the entrepreneur must — humbly — adjust. The most successful entrepreneurs are able to maintain their attitude of humility at all points in the value cycle.
Austrian entrepreneurs take the role of fitting in to the customer’s value system. It’s a flow, not a plan. Conventional business planning is anathema to Austrian entrepreneurs. The linear process of producing and selling to generate transactions with the goal of meeting a targeted volume or revenue in a fixed period of time is not appropriate for the humble, learning, exploring business of entrepreneurship.
Entrepreneurial success stems not from good planning but from adaptively fitting in to the evolving value system we call the market — a system that is different for every individual customer, and into which many overlapping and competing entrepreneurial value propositions are also trying to fit.
Planning is not a good tool for this purpose. Creativity, imagination, and adaptiveness are called for. The dynamic of learning from the customer and adjusting to changing signals calls for responsiveness not plans. The entrepreneurial journey with the customer is a flow, sometimes through white water. In this context, the Silicon Valley concept of pivoting is appropriate, although not quite as the West Coast gurus see it. Their pivot is a one-time major shift in direction, perhaps to a new business model when the original one proves inadequate. The Austrian pivot is continuous and flowing, adjusting the boat to the subtle and frequent signals sent by customers.
Explore, Realize, Then Keep Exploring. We’ve talked in the past about an “explore and expand” model for entrepreneurial value generation. The entrepreneur co-explores various paths to value with the customer, and when one emerges as productive of significant value, the entrepreneur can expand the allocation of resources to that path and drive revenue growth, through selling more to the same customers, or recruiting new customers or both.
Professor Bylund added some nuance to this: the entrepreneur never stops exploring. When an exploration results in substantial value realized, there remains a lot of further exploration to understand the value experience of the customer in greater depth and detail, and continuous monitoring of changes and adjustments in the customer’s system and value network. The entrepreneur is continuously tested.
The entrepreneurial ethic is an ethic of service; profit is a shared outcome of consumer and producer choices. Entrepreneurial firms are in business to serve customers. This principle may be appropriately expressed via mission statements and expressions of purpose; it remains the core of all entrepreneurship. Profit is an outcome of two collaborative choices: the exchange price the consumer is willing to pay for the value they anticipate receiving, and the choice of costs the entrepreneur considers proportionate to the value he or she expects to generate for the customer. There are many entrepreneurs in the market for resources bidding on costs at the same time, and so the individual entrepreneur’s choices are conditioned by those made by others. Profits emerge from this system.
Cash flow is a better indicator of the capacity of the entrepreneur’s business model to convert resources into exchange value for customers (although not the artificial cash flows of engineered P&L’s — rather, the true cash flow of the customer’s eagerness to exchange for the newly produced offerings from the entrepreneur).
There’s a distinctly Austrian approach to entrepreneurial business. In a famous paper called "Inversions of Service-Dominant Logic," (see Mises.org/E4B_143_PDF) professors Stephen Vargo and Robert Lusch called for inverting “old enterprise economics or neoclassical economics” in favor of a new perspective. One of their proposals was an inversion of “entrepreneurship and the view that value creation is an unfolding, emergent process” to a position “superordinate to management”. Business schools, they stated, teach a management discipline rooted in the industrial revolution. There’s an emphasis on centralized control and planning. Vargo and Lusch sought to replace this approach with value creation as “an emergent process within an ever-changing context, including ever-changing resources; it is, by necessity, an entrepreneurial process”.
The distinctive Austrian entrepreneurship approach captures and expresses the emergent process, and provides entrepreneurs (and managers) with the tools and methods to help them shape thriving businesses as they discover new solutions to relieve customer unease.
Additional Resources "Explore and Realize (and Keep Exploring): How Austrian Entrepreneurs Generate Value on the Path to Business Success" (PowerPoint): Mises.org/E4B_143_PPT
"Inversions of Service-Dominant Logic" by Stephen L. Vargo and Robert F. Lusch (PDF): Mises.org/E4B_143_PDF
Entrepreneurial businesses acknowledge and understand the inevitability of boom-bust cycles in the Fed-manipulated economy. But they refuse to be defeated or even deterred. They find the profitable pathway through both the boom and the bust. Murray Sabrin has compiled a guide in his latest book, Navigating The Boom/Bust Cycle, An Entrepreneur’s Survival Guide (Mises.org/E4B_142_Book).
Key Takeaways and Actionable Insights So long as we have central banking, entrepreneurs will experience boom-bust cycles. They adapt to this reality. Entrepreneurship is, in its essence, focused on the generation of new value, producing betterment, growth, and improvement. While customer preferences and the nature of competitive offerings may change, and conditions such as pricing and contracts may vary, entrepreneurs work towards continuous enhancement of markets.
Their efforts are thwarted by governments, who can’t leave markets alone to function smoothly, and especially to central banks who aim overtly at manipulating markets through artificial credit creation. Austrian entrepreneurs are acutely conscious of this problem, since they understand Austrian business cycle theory. But they must nevertheless adapt to the boom-bust problems the central bankers bring about.
The first tool of adaptiveness is the recognition that there is the private economy and the public economy are different and separate. Some economists talk of a mixed economy, but, as Mises pointed out, such middle-of-the-road thinking is socialist. The public economy is where the government trades, including trading in money, debt, and credit manipulation, and in the regulations that governments use as their management tool.
Entrepreneurs seek to establish a private economy where the government does not trade. The most important part of the market where the government is absent is the creation of customer value, especially in the form of innovation. Governments destroy value and deny innovation. When entrepreneurs can operate in the light of value generation, leaving governments in the dark, there’s room for profitable operations.
Entrepreneurs can further protect their safe haven with good anticipatory timing of the boom-bust cycle. There are signals that help. Murray Sabrin’s book provides a long list of websites and links where relevant data is published that can help entrepreneurs watch the trend that might signal the timing of the boom-bust cycle.
The first signal is the so-called inversion yield curve, when short term interest rates start to elevate, and even get to higher levels than longer term rates. This is unnatural, implying that there is greater uncertainty in the short term than the long term. It can only happen when markets are fearful of the short-term consequences of government policies and interventions, even though they are confident of entrepreneurially-induced growth and improvement in the long run.
As a rule of thumb, according to Murray, the beginning of a recession can be anticipated roughly one year from the inversion of the yield curve. Of course, other factors can intervene, such as the government’s idiotic shutting down of businesses over the fake COVID-19 pandemic. Nevertheless, entrepreneurs should pay attention to the yield curve signal. They can monitor it at Mises.org/E4B_142_Fred.
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Another signal for entrepreneurs to monitor in the overall economy is the unemployment rate. This rate declines during the boom, and actually starts declining as the recession is ending or a few months afterwards. There are variations in the pattern by industry, which Murray describes in detail in the book. He provides a list of 12 St. Louis Fed employment data series to monitor, covering sectors such as manufacturing, durable consumer goods, finance and insurance, and construction.
He offers many more signals — such as homebuilder stock prices — to monitor boom-bust timing. There is plenty of data for the savvy entrepreneur.
Strengthening value effectiveness and value security beats managing for efficiency. The economics profession has been guilty of misguiding entrepreneurs with its focus on efficiency, i.e., managing for fewer inputs per unit of output, and eliminating “waste”. It can cause fragility, impede value generation, and slow down innovation and responsiveness to change.
One example is the management of supply chains. Managing them for maximum efficiency can also make them insecure, if, for example, there are no ready supplier replacements when one slips up. We are experiencing the impacts of supply chain fragility right now in the US. It’s for reasons extraneous to regular business operations, but the effects serve to highlight the need to keep supply chains secure under attack from government interventions. Entrepreneurial businesses that develop the strongest possible upstream supplier relationships and cultivate a richly connected value network may be able to perform better when boom-bust hits the supply chain.
Entrepreneurs fight the Fed on inflation. The Federal Reserve insists on maintaining its 2 percent inflation target, which is economically destructive in many ways (see "Why the Fed's 2 Percent Inflation Standard Is So Bad" by Ryan McMaken: Mises.org/E4B_142_Article). Entrepreneurs pursue deflation, always aiming to deliver better quality at lower prices. Why? Because it’s what customers want, and entrepreneurs are in business to serve customer needs. Entrepreneurs bring abundance. The Federal Reserve, taking the position that higher prices are good for the economy, promotes scarcity.
Entrepreneurs make their workforce a strong resource, rather than a source of cost-cutting in economic downturns. The purveyors of so-called efficient management traditionally see the workforce as a cost, and urges entrepreneurs to cut costs by firing people in economic downturns. Entrepreneurs focus on effectiveness instead, and see their workforce as a resource and a source of ideas and initiatives for improvement and adaptation in all environments. A motivated frontline workforce is closest to customers and can bring back information, ideas, and new initiatives to make the business more responsive to customer needs and more capable of delivering desired customer experiences. This is the case whatever the state of the Fed-manipulated economic cycle.
Growth entrepreneurs think expansively at all times. Entrepreneurs create new value for customers, and they don’t call a halt to their pursuit of value just because of the macro-economic data that’s being reported in the mainstream media.
They understand that customer preferences, or the order of those preferences, may well change in a boom or a bust time, and they maintain their vigilance in monitoring and responding to these changes. These are the signals to which they respond, not the economic headlines. Entrepreneurs look for the opportunity to introduce new goods and services at all times, and not just at the “right” moments in the economic cycle. They’re always looking for new ways to deliver more value. Perhaps, in a downturn, there’s a greater call for service and repairs on existing equipment than for buying new equipment. Entrepreneurs can adjust and recombine their assets to provide more repair work and thus make up for lost sales revenue.
Entrepreneurs are great cash flow managers, and tend to keep cash on hand or available for those times when this level of money can be utilized for expansion. One potential application in this book is the acquisition of assets from other businesses in a downturn, when business operators who are less savvy run out of cash and offer assets for sale at low cost. Murray calls this “picking up the pieces”.
There may also be the opportunity to expand geographically into new regions. There’s always growth somewhere.
In sum, the answer to the boom-bust cycle is value agility. In the 4Vs business model on the Economics For Business platform, the fourth phase of the value cycle is value agility. We use this term to indicate the speed of responsiveness that successful entrepreneurs exhibit in response to customer feedback. Murray Sabrin uses the same term in his book, and defines it as “a process where entrepreneurs... adapt and adjust to continue to meet consumers’ perceptions of value your business delivers” (p. 111).
He asks, “do entrepreneurs stick it out when the economy is in a slump or wave the white flag and close the doors?” Mastering value agility means never being faced with that agonizing decision.
Additional Resources Purchase Navigating The Boom/Bust Cycle, An Entrepreneur’s Survival Guide at Mises.org/E4B_142_Book. Use promo code BOOM20 for 20% off.
See a preview of Murray Sabrin's book at Mises.org/E4B_142_Preview (PDF).
"The 4Vs Business Model" (Video): Mises.org/E4B_142_Video
The Economics For Business platform: Econ4Business.com
"Why the Fed's 2 Percent Inflation Standard Is So Bad" by Ryan McMaken: Mises.org/E4B_142_Article
10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (Chart): Mises.org/E4B_142_Fred
All value is subjective. But often, when an exchange is to be made, a numerical value is required. It’s a special kind of economic calculation, what Bharat Kanodia terms “a subjective opinion based on objective facts”.
Bharat has built a career on valuations, from 2-founder garage start-ups to the Eiffel Tower. He shares his knowledge, experience, and insights with the Economics For Business podcast.
Key Takeaways And Actionable Insights Valuations start with a “what?” and a “why?” What is the subject of the valuation? Is it a building but not the land it’s sitting on? Is it a patent? Is it a monetized patent or just an approved patent? Is it the assets of a business or is the going business? All these definitions and classifications of what’s being valued clearly make a big difference to the outcome.
What is the purpose of making a valuation? It might be a step in buying a business. Or in selling a business. It may be a valuation of an asset for insurance purposes, or for estate tax estimation. The valuation may be a tool for raising capital, or an assessment following a capital raise. The same asset can have different valuations for different purposes.
That’s why it’s important to start with the what and the why.
The most challenging business valuation is for a start-up. Two founders working from a garage have a business idea and some code but no customers and no revenue. The business needs a valuation in order to raise capital. It makes no sense to value it on the basis of discounted future projected cash flows. They’re imaginary.
The business is going to be valued based on the story the founders tell, and a rule of thumb valuation that works backwards from the percentage of the business the founders are willing to give to a seed investor.
Most 2-founder garage pre-revenue businesses are deemed worthy of a $1 million valuation, because an investor can be given 20% of the business for a $200,000 investment, which are reasonable heuristics for both parties. Bharat advises founders not to haggle too much over this valuation stage — if the business is successful, this initial financial structure is largely irrelevant for the founders.
In subsequent post-revenue investment rounds, operations have more impact on valuation than future revenue projections. Even once there’s revenue and a validated business model, projected future revenues are seldom the basis for valuation. There’s usually a hockey stick projection, or a long list of unverifiable assumptions. It’s more important to investors — and valuers — to examine operations, and specifically whether the business owners have a valid, detailed, and convincing plan to scale up. This kind of operations planning demands great rigor, both for purposes of implementation and for convincing investors.
Often, it’s the quality of storytelling that underpins the valuation. With a detailed operations plan in place, the selling business founder or proprietor can build a persuasive story about future growth and potential. Here, emotion plays a big part. Can the business owner communicate how intensely the need is felt by potential customers? Can he or she communicate the passion they feel to deliver a solution to those customers? And the deep emotional commitment to the years of hard work it will take to attain appropriately ambitious goals?
The story, well-executed, validates the valuation.
For businesses like CPA firms, medical practices, and construction, 2 major factors have an outsize influence on valuations. When an investor buys a mature service business, especially a local one, they are generally seeking hassle-free cash flow. They’re not looking to buy problems to fix.
Two factors stand out for these kinds of buyers. One is reliable recurring revenue from loyal customers. It must be revenues that are fully attributable to the service, and unlikely to be cut when there is a change of ownership.
The second is automation or established smooth-running and self-maintaining operations mechanisms. Bharat’s advice to sellers of these kinds of businesses is to automate everything you can, with reliable control software wherever possible.
These kinds of service businesses may have high levels of reputation and trust based on surveys and qualitative data, but those intangibles must be backed up with the behavioral reliability of the customer base.
In today’s markets, followers are a highly valued asset. In many ways, recurring revenue is a metric to quantify followership. Ryan Reynolds has a followership. Nike has a followership. Tom Cruise has a followership. These followers are all monetizable as buyers of goods or services or movie tickets associated with these personalities and brands. Your personal brand has value if you have followers and if the followership can be monetized.
Every asset can be assigned a valuation — even the State of Hawaii and the Brooklyn Bridge. Bharat has been called upon to give valuations of the Brooklyn Bridge, the Atlanta airport, and the state of Hawaii, among many other famous places or things. Sometimes, the valuation is for insurance purposes, sometimes for accounting. In all cases, there’s a number (or a range).
Once the what and the why are established, there is a mechanism for valuation that can be applied to any asset or stock or flow.
Additional Resources "Pathways To Business Valuation" (PDF): Mises.org/E4B_141_PDF
"How to Double Valuation?" (Video): Mises.org/E4B_141_Video1
"What’s Pre-IPO Worth?" (Video): Mises.org/E4B_141_Video2
Family businesses play a major role in the US economy. According to the Conway Center, family businesses comprise 90% of the business ventures in the US, generate 62% of the employment in the nation, and deliver 64% of US GDP.
And, they’re good at venture capital. Samuele Murtinu, Professor of Law, Economics, and Governance at Utrecht University, visits the Economics For Business podcast to share the findings and insights (see Mises.org/E4B_140_PDF) from his very recent analysis of venture capital databases.
Key Takeaways and Actionable Insights Corporate venture capital is a special animal. There are many types of venture capital. Professor Murtinu focused first on the distinction between traditional or independent venture capital (IVC) and corporate venture capital (CVC). Independent venture capital funds are structured with a general partner in the operational, decision-making role, and investors in the role of limited partner.
Corporate venture capital funds are fully owned and managed by their parent corporation. The CEO or CFO of the corporation typically appoints a corporate venture capital manager, who selects targets, conducts due diligence and so on from a subordinate position in the corporate hierarchy.
The important difference between IVC and CVC lies in objectives and goals. IVC goals are purely financial — the highest capital gain in the shortest possible time. CVC funds often have strategic goals in addition to, or substituting for, financial goals. These strategic goals might include augmenting internal R&D capabilities and performance, and accessing new technologies and new innovations, or entering new markets.
Another form of CVC licenses patented technologies to startups in cases where the corporate firm does not have the capacity to exploit the IP, but can oversee the implementation at the startup with a view to further future investment or acquisition. This is the method of Microsoft’s IP Ventures arm, for example.
Typically, IVC investments are easy to measure against financial performance benchmarks or targets. CVC’s strategic investments are harder to measure. Goals such as technology integration are too non-specific to measure, and normal VC guardrails like specified duration of investments are not typically in place and so can’t be used as benchmarks. On the other hand, CVC investments often expand beyond the financial into strategic support via corporate assets such as brand, sales and distribution channels and systems.
Corporate venture capital out-performs traditional venture capital in overall economic performance. Professor Murtinu’s performance metric in his data analysis was total factor productivity — performance over and above what’s attributable to the additions to capital and labor inputs. IVC’s performance for its investments was measured in the +40% range, and CVC’s was measured at roughly +50%. IVC performs better in the short term, while CVC performs better in the longer term. This difference reflects the lower time preference of CVC. It extends to IPO’s: corporate venture capital funds stay longer in the equity capital of their portfolio companies in comparison to independent venture capital.
Family CVC is another animal again — and even higher performing than non-family CVC. Professor Murtinu separated out family-owned firms (based on a percentage of equity held) with corporate venture capital funds for analysis. Some of his findings include:
They prefer to maintain longer and more stable involvement in the companies in which they invest.They prefer to maintain control over time (as opposed to exiting for financial gain).They look to gains beyond purely financial returns, including technology acquisition / integration into the parent company and/or learning new processes.They are more likely to syndicate with other investors, for purposes of portfolio risk mitigation.They target venture investments that are “close to home” both in geographic terms and in terms of industries closely related to their core business. The resultant outcomes are superior: a higher likelihood of successful exits (IPO or sale to another entity), and a greater long term value effect on the sold company after the IPO or exit. Further, there is evidence from the data of a higher innovation effect for Family CVC holdings, as measured by the post-exit value of the patent portfolio held by the ventures.
Family CVC is resilient in economic downturns. During the last economic downturn, family CVC invested at double the amount of corporate venture capital, reflecting family businesses’ preference for long-term investing and for control.
The lower time preference of family businesses and family CVC is crucial for the achievement of superior financial performance, especially in the longer term. Family CVC’s lower time preference and longer investment time horizons result in beneficial effects. Ownership in the venture companies is more stable, and the value effect after IPO (when family CVC stability continues because these funds stay in the post-IPO company longer) is significant.
Professor Murtinu relates this phenomenon to Austrian economics. The longer time horizon permits a closer relationship between investor and entrepreneur — it develops over time — and their subjective judgment about the future state become more aligned. Frictions and information asymmetries are reduced, and a shared view of the future emerges. This stability can scale up to the industry level and national level when there are more family CVC funds at work. Instead of pursuing unicorns and gazelles, an environment more conducive to duration and resilience is created.
Additional Resources "Types of Venture Capital" (PDF): Mises.org/E4B_140_PDF
"Families In Corporate Venture Capital" by Samuele Murtinu, Mario Daniele Amore, and Valerio Pelucco (PDF): Mises.org/E4B_140_Paper
Entrepreneurship is a method, and it’s also a mindset. Fabrice Testa has written a book that brilliantly integrates the two: he calls the integration "Super Entrepreneurship," and his book title is therefore Super Entrepreneurship Decoded (Mises.org/E4B_139_Book). He has the appropriate credentials as a proven super-entrepreneur who has created and nurtured numerous great companies (and successfully sold a couple of them).
Fabrice knows the true meaning of the phrase, “The day before something is a breakthrough, it’s a crazy idea”.
Entrepreneurs are animated by their purpose. Super entrepreneurs embrace a massive transformative purpose. The motivation for entrepreneurs is to help others — to solve problems for others, as we sometimes phrase it. Super entrepreneurs, in Fabrice Testa’s language, are those who choose to dedicate their businesses to solving the biggest problems. By setting big goals, they attract many like-minded partners, collaborators, and employees. By targeting transformation, they aim to change the world in a significant way.
In making this choice, super entrepreneurs are delving deeply into their own personal story to understand their own drivers and their own passionate commitment. There’s a major self-discovery component.
Having set their MTP, super entrepreneurs develop a systematic approach to the pursuit of their goal. Fabrice Testa recommends that super entrepreneurs combine what he calls CRAZY thinking with a relentless sense of purpose. CRAZY is an acronym for elements of entrepreneurship that Testa calls the Five Secrets. We agreed not to give them away, but they add up to a five-step method entrepreneurs can follow, and a checklist that they can use to assess the market power of their own concepts and business models.
The context for the 5-step method is the exponential rate of growth of available and applicable technologies for entrepreneurship, and the convergence of those technologies that results in a compounding of productivity. When, for example, sensor-based data collection can be combined with A.I. and robotics, whole new fields of automation open up, potentially helping billions of people.
A relentless sense of purpose is a major element in the super entrepreneurial mix. Super entrepreneurs are highly motivated. They display high levels of ambition and drive, and they generate strong momentum. They seek change, and aim for breakthroughs. They love to set the bar high.
There is a spirit to super entrepreneurship, an intangible spark of super energy and boldness that sets the best entrepreneurs apart and powers them to unusual levels of achievement.
There’s a plan, but it’s not fixed. Fabrice Testa identifies a master plan for the activities of high-achieving entrepreneurs, but it’s not the restrictive plan of the business school strategist. One term he used was Roadmap: there’s a goal to get from A to B, but it’s OK to visit C, D and E along the way, and to learn and double back and embrace recursive procedures to reach the targeted end-results. The key to success is keeping the goal in mind with flexibility on the route to get there.
Let the customer be the guide. Testa subscribes to the protocol of involving the customer early and often in the process of designing and building a product or service or a company. Entrepreneurs are always working with assumptions, and, at minimum, must validate them with customers.
He introduced us to the “Starbucks method” of customer validation. Park yourself in Starbucks, order a beverage of your choice, then look around for likely-looking people who might be open to a brief conversation about your idea or proposal or even prototype. It’s easy to engage people, they’re willing to help, and you can offer to buy them a coffee to lubricate the relationship. A few hours investment of your time and a few dollars invested in coffee will result in a deep, broad and rich set of reactions and responses and a meaningful feedback loop.
Success is more about fitting in than it is about timing. When writers and historians are trying to analyze the unusual success of a particular business, they often attribute a lot of the cause of the outcome to timing — the product or service or technology came along at just the right time. This is a misinterpretation. The happy correspondence of a new offering with a receptive context is not timing but fitting in.
According to Fabrice, to fit in in a big way is to fit in with the zeitgeist of the era. The dictionary definition of zeitgeist is the general intellectual, moral, and cultural climate of an era. What Fabrice is pointing towards is a heightened ability to sense the movement of the time, and the direction of its flow, and to step into that river at the right point.
Entrepreneurship is everywhere, and can be achieved at multiple scales. Super entrepreneurship is not limited by the scale of resources, but it can certainly be augmented wherever resources are abundant. That’s why we seek to encourage entrepreneurship for individuals, teams, and firms of all size, including the largest corporations. Big companies under-perform at entrepreneurship for two reasons. First, they spawn bureaucracy, which is a form of organization that is counter-entrepreneurial. Second, they have existing businesses to defend and fear the consequences of self-disruption.
The solution is to change the purpose of big corporations so that they can become super-entrepreneurial. The purpose would be to create new businesses with no bureaucracy and separated from the defense mechanisms of existing business units or divisions.
Additional Resources Super-Entrepreneurship Decoded: 5 Secret Keys to Create Breakthrough Businesses that Change the World by Fabrice Testa: Mises.org/E4B_139_Book
"Super Entrepreneurship" (PDF): Mises.org/E4B_139_PDF
Austrian economics is distinctive in its recognition and, indeed, embrace of continuous change: customer preferences change, competitors’ actions change, markets change, technology changes, prices change, business methods change. New knowledge is continuously created and accumulated. And Austrian economics equally recognizes that entrepreneurial businesses must change in response: capital combinations change, supplier and customer relationships change, organization structure changes, business portfolios and value propositions change. Continuous change is required — which is something business has not traditionally been designed for. How do businesses manage continuous change?
In the current digital age, the rate of change in the external business environment is accelerating, largely as a consequence of rapid technological evolution and the ways in which customer behavior and preferences change in response. We plan to cover the issue of continuous change from multiple angles in the coming weeks and months.
This week, Mark McGrath joins us to review a tool for value creation amidst continuous, roiling change. It has been around for a while and so is proven in multiple arenas and situations. It goes by the name of OODA.
Key Takeaways and Actionable Insights The OODA loop is a deeply sourced tool that draws on eastern philosophy, western science, and aligns with Austrian economics. When a firm as a network of individuals, knowledge, ideas, tools, processes and resources works with clients and customers and their systems, all should be better off as a result of their co-ordinated action. The better the capacity to learn and make adjustments together, the better the capability to recognize and seize opportunities, and to act at co-ordinated speed. Those who can handle the rate of change fastest will be the most successful.
The originator of the OODA loop model, John Boyd, synthesized thinking from multiple sources about this problem. In business, we can call it the Adaptive Entrepreneurial Method.
The loop is triggered by uncertainty, or what is referred to in the model as VUCA:
Volatility — circumstances change abruptly and unpredictably;
Uncertainty — knowledge is incomplete and the future is indeterminate;
Complexity — we are individuals in a dynamic interconnected whole with emergent outcomes;
Ambiguity — multiple interpretations from multiple observers, and multiple conclusions.
VUCA enters the OODA loop as unfolding interaction with the ever-changing external environment or market, as information and data coming into the company, and as unfolding circumstances, whether these are the company’s own sales trends and customer relationships or the activities of competitors.
VUCA is the state of the universe. It’s the normal condition that entrepreneurs should assume as the basis for action. It also creates an exciting state of opportunity in which dynamically adaptive entrepreneurial businesses can thrive.
OODA is a feedback loop. OODA stands for observing, orienting, deciding, acting — a continuous process.
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Orientation is critical to successful operation of the model. For a firm or for an individual entrepreneur, orientation is a mélange of inputs: mindset, personality, our way of thinking and interpreting, previous experiences and how we’ve processed them, our ability to process new information, our ability to handle change, our ability to analyze and break things down while simultaneously piecing things together and synthesizing them into an insight or construct that never existed before.
Orientation houses all our biases, and all our cognitive models. It’s how we perceive and how we experience the world. It determines how we process all the information we observe.
Decisions are hypotheses. From our orientation-determined analysis and synthesis of incoming data, we envision a future state: what could happen if we did something? In Misesian terms, we imagine what it would be like in the future if we were able to address our own uneasiness — if we were to change our current state and trade it for another one. Any action that follows must be preceded by a decision, a hypothesis of what we think might happen.
Action is an experiment to test the hypothesis. In applying the OODA loop, entrepreneurs demonstrate a bias for learning and a bias for action. We learn by testing what happens when we act and making new observations of the outcomes of the action. These outcomes will give us new signals to employ in re-orienting to ensure that our decisions and actions are well-aligned with reality.
The OODA loop model is consistent with the Explore and Expand approach to business strategy. At Economics For Business, we have frequently urged entrepreneurial firms to abandon business school strategic thinking and replace it with an Explore-And-Expand approach, running many fast, low-cost exploratory experiments and quickly expanding investment in those that work, discarding others. In OODA loop, experiments are decisions and actions, and re-orientation results in expanding application of the successful ones.
In OODA, we continuously build and re-build our perception of the VUCA world and attempt to match our perception with reality through exploration and expansion. We aim to ensure our orientation is attuned to the way the world is and not to the way we want it to be or imagine it to be.
The more we learn, the more we build and re-build, the faster we can advance. Speed of learning is important, so long as it is based on well-processed information.
Guidance and control. In the OODA loop graphic, there are two areas designated “implicit guidance and control”: our actions and our observations. Our orientation implicitly guides and controls both. Our orientation as entrepreneurs or as economists will always affect how we perceive things. Where some might see an obstacle, others see an opportunity. That’s orientation at work. On the action side, orientation implicitly guides and controls our actions. There are some things we can do automatically, employing heuristics or procedures that we don’t stop to think about. This also is orientation at work — and at speed.
Continuous testing. The OODA loop, processing VUCA information into decisions and action via continuous reorientation, is a test. An entrepreneur is always being tested. As time moves unstoppably forward, new challenges continuously emerge. It’s the ceaseless flux of human affairs, as Mises put it in Human Action.
If we maintain an open and flexible or agile approach or orientation to this continuous testing, we’ll avoid failure.
Focusing on a well-understood purpose will eliminate wasted time and wasted action. The Adaptive Entrepreneurial Model has three major elements: VUCA, the way the world is; OODA, as described above; and IOT. IOT stands for In Order To: the purpose or mission. As we deal with VUCA, and continuously change our orientation as we learn from our decisions and experiments, quickly finding out what works and what doesn’t, we must never lose sight of our purpose and our intent. What are we trying to accomplish?
Everyone in our firm, or on our team, must share the same purpose and be able to articulate it in the same way. When that’s the case, creative and co-ordinating action can move forward without instruction: we don’t have to tell people what to do when they’re in the middle of VUCA so long as they have the same shared purpose in mind. Everyone focuses on what needs to happen and why. There’s never action for action’s sake; it’s always with a shared purpose. If team members do not share the same understanding of purpose, then they’re creating more VUCA. If they do share understanding, the orchestration of their individual efforts produces harmony.
People, ideas, things — in that order. All action is human action, all decisions are human decisions, all teams are human teams. When orientations are aligned, harmonious co-ordinated action is possible. There’s a high priority on relationships — with teammates, colleagues, customers, vendors, partners.
In a business utilizing the OODA model, people always come first because they are the ones who act. Ideas follow, judged through the lens of helping people to decide and act. Things — technology, property, money — are at the third priority level to ensure they support people and enable their ideas.
"A sound understanding in application of these comments will yield geometric results." Improved results are the repayment for the effort expended to study the Adaptive Entrepreneurial Method.
Additional Resources "The Adaptive Entrepreneurial Model — Core Thesis" (PDF): Mises.org/E4B_138_PDF
John Boyd's "OODA Loop Graphic" (PPT): Mises.org/E4B_138_PPT
"The Epistemology of the OODA Loop" (PDF): Mises.org/E4B_138_PDF2
"Destruction And Creation" by John R. Boyd (PDF): Mises.org/E4B_138_Boyd
The Theory Of Dynamic Efficiency by Jesús Huerta De Soto: Mises.org/E4B_138_deSoto
The Ultimate Foundation Of Economic Science by Ludwig von Mises: Mises.org/E4B_138_Mises
Entrepreneurs solve problems for customers. There are few problems bigger than the horribly perverse medical care system under which patients suffer in the US. The system has evolved over time, with the stimulus of bad decisions, bad actors, and bad incentives. Entrepreneurship can solve the system problem with specific actions at the component level, each of which are practical and do-able, and can interact to create a new outcome at the system level.
Murray Sabrin has studied both the system and the component solutions, and he joins the Economics For Business podcast to enumerate his proposed actions.
Key Takeaways and Actionable Insights Healthcare is a consumer good, and a consumer responsibility. Medical care is a provider proposition. Consumer sovereignty is a cornerstone concept in Austrian economic theory. Consumers determine what is produced as a result of their buying or not buying. Does this principle apply in healthcare?
To answer requires us to differentiate between healthcare and medical care. Healthcare is an individual choice and a personal responsibility: we do everything we can to maintain a healthy lifestyle of eating and drinking, exercise and sound physical and mental health practices. In the internet age, there is plenty of knowledge available to help us in our decision-making. Medical care is what we turn to when sound healthcare proves to be insufficient to keep us off medication and out of hospital.
How do consumers realize value from medical care providers? To do so is very challenging due to (among other barriers) price fixing, price opacity, price inflation, monopolistic and duopolistic market structures, the misuse of insurance, bureaucratic management, perverse incentives, government intervention, and barriers to entrepreneurial entry.
Are there potential solutions in the face of this systemic dysfunction? Yes: solutions that come from the best countervailing source — entrepreneurship.
Entrepreneurial Solution #1: Direct Primary Care — Restoring the doctor-patient relationship. Murray Sabrin recalled the $5 doctor visit of the past, characterized by a personal relationship with no bureaucracy or insurance forms. Entrepreneurs are now re-establishing that relationship via Direct Primary Care. DPC is retainer fee-based access to unlimited doctor visits, including office-based testing and additional services, with no insurance forms. DPC doctors have fewer patients in their practice and can consequently provide more time and attention. Stronger relationships are built, which is the essence of entrepreneurial value-generation.
Entrepreneurial Solution #2: Transparent versus distorted pricing. Pricing is one of the most important bulwarks of free markets. In medical care, pricing is opaque to the point of invisibility, distorted, and inflated. It is unresponsive to the normal choice-based supply-demand mechanisms, and not indicative of value.
Some entrepreneurs are acting to change these pricing conditions via what is termed fee-for-service: transparent pricing for specific services. An often-cited example is Surgery Center of Oklahoma, where specific prices for specific surgical services are openly posted on their website. Other members of the Free Market Medical Association provide similar price transparency.
One of the results is revelatory price comparison: Murray told the story of a DPC practice patient who identified a 75% price reduction at Surgery Center of Oklahoma compared to a local South Florida hospital.
Entrepreneurial Solution # 3: One stop shopping at local non-profit clinics. Murray described the launch and success of several non-profit local and regional clinics, including one for which he was the founding trustee. These are philanthropically established and funded local clinics with volunteer staff, providing a range of services. Equipment and pharmaceuticals may be fully or partially donated by the manufacturing companies. The combination of direct primary care doctors and specialists can make these clinics one-stop shopping solutions for patients seeking quality medical care. With a little philanthropic assistance, they could eliminate the need for Medicaid.
Entrepreneurial Solution #4: Direct Contracting. Insurance companies purposefully inflate medical care prices to fund their business model. Murray told the story of a large (4-500 employees) company that contracted directly with a service that brought a vehicle with an MRI machine to the employers location, and charged $400 per MRI to the employees. The same vehicle was utilized by a nearby hospital that charged $6,000 for the same MRI. Direct contracting saved $5400 per unit cost, or 90%.
Direct contracting has the potential to significantly reduce costs in the Medical Care system, while opening access and increasing convenience.
Entrepreneurial Solution #5: The 3-tier household medical care budget system. Murray has a well-constructed and eminently practical household medical care budget system. There’s a version for families with at least on member in employment and an alternative for those on Medicare today. There are three elements:
Direct Primary Care for a monthly fee, covering unlimited office visits and routine tests.A Health Savings Account to cover costs of specialists, prescription drugs, medical equipment, major tests and brief hospitalizations.Catastrophic insurance coverage for major operations and hospitalizations and long term care. Greater detail is provided in Murray’s book, Universal Medical Care From Conception To End Of Life.
Download our corresponding PDF, which features an adapted table from Murray’s book: Mises.org/E4B_137_PDF
In a system of personal responsibility, we would all manage our household medical care budgets with these kinds of tools.
Entrepreneurial Solution #6: Voluntarism And Mutualism. Voluntarism has a long tradition in America. Mutual aid societies were prevalent before the New Deal. Ethnic, religious and trade groups joined together for mutual support. The Federal Government co-opted these functions and now people look to Washington DC to solve their problems.
But young people today are more interested in voluntarism and non-political social activism. 30 years ago in the Wall Street Journal, Peter Drucker argued for the non-profit sector to replace the welfare state. Creative and innovative people find ways to surmount institutionally-erected barriers in all phases of life, and medical care is certainly one of those. There’s a liberating and energizing sense of acting as the custodian of one’s own life and helping others who need it. It’s the entrepreneurial ethic.
Entrepreneurial Solution #7: Distributed Knowledge. There is so much available knowledge today about healthy life habits and about the symptoms and characteristics of various medical conditions, and about options for treatment. We as individuals are free to explore, and responsible for gathering our own store of knowledge. The outcome of the research may not be definitive, and we may find ourselves making a choice between alternatives. But doctors and hospital administrators make choices too, and they are not infallible. It may be possible for an individual to gather more knowledge about their own specific condition from the internet than any single doctor can know, simply as a consequence of concentrated effort. Each of us can take responsibility for our own life.
Summing up: Murray Sabrin’s prescription: Eliminate employer-based insurance.Make a single exception for the case in which the employer pays the direct primary care fee for the patient.The resultant employer savings are deposited in employees’ health savings accounts.Employees determine their best medical care options.Phase out Medicare and Medicaid.Let young people create super health savings accounts so that they don’t need Medicare in the future.Hospitals price at realistic market pricing, not insurance-inflated prices.All prices are transparent.Get the government out of medical care — it’s none of their business.Free up resources from the medical-pharmaceutical-insurance complex and redirect them to savings, investment and philanthropy. Additional Resources Read Murray’s book, Universal Medical Care from Conception to End of Life: The Case for A Single-Payer System: Mises.org/E4B_137_Book It’s self-published and all proceeds go to charity and non-profits.
"Individual Single-Payer Alternative For Employer-Based Insurance" (PDF): Mises.org/E4B_137_PDF
Surgery Center Of Oklahoma: surgerycenterok.com
Forward: goforward.com
Direct Primary Care Coalition: dpcare.org
Volunteers in America: vimamerica.org
Entrepreneurs are developing a new world of innovative business models far from regulated markets, crony capitalism, and corporate control. It’s a new world of cyber security, free software, value-for-value exchange, integrated with bitcoin. Max Hillebrand operates in this new world, and he shares both his vision and his expertise on the Economics For Business podcast.
Key Takeaways and Actionable Insights The praxeology of cyberspace. Praxeology is timeless, with equal application in this era of cyberspace and the internet as in any other era. Individuals are in a state of unease, and they can perceive a better future in which their unease is relieved. They allocate resources to achieve that end.
Those resources can be scarce or non-scarce. Non-scarce goods are non-rivalrous; I can share them with you and not give them up for myself. Information goods are non-scarce. They are patterns of words and symbols that can be shared. This is the world of free software.
It’s also the world of cyber security. Cryptography is just a math formula. If I wish to express myself freely to one other person or a small group of people, I can enable my non-scarce expression for only that small group, giving them the private key to decrypt the message.
The value of free software: scratch your own itch. A growing cadre and movement of internet entrepreneurs is engaged in the preparation and distribution of free software. Free doesn’t mean it’s not valuable. New technologies and new free software are created to solve customer problems more efficiently and more effectively. One of the beautiful attributes of free software is that it is open to user contribution — anyone who can read the software can change the software and publish those changes, so that future users can enjoy an even better experience. Everyone in the free software community — producers and consumers — is incentivized to ensure that the tools that they all use are running at their best.
This is sometimes referred to as the “scratch your own itch” ethos. The creators of the software are also the users of the software. Customers know the problems that they want to have solved, and give the ultimate feedback of fixing it themselves.
Free software in business. Producers of free software create the highest quality technology tools. Entrepreneurs looking for the best technology have an incentive to seek out these producers and their products. There is no lack of demand. How do the producers get paid for their development efforts?
One way is via a service exchange. Users of free software often like to add customization, personalization and locally specific integration features to free software that they use. Producers can be contracted and compensated for these customization services. Red Hat followed this business model of servicing Linux users all the way to a $US34 billion valuation in an acquisition transaction with IBM.
Value-for-value exchange: a new business model? The second way to get revenue from free software production is via donations — users recognize the value of the experience of using the product and voluntarily send payment to the producer, even though no “price” was asked.
This emergent concept of voluntary payments made for freely distributed valuable content and products is beginning to bloom into a new form of exchange, which has been given the name of the value-for-value (VFV) model. It’s especially prevalent on the blockchain and on bitcoin networks.
Take a freely distributed podcast as an example. The producer can put a Bitcoin lightning network public key in the RSS feed and listeners can voluntarily send any amount of bitcoin back for every minute they are listening to the podcast. This happens automatically in the background when the listener hits Play and stops when he or she hits Pause or Stop. One-time payments can be made as well, if preferred. Payment can be boosted if the listener here’s something they deem especially valuable to them and wish to extend an extra reward. It’s the ultimate market feedback mechanism.
Bitcoin as free software Bitcoin is another tool of cyberspace, engineered and designed to solve the problem of money. Many innovators over time have made attempts to create digital money to make internet transactions fast, infinitely cheap, stable and private. But none of the attempt, until bitcoin, were able to solve the problem of verification of transactions and enforcement of rules without a trusted third party. Bitcoin solves the important problems, not just of verification but of “who verifies?”
Verification is always and ultimately human. Bitcoin entrains entrepreneurs who download the bitcoin software and confirm they are running the agreed monetary rules on their own hardware. When another entrepreneur connects and asks for rules-based verifications of valid transactions, bitcoin merchants on the network are running the software and checking the transactions of others. They are entrepreneurs producing verification according to established and agreed rules. It’s an entrepreneurial merchant network.
Get paid in bitcoin, hold bitcoin, invest with bitcoin. Max emphasizes 3 aspects of the bitcoin enabled life that can insulate and protect entrepreneurs from the inflationary fiat future.
Get paid in bitcoin To get paid in bitcoin means to have a “censorship resistant” method of receiving payment from customers. People who do not have access to a bank account can become entrepreneurs. People whose bank accounts might get shut down can remain entrepreneurs. Anyone who fears for the future of the fiat system can insulate themselves against future payment system uncertainty.
Hold cash reserves in bitcoin Saving should mean holding an asset without counterparty risk. Bitcoin serves that purpose — it’s counterparty risk-free money. Holding a reserve without counterparty risk frees the individual to make a trade with an entrepreneur at any time in the future. There I no risk of inflation. Your saving can’t be diluted.
Denominate your contracts in bitcoin When more and more entrepreneurs denominate their contracts in bitcoin, a stable monetary asset that cannot be inflated, the detrimental cycles identified by Austrian Business Cycle Theory can be eliminated. This is the exciting long term prospect of bitcoin.
It may be a long path, and it will take time and courage to complete the journey, but it is possible. There are entrepreneurs today (Max is one) who get paid exclusively in bitcoin and hold their cash reserve in bitcoin.
Additional Resources Max’s website: TowardsLiberty.com
Some examples of free software tools:
btcpayserver.orgwasabiwallet.iovalue4value.io Professor Mohammad Keyhani’s Entrepreneur Tools: Mises.org/E4B_136_Tools
Cryptoeconomics: Fundamental Principles of Bitcoin by Eric Voskuil: Mises.org/E4B_136_Book
Entrepreneurial action occurs in time. This brings uncertainty, because of continuous change. We can’t know what will be our future result, yet we must produce now in order to discover it. Are there answers to this conundrum? Yes. They’re found in action, and the timing of action (see Mises.org/E4B_135_PDF1). Mark Packard joins the Economics For Business podcast to share his research.
Kay Takeaways and Actionable Insights There are three ways we can think about time. Eternalism: Time goes back in the past to infinity and forward in the future to infinity. It’s a real thing, e.g., we can identify “points” in time. This is the time of physics.
Presentism: Past time does not exist, it is a memory pattern; the future is undetermined, it’s just a mental image. The only time that exists, and is real, is now. This is the time of Austrian economics.
Growing tree: The past is real, it has been determined, and there is one real historical truth (think roots and branches). The present is real and unfolding (new leaves growing every day). The future is undetermined.
Presentism is the view of time that best aligns with Austrian entrepreneurship and subjectivism. Entrepreneurs act based on their own sense of time, which can be both objective (the clock is ticking) and subjective (how I act in time and how I feel about it).
Entrepreneurial action occurs in time, which brings uncertainty. Why must entrepreneurs deal with uncertainty? Because production takes time, and there is continuous change, so the outcomes of the production process in the future can’t be known. Even if the entrepreneur knows what demand is today, it can change over time, and can’t be known in the future. Businesses choose entrepreneurial action long before they know how it is going to turn out. Entrepreneurial uncertainty is a consequence of the existence of time.
Time is scarce, but it’s not a resource. We can legitimately refer to time as being scarce. We often feel as though there is not “enough” of it. We’d like to be able to try to pack more effort and action into the time available to us.
When we talk in terms of scarcity, it’s tempting to think that time is a resource, akin to other scarce resources. We manage those other resources, we allocate them, we combine them, we use them efficiently.
We’d like to think the same way about managing time. But we don’t have control of it. Time just flows. It’s not at our disposal to use and allocate as we see fit. We can’t defer judgement on how to allocate our time, for example, because time keeps flowing and by deferring judgement we just did allocate some present time to not acting.
The resource over which we do have control is our effort. We can choose how to allocate our efforts in time. Our efforts are not scarce in the same way that time is scarce. Our efforts are limitless; we can put effort into a wide range of applications. It’s because time is scarce that effort must be allocated as if it were scarce.
As time flows, customers’ perception of value changes, and entrepreneurs must follow this change process closely. The effects of the flow of time are not exclusively limited to the allocation of entrepreneurial effort. They are also manifested in the customer’s Value Learning Process. (Mark Packard describes this in detail, and gives us some management tools: Mises.org/E4E_44, Mises.org/E4E_55, Mises.org/E4E_62, and Mises.org/E4E_73).
As a result of the flow of time, customer value is a process. Customers prefer the best satisfaction they can presently identify. As time flows, and they gain more knowledge and experience, what they value changes. Their preferences are different in the future than in the present. There is continuous change.
Since consumers are sovereign to the entrepreneur, it is mandatory to keep up with these changes. The continuous process of value learning never stops, and entrepreneurs must follow closely, gathering feedback, empathically interacting with this feedback, and making adaptive changes in their value propositions in response.
Sometimes, customer preferences may stabilize. Entrepreneurs may come to believe that there is a loyal cadre of reliable customers, and may invest in nurturing this loyalty and in relationship building. But they can not permit themselves to become too comfortable in these relationships. Customers are not loyal to a product or service or brand or supplier. They always seek the best satisfaction, and once new knowledge is available to them, they will change their behavior.
All entrepreneurial choices about action are made in the context of time, with significant consequences for outcomes. Because customer preferences are continuously changing through time, entrepreneurs are faced with an uncertain decision about when to act. At what point in time do they have enough knowledge to go to market with a new value proposition, or a new or improved product or service? They know that, as soon as they act, customer preferences are going to change further (perhaps as a consequence of the action). If the entrepreneur decides that acting as the first mover in introducing an innovation gives them an advantage, they also know that competitors have an opportunity to process the new changes and overtrump that advantage as a second mover. Both are competing over the customer’s shifting sense of greater satisfaction.
When does the entrepreneur know enough? How does a business identify the narrow window in the customer’s value learning process that provides a signal to act? Timing is a big, important piece in the entrepreneurial puzzle.
There are several areas of time management where entrepreneurs can improve their skills. While time isn’t a resource to be allocated, it provides a context for action in which entrepreneurs can subjectively make changes for the better.
Recalibration Is your internal clock moving too fast or too slow? Do you find that you are always running late, or, alternatively, arriving too early and consequently “wasting” time (i.e., burdened with time periods you can’t fill with appropriate action)? If so, it’s time to recalibrate. Change the pace at which you do things. The world proceeds objectively at clock time, but your internal clock is subjective. You may need to align the clocks better. Change your schedule or rearrange your tasks to make your internal clock better aligned with real clock time.
Better time planning Sometimes we simply err in assessing how much time to allocate to each of our various tasks. Each one takes longer than we planned, and by the end of the day, we’re several tasks “behind” and some will remain undone. If that happens over and over again, if there is regularity in your mistiming, you should change your mode of planning. Allocate different — more realistic — amounts of time to the completion of each task. Allow for delays. Don’t “lose track of time”.
Fix your prospective memory Do you put tasks on your to-do list for the future and then forget them? This is a failure of prospective memory — your memory of the future. Prospective memory is your recall of the schedule you had planned out for yourself. One answer is to use mechanical or digital aids. Write down your to-do’s on a calendar. Enter them into your phone. Set an alarm as reminder.
Whatever, happens, don’t be the bottleneck. Time management is not trivial. For entrepreneurs, being late, missing meetings, missing deadlines, or experiencing delays is likely going to cost you dearly.
Don’t be the bottleneck, don’t be the one causing the problems, for your colleagues, your partners, your customers, or any collaborators. Fix your own timing issues.
Additional Resources "How to Master Time" (PDF): Mises.org/E4B_135_PDF1
"Value is a Learning Process" (PDF): Mises.org/E4B_135_PDF2
Understanding The Unrealized requires us as entrepreneurial businesspeople to think better, and to resist settling for what is merely feasible in a regulated, risk-mitigated world. We must ask what could be possible in a different world, and act on that basis. Sound economics supports such action. Per Bylund takes us through his thinking about The Unrealized.
Key Takeaways and Actionable Insights First, see beyond what’s there. From Bastiat’s famous parable about the broken window comes the economist’s instinct to think about 2nd, 3rd, and Nth order consequences of actions. These are typically unseen by those who don’t think like economists, and never even considered by politicians.
Entrepreneurs always have 2nd or 3rd alternative actions in mind if the consequences of their first choice are unexpected, and they will always adjust further if required by customer feedback, with the constant aim of producing high customer value and satisfaction. They see beyond what’s there.
Government regulators and legislators make promises on the basis of forecast 1st order consequences only. Regulators promise that the consequences of their actions will be beneficial, at least to some groups. For example, in minimum wage legislation, they promise a pay raise for the lowest paid workers. What is not seen are all the jobs that disappear — are never offered — as a 2nd order consequence of making minimum wage labor unaffordable to the profit seeking entrepreneurs, the ones who create jobs.
Beyond the unseen is The Unrealized. In reality, regulations are not what politicians promise. They are not actions to help people. They are restrictions on entrepreneurs’ economic behavior. Entrepreneurs are aiming at satisfying customer wants as much as possible. Regulations aim to restrict this customer-satisfying action by forbidding certain innovations, or declaring that they must be designed and implemented in ways that have value for the regulator and not for the customer or entrepreneur.
Entrepreneurs are forced to abandon some of their efforts to generate new value by satisfying customers, or to redirect their efforts into less value-producing channels. The potential output of their creativity goes Unrealized.
Society accumulates and compounds losses when entrepreneurial creativity is curtailed. What could have been the case if entrepreneurs were unbound, if the regulatory chains were cast off? We can’t know. But we can know that The Unrealized is a cost to society.
And the cost is cumulative. Technology and innovation thrive and grow in response to observations of how customers experience value from it. Entrepreneurs introduce a new application of technology by building on what’s available today and adding to the value experience that they observe customers enjoying today. If innovation is restricted by regulation (or any other barrier), these observations can’t take place. The next big thing that builds on today’s big thing won’t happen. We keep falling behind what is possible because of these regulatory restraints. Consumers become cumulatively worse off. Society is permanently and increasingly damaged.
We are placed on a different value trajectory — one that limits our options. What if Henry Ford had been restricted from introducing assembly line manufacturing of automobiles? It’s not hard to imagine such a case in the OSHA environment of today. What if the innovation cloud of new roads, better engines, gas stations with coffee and hot dogs, and all the other ancillary results of assembly line manufacturing had not been allowed to form?
Such a thought experiment demonstrates how regulation places society on a different trajectory than what is possible from unlimited entrepreneurial innovation. Will Uber’s technology launch us on a trajectory of ever-more-ingenious applications of on-demand service, stimulated by consumers’ unlimited imagination of greater and greater convenience? Or will taxi medallion regulation permanently limit that imagination to keep it within the boundaries of bureaucratic compliance and control?
Per Bylund’s term for the effects of bureaucratic control is limited optionality. Quality of life is elevated when we have greater optionality. Regulators don’t want us to have that experience. Less optionality means less value.
Continuous reinvention can’t be planned. The second and third and Nth order consequences of unrestricted entrepreneurial creativity and consumer imagination are not subject to planning. Emergent new inventions and innovations are not predictable. The probability of positive outcomes from the creative process can be enhanced by entrepreneurial intent and aspiration and effort. But on the other hand, the range of positive probabilities is greatly reduced by restrictions on that intent and aspiration. What could be is bounded by what is attempted, and regulations narrow the field in which attempts are made.
Make sure you do not restrict your own creativity with self-imposed regulation-like limitations. Regulation limits innovative possibilities. What if the same is true of your own entrepreneurial practice? What if The Unrealized is concealing itself in your own business? Are you sure that your imagination about possible futures based on your understanding of customer wants is expansive enough? Are you sure that you have considered all possible approaches to satisfying those wants, even the ones that are most unlikely? Have you examined every possible pathway to a unique position in the marketplace? Have you found every possible way to cut out cost and time from your production process? Are all your processes designed and engineered to remove all barriers to successful outcomes?
If you are inside a corporation, are there corporate restrictions that act like regulations, channeling your creativity into pre-ordained pathways and towards pre-selected attractors? Are there unnecessary constraints on emergence?
The Unrealized lurks everywhere. The entrepreneurial task is to root it out.
Additional Resources Per Bylund's book, The Seen, The Unseen, And The Unrealized: Mises.org/E4B_134_Book
Mises U 2021 presentation, "The Seen, The Unseen And The Unrealized": Mises.org/E4B_134_Lecture
"The Broken Window Fallacy" by Robert P. Murphy: Mises.org/E4B_134_Article1
"Compounding Shortfalls in Innovation" by Hunter Hastings: Mises.org/E4B_134_Article2
"Mark Spitznagel: At What Price Safety?" — another take on The Unrealized from an investing perspective: Mises.org/E4B_134_Article3
Austrian economics has a lot to say about how to organize firms for maximum value generation. Austrian principles point to the delegation of entrepreneurial judgement to the front-line employees who interact directly with those who actually create value: users.
The military organization models of the twentieth century, involving command-and-control in hierarchical structures, are slow to change, and the management literature evidences an unwillingness to abandon the hierarchy. But there is a fast-growing industry that’s the locus of prodigious value generation where the hierarchy has already been abandoned and flat networks of distributed judgement are taking its place. Ulrich Möller is one of several Austrian economists who are studying the firms in the video game industry and demonstrating how their findings can bring positive organizational change to the rest of the business world (see our E4B Knowledge Graphic at Mises.org/E4B_133_PDF).
Key Takeaways and Actionable Insights Organizational innovation has a long and successful track record in the video game industry. A lot of value has been generated in the video game industry in a short period of time. Video games surpass movies and music in revenue. Without a long history of corporate hierarchies and bureaucracy to shed, firms in the industry embraced the organizational innovations of open source software, including anonymous collaboration among highly distributed self-organized teams, peer review systems, and agile processes.
In addition, the industry created its own laboratory for testing revolutionary organizational theories in virtual economies set in virtual worlds.
Valve is a company in the video game industry that took organizational innovation to its logical conclusion: the end of hierarchy. Valve — a very successful, industry-leading company — pursued a value-generation logic to frame its approach to organization:
Creativity is our core resource — the most important skill in game development.Creative employees are key to our capabilities.Creative people are most productive when left to express their own creativity in their own way.Hierarchy blocks creativity, as do planning and routine.How do we design a company to attract and retain the sort of people who are able to take the boldest creative steps? The answer? Let employees decide what to work on. Let them exercise entrepreneurial judgement. Let them, in effect, do both strategy and implementation. Give them all the decision rights. Let them identify customer preferences — since they know the customer best; let them decide how best to address those preferences; let them decide how to achieve competitive differentiation; let them allocate resources, choose costs, and manage profitability; let them control quality and decide when software is ready to ship.
Employees work in self-organizing teams, and are free to migrate from team to team, and free to change their roles. There are no fixed job descriptions.
In place of command-and-control, a few simple rules or constraints have emerged for the exercise of governance. F.A. Hayek wrote about norms that emerge in social groups to shape behavior. These are not legislation, i.e., written formal restrictions. They are what he called rules, constraints that everyone accepts in the shared commitment to collaboration and the pursuit of the most favorable outcomes.
The most significant of these rules at Valve is the “Rule Of Three”, a simple agreement that at least three individuals must agree on the initiation of a new project, or on other major decision points. The emergent standard was that this is just enough to prevent maverick behavior, and a low enough number to facilitate agile action that’s not bureaucratically constrained.
Another rule or constraint goes by the name of Social Proof. This is a broader and looser peer review standard. If the original team wishes to recruit more members, they must persuade others of the value generating potential of the project (in competition with other projects in the firm); successfully doing so constitutes “social proof” of value.
Rules-based peer review process replaces management structure. Conventional approaches to organizational design focus on structure. This might be command-and-control hierarchy, or structured networks, or strategic business units or functional departments. Valve abandoned structural thinking and replaced it with flow analysis. How can we attract the most creative people to our venture? How can we encourage the most productive flows of bold creative thinking? How can teams best assemble and collaborate for the most productive output? How can we integrate with the user community in the best way? How can the most value-generative projects attract the best resources?
These are all questions about flow. Austrian economists are distinctive in viewing capital as a flow rather than a structure, and this view holds true for human capital just as much as physical capital. Emergent rules for self-organizing human systems can perform all the managerial functions that were historically left to control structures.
Actionable Insight Summary Design your organization for flow not structure.Design to attract the most entrepreneurial people in the most entrepreneurial roles (self-selection).Let them self-organize.Let rules and value codes emerge.Teams as business units.Eliminate the boundaries between the firm and customers and other partners. Additional Resources "The Future of Organizational Design" — our E4B Knowledge Graphic (PDF): Mises.org/E4B_133_PDF
"Levels without Bosses? Entrepreneurship and Valve’s Organizational Design" by Ulrich Möller and Matthew McCaffrey: Mises.org/E4B_133_Paper1
"Entrepreneurship and Firm Strategy: Integrating Resources, Capabilities, and Judgment through an Austrian Framework" by Ulrich Möller and Matthew McCaffrey: Mises.org/E4B_133_Paper2
Saifedean Ammous is a knowledge entrepreneur. He creates new knowledge that’s valued by his customers, because it helps them to think better and better informs their actions. He carefully appraises the knowledge provided by great thinkers of the past, and re-presents in a newly compelling fashion. He develops effective memes and ideas. He innovates in channels and distribution. He demonstrates how knowledge entrepreneurship can work in the 21st Century's globally-connected and digitally-connected economy. He joins the Economics For Business podcast to share some of his learnings and experiences
Key Takeaways and Actionable Insights. Collect available knowledge then develop a new perspective. Saifedean took degrees in economics and engineering, at bachelor’s, master’s and Ph.D. levels. His accumulated knowledge was valid for the university professor track. Then his spontaneous knowledge accumulation efforts took him to Austrian economics and a new perspective: that the economics he had learned to date didn’t make any sense, and that regime higher education was best understood as just another malinvestment. Most importantly, regime higher education was customer-less: it did not provide value for customers, because that was not its purpose. From that point on, Saifedean followed the path of customer sovereignty and of exploring what customers identified as valuable.
Teaching is value generation. Saifedean’s first customers were students in his university classes. He was able to generate value for his students by teaching them the economics they wanted to learn, along with giving them the optionality of seeing the knowledge through his distinctive perspective. When students engage and say thank you, it’s a signal of value.
A transformative event precipitated a shift into independent knowledge entrepreneurship. In Saifedean’s case, the transformative event was Bitcoin, the study of which opened up a deeper understanding of hard money and low time preference. He “upgraded” to the Bitcoin Standard by exiting academic teaching and switching to entrepreneurial knowledge sharing. The first step was writing and publishing a book called the Bitcoin Standard (conventionally published by Wiley) and then leaving academia for the joys of hard money.
He switched his platform for teaching from the university to the internet, and now is able to reach many more customers — citizens of the world who want to learn more about Austrian economics and to understand Bitcoin and hard money. How did he know they were out there? They self-selected via Saifedean’s twitter feed.
The “factory” for knowledge production and distribution is a website. A fairly basic website (i.e., not requiring any technological expertise or gear that is not available to everyone) is the platform for the new level of knowledge entrepreneurship. At saifedean.com, customers have been able to:
Receive and read book chapters as they are written;Access video and audio online courses in Austrian economics;Buy books;Subscribe to podcasts (which he runs like a seminar);Find a “complete central bank replacement pack”. Saifedean told us he is just getting started, and there are more knowledge innovations in the pipeline.
The Entrepreneurial Method. This unfolding timeline is an excellent example of the entrepreneurial method at work.
Start with what you know.Find motivation in what you are passionate about.Utilize available resources.Let collaborators and customers self-select in.Use networking and influencers rather than conventional advertising and marketing to drive expansion.Let spontaneous order unfold. In addition, Saifedean associates the Austrian concept of lowering time preference with entrepreneurial success. Low time preference — willingness to save/sacrifice in the short terms for benefit in the longer term — is an essential part of the entrepreneurial method. One of the entrepreneur’s “bird-in-the-hand” resources is their individual utilization and allocation of their personal time and effort.
A new age of entrepreneurship is emerging and surging. In The Bitcoin Standard, Saifedean looks back to the nineteenth and early twentieth century as a period of technological innovation by entrepreneurs under the gold standard, bringing us indoor plumbing, electricity, the internal combustion engine, airplanes and elevators, among many more. Entrepreneurs were able to accumulate capital in the form of wealth stored in hard money to finance their innovations.
He believes that the emerging Bitcoin Standard era will precipitate a new entrepreneurial flourishing, further accelerated by free software, network access, blockchain and hard money savings.
Our goal at Economics For Business is to be a knowledge and tools provider for this entrepreneurial surge.
Some knowledge links: "Knowledge Entrepreneurship" — our E4B Process Map (PDF): Mises.org/E4B_132_PDF
Saifedean.com
The Bitcoin Standard (in over 20 language translations): Mises.org/E4B_132_Book1
Principles of Economics: Mises.org/E4B_132_Book2
The Fiat Standard: Mises.org/E4B_132_Book3
Twitter for Saifedean.com: @Saifedean
Twitter for Saifedean Ammous: @SaifedeanAmmou6
The scientific method has served us well to date. The entrepreneurial method, informed by the principles of Austrian economics, can take society much further. Dr. Saras Sarasvathy joins the Economics For Business podcast to distill the essence of the value generating and wealth producing method.
Download our knowledge graphic for the Entrepreneurial Method: Mises.org/E4B_131_PDF
There is an entrepreneurial method — a systematic way to achieve the unpredictable. The scientific method aims to discover universal laws that make the future predictable. If we have enough scientific understanding we can, for example, build bridges that we can predict will not collapse. We can construct an entire scientific infrastructure in our society.
The entrepreneurial method aims higher, at human flourishing. It aims at discovering how we can all work together to achieve our human purpose, including new purposes that we all agree are worth achieving. We can construct an entrepreneurial structure to build a better human life and a better society.
Entrepreneurs choose a control strategy that’s appropriate to uncertainty. Some people fear entrepreneurship because its outcomes are uncertain. But this is worrying about the wrong things: outcomes are outside your control. Entrepreneurs are more discerning about what can be controlled: means.
Dr. Sarasvathy lists several control strategies:
The Bird-In-The-Hand Principle: work with what you’ve got and can control, which she sums up in the questions: Who Am I? What Do I Know? Whom Do I Know? What resources do I own or control now? This is the first principle of control.
Affordable Loss Principle: Entrepreneurs can control their downside, making it affordable and limiting uncertainty, by asking “What one value generation project would I undertake even if I risk losing everything I invest In it?”
Crazy Quilt Principle: How do entrepreneurs control the uncertain process of identifying the right partners, including hiring the right people? They don’t try to predict the results of hiring and pitching. Instead, don’t hire, don’t ask. Just talk to people — those who fit best will self-select into your project.
Lemonade Principle: Don’t fear the unexpected. Welcome surprises. All unexpected happenings are opportunities and can become resources. Leverage contingency, and make lemonade out of lemons.
The Pilot Is The Plane Principle: Everyone on the plane is a pilot, co-engaged in shaping history. The plane will reach a destination, the exact nature of which is unclear, and everyone on the plane contributes to getting there.
There are some guidelines that entrepreneurs have established over time.
Non-Predictive Action Is The Driver Everything in the entrepreneurial method is driven by action. Or, more completely, action, interaction and reaction. Things you care about, things you can actually do, things we can do together, and how we handle surprises. Interacting with the environment with a sense of purpose, and thereby changing it in some way.
Even-If Thinking Our aspirations and the outcomes we experience may not be symmetrical. Not succeeding is not the same as failing. Even if a new idea does not work out, what is the worst that can happen? We shouldn’t make decisions just because we can’t predict the future. Embrace the unpredictable but make sure the downside is under your control.
Intersubjectivity The great productivity of entrepreneurship comes from intersubjectivity — two or more people can interact and come up with something neither one had actually thought about or dealt with or considered or contemplated before. Intersubjectivity is more than interpersonal and beyond negotiation. It’s a question: “I am doing this. What do you think?”
The Entrepreneurial Method leads to social good and a new role for business in society. A side effect of everyone in society learning the scientific method was the emergence of the middle class, defined by income. Science brought productivity which enabled a large swath of society to earn enough money to escape poverty. Everyone was able to harness science.
Let’s teach everyone the entrepreneurial method. Let everyone start companies, grow companies, invest in companies, all with no thought of prediction. A middle class of business will emerge, defined not by income but by venturing. This middle class will produce more jobs and more enduring, more stable companies, embedded in strong communities, with greater well-being and less churn. The fruits of creativity take root in endurance and durability — not in Schumpeterian creative destruction — and contribute to stability and the taking on of bigger challenges. Decade after decade, the middle class of business will generate value and produce wealth, employing lots of people and educating successive generations to take the entrepreneurial method with them into a better future.
Additional Resources "The Entrepreneurial Method" (PDF): Mises.org/E4B_131_PDF
Among the innovations planned for the Economics For Business platform is a series of encapsulations of important research papers. Here is a sample:
"The World-Making Scope Of The Entrepreneurial Method — An Encapsulation" By Gabriele Marasti (Original paper: "The Middle Class Of Business"): Mises.org/E4B_131_PDF2
Some links:
Effectual Entrepreneurship (PDF): Mises.org/E4B_131_Book
"What Makes Entrepreneurs Entrepreneurial?" (PDF) Mises.org/E4B_131_Paper
"Entrepreneurship As Method: Open Questions for an Entrepreneurial Future" (PDF): Mises.org/E4B_131_Article
Abstract: China is currently the world’s largest installer of wind power. However, with twice the installed wind capacity compared to the United States in 2015, the Chinese produce less power. The question is: Why is this the case? This article shows that Chinese grid connectivity is low, Chinese firms have few international patents, and that export is low even though production capacity far exceeds domestic production needs. Using the tools of Austrian economics, China’s wind power development from 1980 to 2016 is documented and analyzed from three angles: (a) planning and knowledge problems, (b) unproductive entrepreneurship, and (c) bureaucracy and government policy. From a theoretical standpoint, both a planning problem and an entrepreneurial problem are evident where governmental policies create misallocation of resources and a hampering of technological development.
JEL Classification: P21, O32, Q55, Q58, B53
Jonas Grafström (jonas.grafstrom@ratio.se) is a researcher at the Ratio Institute and an assistant professor at Luleå University of Technology. He is also a visiting fellow at the Oxford Institute for Energy Studies. He is thankful for comments by John Taylor, Nils Karlson, and Christopher Coyne. All errors are solely upon the author.
INTRODUCTION The headline of a 1953 article by Peter Wiles in Foreign Affairs had stated that “The Soviet Economy Outpaces the West.” Based on the official Soviet statistics, the GDP growth numbers suggested that the Soviet Union could plausibly outgrow the West, but as later revealed, the numbers did not match reality (Levy and Peart 2011). What Peter Wiles and numerous scholars at the time did not see were the cracks in the Soviet economic system (Boettke 2001, 2002a; Huerta de Soto [1992] 2010). The Soviet Union is gone; the slightly younger, seventy-year-old People’s Republic of China is still (to a large extentAs seen in Boettke’s (2001) Calculation and Coordination, the degree of planning in the planned economy of the Soviet Union varied over the decades, and this is also the case for China, which tolerates different degrees of capitalism in different parts of its economic system. It has also been argued that the Soviet economy was never a planned economy but rather a form of military-state capitalist system (Polanyi 1957). A similar argument can be made about the Chinese economy. In the Chinese case presented in this paper, it is not a case of pure socialism but rather there are plans, government orders, and an environment in which traditional entrepreneurs find it difficult to thrive.) a planned economy that by some accounts appears to be on the verge of outpacing the West. However, cracks can be seen in the Chinese economy, as illustrated by its wind power industry, which is analyzed in this paper.E.g., the problematic housing market and a fast-increasing debt (see Liu 2018; Curran 2018).
There are many problems in the Chinese wind power expansion effort (see e.g., Zeng et al. 2015; Karltorp, Guo, and Sandén 2017). The installed wind capacity in China has long been twice that of the United States (IRENA 2018). However, despite having twice the installed capacity, China produces less power than the US. Grid connectivity is low, Chinese firms have few international patents, and exports are low even though production capacity far exceeds domestic needs (Cass 2009; Zhe 2011; Xingang et al. 2012; Sun et al. 2015; Zeng et al. 2015; Karltorp, Guo, and Sandén 2017; Lam, Branstetter, and Azevedo 2017; Zhang et al. 2017).
Despite robust government support, wind power in China is obstructed by various barriers like quality deficiencies, low operational efficiency, and two-year permit delays from the central government for grid construction (Junfeng et al., 2002; Han et al. 2009; Xingang et al. 2012; Luo et al. 2016; Zhao, Chang, and Chen 2016; Liao 2016; Sahu 2017). These issues have hampered China’s wind power energy output and exports (Zhang et al. 2015; Sun et al. 2015).
Boettke (2002a) found that the failure to predict the fall of the Soviet Union was due to three reasons: (1) a disregard among economists for evidence other than measurable statistics, (2) the elegance of the formal structure of central planning and the balancing of inputs and outputs, and (3) the preoccupation with aggregate measures of economic growth as opposed to detailed microeconomic analysis of the industrial structure. All, but especially the third reason, are an appropriate approach when investigating Chinese economic shortcomings.
Taking inspiration from Boettke’s insight above, the purpose of this article is to synthesize the literature that has documented problems in Chinese wind power development and theoretically explain these problems. Identifying problems should be useful for policymakers in other countries that are considering a transition to large-scale renewable energy utilization. In a broader sense, the paper adds to the discussion of the sustainability of Chinese economic expansion in the long term.
A reader who is familiar with the Chinese wind energy sector and has read influential works, such as Joanna Lewis’s 2012 book Green Innovation in China: China’s Wind Power Industry and the Global Transition to a Low-Carbon Economy, would probably perceive that on an aggregate level everything is all right. In Lewis’s book, as well as in most academic literature, the economic problems of Chinese energy are alluded to but never assembled and analyzed. In this article a less optimistic view of the state of China’s wind power development is presented.
It should be noted that the United States and other countries also have different government interventions in the wind power market and that negative effects have been documented. For example, US policies in the 1980s caused problems similar to the ones observed in China (Keller and Negoita 2013). Later the United States policies focused on promoting research and development (R&D) (Wiser and Millstein 2020). The German Energiewende (energy transition) and the Spanish solar bubble would be good cases for another paper, but this paper will focus on China since it is the largest producer at the moment and will probably be for some time to come.
The findings will be presented and followed by an analysis based on theoretical works by scholars of the Austrian school of economics which is utilized in two ways: firstly, in terms of its theoretical contributions regarding the role of entrepreneurship and its utilization of price signals,A reviewer brought up merit order (describes the lowering of power prices at the electricity exchange due to an increased supply of renewable energies) effects and cannibalizing effects (loss in sales caused by a company’s introduction of a new product) that might affect firms’ behavior when it comes to adding new capacity. In a stable demand market this is an issue; however, the Chinese electricity consumption increased several hundred percent during the studied period and the renewable energy portion was rather small compared to the absolute growth in other energy sources. and, secondly, in terms of the planning debate, the use of knowledge in society, and the role of the market. Using Austrian economic theory as a starting point, it is found that both a planning problem and an entrepreneurial problem exist where governmental policies create misallocation of resources and a hampering of technological development.
The article is organized as follows: First, the Austrian theoretical background for the analysis of the wind power sector will be provided. Then, the historical context for China’s wind power development will be described. Finally, the theoretical framework will be utilized to analyze problems in Chinese wind power development.
THE LIMITATIONS OF PLANNING AND THE ENTREPRENEURIAL PROCESS A cartoon in the Soviet satirical journal Krokodil that was published in 1952 showcases the failure of the Soviet economic system with a worker and a bureaucrat depicted under an enormous two thousand–kilo nail. The worker asked who needed such a big nail and the bureaucrat answered: “the month’s plan fulfilled” (Nove 1986, 94). The Soviet Union and its planned economy ended at the age of seventy-four years in 1991, which was a surprise for some, but not to a student of Hayek’s (1937, 1945), Mises’s (1920, 1949, n.d.) and Weber’s (1922) contributions to the great planning debate in the 1920s through to the 1940s (see also Lavoie 1985a and 1985b).
Let us contrast the outcome of a market with that of a centrally planned arrangement. In a market, profit is a powerful signal. Profit informs producers that consumers value that use of those scarce resources as compared to other alternatives (in the case of profits) or that they do not value that use (in the case of losses). Before a corrective process moves toward even an approximate equilibrium, changes in the market (individual preferences, the endowments of resources, and available technology) will distort any plan and make it irrelevant (Mises [1929] 2011; Kirzner 1982, 1999).
Hayek ([1968] 2002) remarked that an equilibrium was too much to hope for, since an equilibrium would presume that all facts are known and that the process of competition has thus ended, rather than that there could be temporary order. Several studies highlight how state planning, with the best of intentions, often fails (see Hayek [1935] 1956; and for a modern application to development and aid, see Boettke 1994; Leeson 2008; Coyne and Ryan 2009; Williamson 2010; Coyne 2013). The case against regulation and interventions in the market (even by well-meaning planners), is based on the insight that the market will never be close to an equilibrium state since there is an ongoing corrective process.
Even though the functioning of the bureaucracy has been more fleshed out by public choice scholars, the Austrians have made contributions to our understanding of how a state bureaucracy works. For example, Niskanen (1994) pointed to the fact that Mises (1944) is often credited as one of the first scholars to approach the problems of bureaucracy from an economic point of view.
Niskanen’s and Mises’s views of bureaucracy differ in significant ways. In Niskanen’s view the bureaucracy is the result of the inability of the market to supply certain goods or services. A state bureaucracy compensates for the deficiencies of the market. According to Mises, bureaucracy appears because of government hindrances of the market process, but bureaucracy also makes economic calculation impossible (Carnis 2009). The Misesian view is more productive for the understanding of the Chinese case where the bureaucratic nature of the Chinese economy is a consequence of human action and design.
In Bureaucracy Mises contrasts different forms of economic organization and shows what happens when there is no profit motive. Mises argues that “[b]ureaucratic management is the method applied in the conduct of administrative affairs the result of which has no cash value on the market…. Bureaucratic management is management of affairs which cannot be checked by economic calculation” (1944, 47–48). If you do not have profits and losses as guide you must follow rigid rule systems. These rule systems will not allow for flexibility and will rather force the bureaucrat to compliance, whether the result make sense or not.
Constant feedback generates socially desirable outcomes without a central coordinator. Knowledge of the optimal use of scarce resources is not given ex ante but instead must be discovered through the process of individual choice (Mises 1920, 1949, n.d.; Hayek 1945). Hayek ([1968] 2002) and Buchanan (1982) also emphasized that market “data” emerge after people interact with each other. Before the participants enter the process, they do not know what their choices will be. Hence, some economics knowledge cannot be gathered by regulators and planers before the interactions take place.
A prerequisite for successful entrepreneurial action is guidance by relative price signals and the attraction of pure profit (which requires calculation through profit and loss accounting). The price system economizes information which economic decision-makers must process. A market system produces social intelligence that no one planner or group of planners could approximate (Boettke 2002b). In the setting of a functioning market economy, the entrepreneur will try to make a monetary profit, which, as described by Smith (1776), enriches the other participants in the economy. Without these important indicators, the economic actor is lost (Mises 1949). These indicators are the product of specific institutional configurations. Absent the institutional context of a private property market society, economic actors will still strive to achieve their goals as best they can (North 1990).
There are several views on what entrepreneurship constitutes. Kirzner’s (1973) focuses on entrepreneurial alertness and the discovery of opportunities, where the entrepreneur is an actor responsible for creating and expanding businesses. The entrepreneurial process reveals previous errors, adjusts these errors, and thus improves the economy (Kirzner 1997).
Lavoie (1985a) extended Kirzner’s work regarding the entrepreneurial market process and revisited the socialist calculation debate and the problems of centralized economic planning (1985a). In Lavoie (1985b) the knowledge problem critique of socialist central planning is extended to include even modest attempts at national economic planning, such as industrial policy, where attempts at planning did not function well.
The Schumpeterian view of the entrepreneur emphasizes the entrepreneur as a creator of new combinations of knowledge (Klein 2008). In Schumpeter’s work ideas about an economy’s creative response to changes in external conditions are highlighted (Schumpeter 1934, 1942, 1947).There are of course more views on entrepreneurship (see, e.g., Leeson and Boettke 2009). Entrepreneurs are present in all societies. Under the existing institutions of any society the entrepreneurs will act to better their position, e.g., money, promotions, or future advancement (Boettke and Coyne 2009; Redford 2020). Schumpeter’s entrepreneur is essentially disruptive, destroying the preexisting state of equilibrium, while Kirzner’s entrepreneur spots opportunities in a disequilibrium and moves the economy toward an equilibrium. In Kirzner (1999) it is argued that the two types of entrepreneurs are not that different, rather they complement each other.
The entrepreneurial process can be contrasted with the social discoordination and lack of economic calculation which necessarily follow any institutional coercion against entrepreneurial freedom. The contrast is an administrative—or centrally planned economy. In a centrally planned economy resources are allocated to fulfil production goals (Mises [1929] 2011; Hayek 1945). The production decisions are set by an administrator with limited information and its own preferences rather than consumer demand. Plans distort the discovery process that an entrepreneur typically provides. Without price as a market signal the planner must rely on alternative measures or disregard signals all together (Huerta de Soto [1992] 2010). Entrepreneurship produces the information necessary for economic calculation. It is impossible to use a theoretical foundation in order to coordinate society by systematically imposing coercive measures.
Institutions create rules which incentivize certain behaviors by changing the payoffs associated with different behaviors. Institutions hence influence the entrepreneur’s actions and are instrumental to economic prosperity (e.g., Boettke and Coyne 2003, 2009). The factors that have been emphasized, by scholars adherent to the Austrian school, are: 1) well-defined and enforceable private property rights, 2) the rule of law, and 3) a moral code of behavior that legitimizes and recognizes these traditions. For example, Hayek (1937, 1945, 1948) and Mises’s (1920, 1949, n.d.) property rights argument revolved around the information problem. Without private property, exchange is distorted. Without market competition, the discovery process is hampered (Hayek [1968] 2002).
Baumol (1990) made the important distinction between productive and unproductive entrepreneurship. Entrepreneurs are under some institutional settings incentivized to destroy societal economic value or perform unproductive entrepreneurship (Baumol 1996). Baumol emphasized that whether entrepreneurship is value adding to society or oriented toward rent seeking or organized crime depends on the relative payoffs.
THE CONTEXT—CHINA’S HISTORICAL WIND POWER DEVELOPMENT There is an increasing interest in the transformation of the Chinese energy system, whose cumulative wind power capacity increase is the largest in the world (Zeng et al. 2015; Lam, Branstetter, and Azevedo 2017; Karltorp, Guo, and Sandén 2017; Sahu 2017). Global installed capacity in 2018 was 597 gigawatts (WWEA 2019). Globally, 52.5 gigawatts were added in 2018, constituting an annual growth rate of 9.1 percent, of which China added 21 gigawatts. The Chinese accumulated wind power capacity was 217 gigawatts in 2018 (WWEA 2019).
China’s early period of wind power expansion was slow. In the 1970s, wind power projects were limited to small off-grid projects in remote areas (Liu, Gan, and Zhang 2002; Xu et al. 2010). Grid-connected wind power in China was achieved in 1985, when four 55-kilowatt Vestas turbines were imported from Denmark (Zhengming et al. [2006]). International agencies such as the World Bank, the United Nations Environment Programme (UNEP), and Asian Development Bank facilitated China’s early buildup of renewable energy (Liu, Gan, and Zhang 2002).
By the end of 2004, accumulated installed wind capacity was 769 megawatts, ranking tenth in the world (Zhang, Andrews-Speed, and Zhao 2013). During China’s “Eleventh Five-Year Plan” period (2006–10), installed capacity doubled for five consecutive years (Sun et al. 2015). Around 2012 China bypassed the USA as the country with most installed capacity (see figure 1). The installed capacity of a power system represents the maximum capacity that the system can produce under ideal conditions. A power plant with a one-megawatt installed capacity can, hence, produce at maximum one megawatt at any instance of time. Electricity generation, on the other hand, describes the amount of electricity that actually is produced during a specific period and is normally measured in kilowatt hours or megawatt hours.
Figure 1. Installed wind power capacity in the US and China, 2000–16
Source: Data from IRENA (2018). However, when it comes to electricity generation the United States was for a long time significantly higher, even though the Chinese installed capacity was almost double—the electricity output was almost equal (See figure 2).
Figure 2. Electricity generation from wind power in the US and China, 2000–17
Source: Data from IRENA (2018). PROBLEMS AND CONSEQUENCES Several problems in Chinese wind power development have been identified and these downsides will be highlighted and discussed from a theoretical perspective. This synthesis of those problems is organized as follows: planning problems and knowledge problems; unproductive entrepreneurship; and bureaucracy and government policy.
Planning Failures and Knowledge Problems
The Chinese wind power industry has faced institutional, managerial, technological, and cultural obstacles. When analyzing undesirable policy results, an economist usually resolves to examine the incentive structure. So, what explains China’s results? The short answer is that the results are in line with the incentives found in an economy where planning and bureaucracy dominate (see e.g., Mises 1944; Nove 1982; and Boettke 2001, 2002a). The existing incentives limit traditional entrepreneurship and have replaced it with institutional entrepreneurship, in which entrepreneurs must navigate the bureaucracy and engage in rent seeking (Mises 1944; Li, Feng, and Jiang, 2006; Huerta de Soto [1992] 2010).
Many of the problems in China’s wind power development reside in political decision--making (Zhang, Andrews-Speed, and Zhao 2013; Huenteleret al. 2018). Governmental policies promoting installed capacity rather than actual utilization of wind resources have been a prevalent problem (Pengfei 2008; Li et al. 2018). For example, Chinese firms were mandated to construct a certain amount of wind power generation capacity. Given the requirement at hand, bureaucrats at state-owned enterprises constructed a specific generation capacity—without ensuring that electricity was actually generated.
The need to construct a certain amount of wind power leads to the sacrifice of quality as a selling point and to an intense price competition that hampers technological improvement and quality (Hayashi et al. 2018). Theoretically, competition should improve the quality of products. However, because quantity—not quality—is the factor for businesses to maximize and actors are spending someone else’s money on someone else, an equilibrium of lower prices and increase sales through quality reductions can be expected. In the case of Chinese wind power, the result of this quality reduction is that the equipment cannot be integrated in a large-scale grid (Xingang et al. 2012; Luo et al. 2016).
Furthermore, foreign firms exited the market driven by quantity competition and a prerequisite in the Power Purchase agreements which stipulated that there should be 50 percent local content (later 70 percent) in the wind turbines. During the eleventh five-year plan (2006–10), plans were made to advance the domestic wind power system and its related components (Feng et al. 2015). While approximately 95 percent of the turbines installed in China until year 2000 were imported, the following decades saw a significant drop. In 2005, more than 70 percent of China’s wind power equipment was imported; in 2008, only 28 percent; and by the end of 2013, domestic manufacturing levels had reached 94 percent (Junfeng, Pengfei, and Hu 2010; Liu et al. 2015; Zhang et al. 2015). In 2012 there were only two international firms (Gamesa and Vestas) among the top ten parts manufacturers in China, accounting for 3.8 percent and 3.2 percent of production, respectively (Feng et al. 2015).
The domestic production goal set in the eleventh five-year plan was fulfilled but created problems. Domestic production overcapacity caused further downward price pressure: in 2011, the manufacturing capacity was 30 gigawatts, but the annual demand was only 18 gigawatts (Li et al. 2012; Zhang et al. 2015). In 2013 the domestic new installed capacity was 16 gigawatts while only 0.7 gigawatts were exported, i.e., around 4 percent of domestic capacity (Liu et al. 2015).
The markets for advanced components such as bearings, converters and control systems were still dominated by international companies. The absence of domestic production capability generated a sizable supply–demand gap for core parts needed in turbines with a capacity exceeding one megawatt, and placed manufacturers at a technology import-absorption stage without key technologies of their own (Xingang et al. 2012). Before 2013 domestic Chinese turbine manufacturers were falling behind noticeably compared to international competitors, in cases where the Chinese companies had not mastered the construction of larger power plants (Liu et al. 2015).
Adam Smith, Ludwig von Mises, and F. A. Hayek all highlighted property rights as the roots of economic development. Property rights are lacking when the state mandates firms to construct unprofitable power plants. Smith’s (1776) argument regarding property rights revolved around the incentives they created. Where property is privately owned, agents are residual claimants on the uses of their property and would not build power plants never meant to be operated. A state employee in a state-run firm who tries to follow state production requirements does not have the same profit motive.
The government policies that intervened in property rights, created a quality–price downward spiral which drew foreign firms out of the market since they could not compete at the low price levels (Klagge et al. 2012). Hence, an important source of know-how and technology transference was cut off. Paraphrasing Kirzner’s (1985) observation; if one (China) only observes how many new plants are constructed and the generating capacity, one might miss “lightbulb moments” that could have made every wind plant more efficient. In China the single-minded focus on expansion of a good within a planned economy created a path toward a low quality equilibrium.
Unproductive Entrepreneurship
As Baumol (1990) pointed out, the entrepreneur can engage in productive and unproductive activities. Subsidies, price interventions and capacity goals have made the productive role of the classical entrepreneur absent under these Chinese institutional settings. In a market economy, it is illogical to construct a wind power plant absent grid connection. However, when the goal is to build as many power plants as possible, with the state and not the entrepreneur owning the company, the cheapest way to achieve the government’s planned goal is to buy inferior products for inferior locations. Hence, as stated by Boettke and Coyne (2009), the institutions controlling the entrepreneur’s behavior are instrumental to economic prosperity. Policies can affect the outcome, but even good policy can create unintended consequences under bad institutions (Rothbard [1970] 1977; Coyne and Moberg 2015; Evans 2016).
Wind power curtailment mainly refers to when a wind turbine must be shut down because of issues of safety, technology, and grid access management, and for other reasons. China has experienced extensive wind power curtailment, leading to a low power plant utilization rate (Sun et al. 2015; Fan et al. 2015; Zeng et al. 2015; Luo et al. 2016). The curtailment between the years 2010 and 2013 was estimated to be 3.9, 10, 20.8, and 16.2 terawatt hours, respectively (Luo et al. 2016). The rapid installation of new wind turbine capacity without adequate maintenance and management technologies compromised operation safety (Feng et al. 2015). From a technological perspective, Lin et al. (2016) identified four reasons for the operating failures: lack of core technologies; inferior quality due to price competition; design standards and wind farm climate differences; and exterior factors, such as wind farm construction, power grids, and maintenance.
In 2007 the average full-load hours of Chinese wind turbines was 1,787, which was considerably lower than in Western countries such as the United Kingdom (2,628 hours), Australia (2,500 hours), and the United States (2,300 hours). In China, some turbines designed for two thousand full-load hours are currently in operation for only three hundred hours a year (Sahu 2017). The utilization fall due to curtailment was up to 15 percent between 2011 and 2015, rendering sizeable financial costs, equivalent to about half of the wind farms’ revenues (Luo et al. 2016; Karltorp, Guo, and Sandén 2017). Bad wind turbine performance, such as when turbines without low-voltage capability ride through disconnect from the power system, creates potential safety risks in the power system.The capability of electric generators to stay connected if lower electric network voltage occurs for a short period. Without this capability a chain reaction might start where more generators are disconnected. Disconnections lead to secondary shocks, which in turn can spill over into other parts of the system (Sahu 2017; Zeng et al. 2015).
The coerced focus on constructing power plants also led to some questionable location decisions. China’s wind resource–rich regions are largely situated in the northern nonpopulated areas at the end of the power grid, where the grid structure is unsuitable for large-scale wind power (Han et al. 2009). Energy demand is concentrated in the south and around the coast, where manufacturing and a large portion of the population are situated. Placing a wind power plant over three thousand kilometers away from the main demand would in any system lead to significant power losses. Grid connection capacity has in some years lagged installed capacity by more than 30 percent. The result has been that power generation has exceeded the grid’s capacity, leading to abandonment and grid instability (Zhe 2011; Sun et al. 2015; Fan et al. 2015; Zeng et al. 2015; Zhang et al. 2017).Grid expansion is costly for power companies, and upgrading the power grid can be even more costly. Even though the concession project policies state that companies shall construct transmission lines to the wind farms, there are potential loopholes regarding when the construction has to be finished or the quality of the transmission line (Han et al. 2009).
Another field negatively affected by wind power policy is technological development. Chinese inventors have been granted few international but numerous domestic patents. Beginning around the year 2000, granted domestic patents flourished. According to Lei et al. (2013) and Li (2012), governmental programs aimed at increasing the number of patents explain the surge. Chinese companies were incentivized to seek local patents. Gosens and Lu (2013, 2014) also noticed that the number of granted patents were an evaluation criterion for many researchers and administrators. Promotions depended on goal fulfilment, and a certain number of patents was a government goal (Li 2012; Lam et al. 2017).The Chinese legal system also had problems with distinguishing real innovations from false innovations. Hence, there was a large number of “junk” patents (Lam, Branstetter, and Azevedo 2017).
In terms of wind power innovation, however, China had limited international success (Lam, Branstetter, and Azevedo 2017). Chinese wind turbine manufacturers secured few international patents, and several major manufacturers were unable to patent their technologies. For example, granted patent applications to the European Patent Office (EPO) originating in China were low (between 1980 and 2014). Even if a firm do not intend to produce on a certain market it is beneficial to patent breakthroughs to license the usage to other firms. Home country bias in patenting should be expected but it is remarkable that so many big industrial manufacturing firms that are engaged in a fast-developing technology do not patent.
The two major Chinese firms that tried to patent—Envision and XEMC—lodged thirty-eight and nineteen EPO applications, respectively. The two firms were granted two and six patents. The firm Sinovel submitted twenty-one patent applications to the EPO; of these all but one was either subsequently withdrawn by Sinovel or rejected by the EPO. At the EPO the average application has a fifty percent success rate (see Grafström, 2017). Among the top ten Chinese wind power manufacturing firms, seven obtained no EPO patents, and five of them have no recorded EPO applications. The success and application rates were similar at the USPTO.
Only observing a single patent office (such as a country’s home office) is not an optimal method for comparing the countries with the most patents in the wind sector, since the local offices can have criteria with differing degrees of strictness. In figure 3 the distribution of wind power patents among these countries when only considering patents approved at one patent office is displayed (see the appendix for each country’s total patents):
Figure 3. Proportion of patents awarded by one office or more
Source: Data from OECD.Stat (Patents - Technology Development; accessed [10 05, 2018]), [https://stats.oecd.org/]. The aggregate Chinese patent approval was high around 2006, but only if data from one patent office is considered. If the criteria are changed to require that the patent be approved by more than one office (an indicator of a higher-quality patent), as in figure 4, then the Chinese patents are absent.
Figure 4. Proportion of patents awarded by four or more patent offices
Source: Data from OECD.Stat (Patents Technology Development; accessed [10 05, 2018]), [https://stats.oecd.org/]. It is likely that it was easier to obtain a patent in China in the early 2000s and that Chinese patents were thus of lower quality, making a side-by-side comparison unproductive. Before 2009 Chinese patent examiners limited their search reports to domestic prior art, thus not considering global novelty (Cass 2009).
From a theoretical standpoint, both a planning problem and an entrepreneurial problem are evident. Policies (as, for example, requiring patents to be secured) trying to direct production and investments is often counterproductive. Drawing on insights from Kirzner (1982), it is unsurprising that attempts at technological development by direct regulation and interventions are based on erroneous information that obstructs or distorts the market’s own complicated discovery process (Rothbard [1970] 1977; Huerta de Soto [1992] 2010). The entrepreneurial process incentivizes entrepreneurs to reveal previous errors and to adjust behavior to correct those errors (Kirzner 1997). When patenting becomes a numbers game (paired with a demand for as low a price as possible, with a disregard for quality), growth can be expected in what is counted—in this case patents.
The Schumpeterian creative destruction process also becomes a dangerous activity in a planned economy. There is a risk that the process will disrupt the plan, and no resources can be allocated to a previously unknown venture. The destruction can also threaten the power of those who might prefer the status quo. Hence, whereas the entrepreneur would struggle against competition in a market economy, he will face a political power struggle in a planned economy.
Following Hayek’s “The Use of Knowledge in Society” (1945) it is evident that any central plan will face obstacles. A centrally planned wind power program in many instances will not match the efficiency of the market. The incentives, knowledge, and imagination of a single planner are only a small fraction of the total sum of knowledge in society.
Bureaucracy and Government Policy
As Mises (1983, 53) observed, the allocation of resources by bureaucracy is made through obedience to rules. When making decisions based on rules, without price signals, consumer satisfaction or production toward a low cost cannot be achieved. The system of profit and loss plays little role in the bureaucratic machinery, and to the extent that it does play a role, the highest value is placed on the bureaucratic administration’s rule-following ability. Hence, we can expect a t neglect of entrepreneurship and prices and costs where rules and regulations determine the product to be supplied, its characteristics, its price, and the method of production (Carnis 2009).
The Chinese wind power sector was under the studied period (1980–2016) profoundly regulated by administrative practices and planning. Some policies were counterproductive due to several competing/uncoordinated governmental entities (Lema and Ruby 2007). For example, Liao (2016) examined seventy-two wind energy policies issued between 1995–2014 and found more than twenty actors who independently or jointly issued policies. The issuers of policy were predominantly agencies that controlled key economic and administrative resources—not the one that oversaw wind power. The governmental agencies could not tap into the localized knowledge or predict the direction of a fast-developing technology. Hence, the agencies produced policies that hindered technological development.
In 1994, one of China’s earliest wind power–specific policies was introduced. The Ministry of Electric Power (MOEP) decided that installed wind power capacity should increase a hundredfold, from about ten megawatts in 1993 to one thousand megawatts in 2000. The government’s target was not reached, stopping at 350 megawatts. To support the government production target, power companies were obliged to buy (or produce) electricity from wind power, and they introduced a price guarantee of 15 percent above construction cost to developers (Lema and Ruby 2007). The policy measures failed, since they did not achieve legal status, meaning that noncompliance was not penalized. Noncompliance was extensive, which was not surprising considering that wind energy was significantly more expensive than coal power (Lema and Ruby 2007; Karltorp, Guo, and Sandén 2017).
Another policy-related example is revealed in the wind farm approval process. Government contract projects appeared in the early 1980s, while the first concession project was carried out in 2003 after a new concession model was established (Han et al. 2009). Approval of contract projects worked as follows: wind power companies presented large (over fifty megawatts) project proposals to the National Development and Reform Commission (NDRC) and smaller (under fifty megawatts) proposals to local administrations such as the Inner Mongolia Development and Reform Commission (IMDRC), whose decisions did not require approval from the NDRC.
The division of the approval process by project size in 2003 was intended to reduce bureaucratic delays. Previously every new project required approval by the NDRC, making the application process for wind power projects complex and time consuming. Since provincial governments could now approve projects below fifty megawatts, a substantial number of wind farms became 49.5 megawatts in size. These smaller local installations were not coordinated in terms of the development of grids, rendering grid problems (Lema and Ruby 2007; Zhang, Andrews-Speed, and Zhao 2013; Karltorp, Guo, and Sandén 2017).
The 2003 concession model opened, and to some extent formed, a market—but the new planned organization had weaknesses (Lema and Ruby 2007). The utilities/firms that offered the best price per kilowatt hour won the concessions and consequently the right to construct wind power plants and produce electricity on the concession sites. The winner was guaranteed a fixed price for the first thirty thousand full-load hours (these were power purchase agreements, PPA). After the initial thirty-thousand full-load hours and until the end of the concession period, electricity would be sold at a uniform on-grid price. The concession model had some unintended and in hindsight obvious disadvantages. Some bidders had incentives to intentionally underestimate operating costs to promise a lower price compared to other bidders.
The power companies in China were obligated to have a certain amount of generation capacity from renewable energy sources; the renewable energy portfolio standards were due to the Renewable Energy Law of 2006 (Gosens and Lu 2013). The combination of the renewable portfolio standard and the concession program initiated a steep fall in the prices of the winning bids (between 30 and 50 percent), since the firms were obligated to have the renewable output. The companies made unprofitable bids using the cash flow from other business areas to sustain unprofitable projects, but the governmental goals were fulfilled. Another price distortion came from the Chinese government’s attempt to support construction of power plants by introducing a price guarantee of 15 percent above construction cost, which incentivized developers to construct otherwise unprofitable plants (Lema and Ruby 2007).
Another problem can be observed in the bureaucratic nature of a Chinese renewable energy price subsidy scheme which caused financial constraint problems in several sectors (Liu et al. 2015; Karltorp, Guo, and Sandén 2017). The electricity end users were obliged to pay a surcharge for renewable electricity. The payment went into a fund under the Ministry of Finance, which redistributed the money to the provincial finance bureaus. The provincial finance bureaus distributed the money to local utility companies based on their renewable energy production. The companies had to wait two to three years for the payments, which was problematic considering that the subsidies were up to half the selling price of electricity (Sahu 2017). The firms in turn had problems paying the turbine manufacturers, who in turn could not pay the component providers.
It is problematic that pricing for both wholesale and retail power remains under the control of the central government, since the central government has failed to deliver incentives for flexibility for generators and end users. The influence of provincial governments over the power system impedes interprovincial electricity trading (Pollitt et al. 2017). For example, local governments have repeatedly intervened in direct electricity trades, reducing energy prices to stimulate their local economies, even though that is not beneficial for the power system (Zhang, Andrews-Speed, and Li 2018).
The application of administrative rather than market mechanisms has been a major hurdle to a well-functioning Chinese energy system (Depuy 2015). Hence, without proper exchange no proper market prices will materialize. As noted by, for example, Mises (1949), price signals direct the entrepreneurs. Without these important indicators, the economic actor is lost. Hayek (1937, 1945) building on Mises, described the information-carrying capacity of market prices, which reveal value and the relative scarcity of resources for consumers and producers.
The problems that have been revealed here should come as no surprise since the Chinese political actors do not operate on a market, but rather in a planned economy with traces of a market. In a market economy, political actions (that are market compatible) can moderately distort market outcomes without modifying the modus operandi of the market (Mises 1944). In contrast, political actions that are noncompatible with market processes, especially in a nonmarket setting, produce an entangled political economy (Smith, Wagner, and Yandle 2010).
IMPLICATIONS China’s policies and regulations between 1980 and 2016 caused problems for a renewable energy transition situation. There were problems with management, strategies, programs, and policies, which were sorted and separated under numerous departments of the Chinese central and local governments. From an economic theoretical perspective, a a strong market structure would provide practical solutions to some of these challenges.
The findings in this paper have several implications. First, as in the 1920s, the 2020s could possibly see a great planning debate because of the perceived success of China’s state-run five-year plans. In this paper, the wind power industry has been identified as revealing limitations to planning. To pass a comprehensive judgment on the Chinese economy more sectors must be investigated, following Boettke’s insight that aggregates might be misleading and that answers hide at the micro level.
Second, there are applications for the coming global energy system transition. Policymakers should use market incentives or else their countries risk experiencing problems like China’s. The observed Chinese power sector was profoundly regulated by administrative practices. Planning was likely the underlying institutional reason for the challenges that have been described.
Third, policymakers should acknowledge incentive problems. When any government set a command-and-control target for new installed capacity, the state power companies delivered to target. For example, the goal of increasing power plant capacity (with mandatory portfolios) led to construction (i.e., generation capacity) but not necessarily more generation of energy. The incentives in China promoted construction—regardless of whether the construction could be connected to a grid or was economically profitable. When a manager is evaluated based on how well he achieves the planned goal, he will optimize his effort to reach the goal, disregarding downsides such as the fact that the new power plants that will not be connected to a grid.
The findings have a last implication for other countries as a guide for what not to do. A policymaker should assume that they do not have enough information to create a detail-oriented approach to reducing carbon emissions for the whole economy.
A last reflection, going back to Boettke (2002a, 10):
Unfortunately, most individuals in these economies wake up every day and go to work at the wrong job, in a factory that is in the wrong place, to produce the wrong goods. Many of the firms actually contribute “negative value added”, that is, the value of the inputs in the production process is greater than the market value of the output that is produced. This is the legacy of decades of attempted central administration of the economy.
The Chinese economy will probably become older than the Soviet economy managed to, but there should be caution against saying that “[t]he Chinese economy outpaces the West” as in the infamous Foreign Affairs article from 1953.
APPENDIX Table 1. Absolute number of patents registered at one or more patent offices
Rounded to the nearest whole number. Source: Data from OECD.Stat (Patents - Technology Development); accessed [10 05, 2018]), [https://stats.oecd.org/].
Table 2. Absolute number of patents registered at four or more patent offices
Rounded to the nearest whole number. Source: Data from OECD.Stat (Patents - Technology Development); accessed [10 05, 2018]), [https://stats.oecd.org/].
Entrepreneurship is the great force for social good — in fact, the greatest force for good in the history of civilization. It’s the system of continuously improving the lives of others so we can improve our own lives. Through entrepreneurship, we can achieve greater and greater levels of community, collaboration and societal advance. Eamonn Butler, Co-Founder and Director of the Adam Smith Institute, has written what he calls a Primer for understanding and appreciating the wonderful institution of entrepreneurship (Mises.org/E4B_130_Book1). He highlights some of the key points on the Economics For Business podcast.
Innovation and improvement. To continuously improve people’s lives, we need new things. We need people to invent things that haven’t been thought of before. And we need innovators, people who improve those things and find new purposes for them or new ways of producing and distributing them. And we need entrepreneurship, the marshalling of resources to produce these better things faster and more efficiently and get them into more people’s hands.
Entrepreneurs are those unique people who organize the marshalling of resources, and who risk their own capital and their investors’ capital in this pursuit of a better future for all.
Cascading Development. When entrepreneurs undertake this act of discovery, and especially when they succeed, they trigger cascading development. One innovation and entrepreneurial initiative leads to another. They are all aimed at making people’s lives better — easier, healthier, more convenient, more affordable, more efficient. And, eventually, knowledge spreads, and people’s lives are transformed, so that Indian peasant farmers can check produce prices on their smartphone and get the best offer from the market. Development cascades from individual to individual, firm to firm, market to market and country to country. It’s never-ending improvement.
Long-termism and ethical behavior. The outcome is long term uplift and benefit for all. Entrepreneurs are long term thinkers. They are focused on the lifetime of their company and their products, and perhaps to passing them on to the next generation (Politicians are the opposite — they can only think in election cycles).
Entrepreneurs don’t want to just make a short term profit and then leave the market. They want long term revenues and long term profits. That means creating reliable, returning customers who love the entrepreneur’s product. That requires delighting those customers, serving them impeccably, never letting them down or breaking a promise. There are few other, if any, institutions that are constituted in this way.
This Long-termism is ethical. Entrepreneurship is ethically driven.
Internationalism A small firm can trade on a global stage, and if they can, they will. It’s easier than ever before in the digital era. New and better ideas quickly spread around the world. But it has always been the case, since the earliest of times. Politicians establish borders to divide people, and then violate them in invasions and wars. Entrepreneurs see no borders between people. Political borders can’t divide markets.
Social good. Entrepreneurship achieves more for social good than any other institution. Entrepreneurial innovation in goods and services enhances life and opens up new possibilities. Customers flock to entrepreneurs because of the tremendous service they deliver. The constant improvement delivered by entrepreneurs constitutes civilizational progress. The competitive pressure to improve quality and utilize resources more efficiently generates more and more value for the world.
It’s an error to see business as extractive — extracting and using up resources. Business is generative, putting life-changing inventions at the disposal of the global population. What’s seen is the dirt and smoke left over from mining or manufacturing. What’s not seen, and is often unappreciated, is the huge amount of good that comes into the world via entrepreneurship.
Entrepreneurship is the application of property rights at every scale. It’s another error to think of entrepreneurship as small business or young and immature business. Ray Kroc of McDonald’s was a great example of an entrepreneur who worked out how to operate a hamburger restaurant at global scale with continuous improvement. Entrepreneurship requires property rights; people need to have control over their property in order to transform it into marketable innovations and services. But that does not limit the scale of entrepreneurship. Property rights are a principle that supports global scaling.
The entrepreneurial method. Probably the best way to define entrepreneurship is as a process or a method. It’s akin to — and as important to civilization as — the scientific method, but different. They both involve trial-and-success, coming up with ideas and testing them. The scientist tests against reality, looking for a law, a repeatable outcome that will never vary. The entrepreneur tests against consumer approval, looking for acceptance that might be repeatable until conditions change, such as new competition arriving. Entrepreneurs can’t predict the future as scientists can, and they can’t exert control in the form of unchanging laboratory conditions. Yet they still are challenged to build a business that lasts.
Can we nurture this institution? Yes. In school, via literacy and entrepreneurially-oriented education, teaching young people about profit, and uncertainty and the requirement for supportive environmental elements such as property rights and flexible labor laws, and the value of trying multiple different initiatives before discovering a winning proposition. We might not be able to teach successful entrepreneurship, but we can create the conditions for learning.
A selection of books by Eamonn Butler Entrepreneurship: A Primer: Mises.org/E4B_130_Book1
Austrian Economics: A Primer: Mises.org/E4B_130_Book2
Classical Liberalism — A Primer: Mises.org/E4B_130_Book3
Ludwig von Mises — A Primer: Mises.org/E4B_130_Book4
Friedrich Hayek: The Ideas and Influence of the Libertarian Economist: Mises.org/E4B_130_Book5
The Condensed Wealth of Nations: Mises.org/E4B_130_Book6
Governments would like to take credit for the level of entrepreneurship in their countries. Entrepreneurship leads to value creation (happier voters) and economic growth (more to tax). But, as Per Bylund points out in the Seen, The Unseen And The Unrealized (Mises.org/E4B_129_Video), governments’ actions restrain entrepreneurship.
Dr. Samuele Murtinu joins the Economics For Business podcast to explain both how and why governments fail in their best efforts to help entrepreneurial businesses succeed.
Key Takeaways And Actionable Insights Europe has an entrepreneurship problem. European economies exhibit lower growth rates than the US. At the firm level, there are fewer unicorns, and fewer new technology-based firms or innovative startups and innovative ventures in general. Venture capital markets are very thin, and most venture financing is debt, which is (as Sergio Alberich described in Episode #123: Mises.org/E4B_123), a poorer choice for startups and young firms than equity.
Consequently, European countries see a lower level of innovative startup behavior. Existing firms have low levels of R&D spending. And, generally, there is an inability to turn the innovative inputs that are available into innovative outputs — new markets and industries tend not to emerge in Europe first.
And the European mindset tends to favor the idea of the entrepreneurial state — the state is thought to be where good ideas and good initiatives come from.
Governments see launching their own venture capital funds as a new means. The key idea of the entrepreneurial state is deep involvement in economic affairs, including funding basic research, financing, shaping and directing R&D investments, and thereby creating new markets. The centrally coordinated state is seen as the driving force for the development of innovation and technological progress. For this mindset, government venture capital seems to be an available means. So governments start and implement venture capital funds — the terminology is Public Venture Capital.
These are companies and funds that are fully owned, fully funded (no limited partner structure) and fully managed by government bureaucrats, with the purpose of investing in innovative startups.
Firstly, Governments get the concept wrong at a fundamental level: they have the wrong goals. Private venture capital funds and even hybrids like sovereign wealth funds have clear goals: rapid, high-level capital appreciation by investing in startups at an early stage and exiting as quickly as possible in a liquidity event such as a commercial sale or an IPO.
Government venture capital may have “social” goals such as encouraging industry sectors, favoring regional technological development, boosting economic growth, and providing jobs. These are vague and unclear, and may contradict individual company business plans (such as automation and minimization of labor costs). With the wrong goals, it’s impossible to succeed.
For example, the selection process for private VCs choosing firms for fund portfolios is rigorously goal-directed and VC firms have honed their candidate identification and due diligence processes in order to maximize their chances of winning from the very first steps in the investment process. Government funds lack this clarity and therefore can’t develop the requisite expertise.
Governments have difficulty letting go of control. Private VC’s have also honed the role of the contract between them and the firms in which they invest, and with the limited partners who provide the investment capital. The contract with the startup firms is as “hands-off” as possible (see, for example, the SAFE contract — Simple Agreement For Future Equity — available for free download and free use from the Y-Combinator website: YCombinator.com/Documents) and the contract with Limited Partners gives them no role in the management of the fund. Private VC’s understand that high levels of control are not appropriate to the adaptive management of immature firms in rapidly changing environments.
Government bureaucrats directing investments in startups are averse to this kind of hands-off management.
Governments can’t get incentives right, and consequently can’t hire the best executives. Private VC managers are highly incentivized. In the largest and most successful funds, they receive high salaries and a 20% participation in fund appreciation. The best individuals from the most prestigious business schools are hired to compete with their peers for promotions and partnerships. The most successful funds attract the most capital from the deepest pocketed sources, and the cycle of success rolls on.
Public VCs can’t attract the same quality of human capital. Typically, managers are paid a fixed salary, which can’t be seen as out-of-bounds from the perspective of bureaucratic rules and standards. If there are bonuses, they are calculated in what Professor Murtinu called a “gloomy” way. No-one is going to break any income-equity norms.
Professor Murtinu’s rigorous data-rich analysis proves beyond any doubt the failure of Public Venture Capital. In order to analyze Public Venture Capital performance, Professor Murtinu utilized the VICO database, a comprehensive data set about venture capital backed companies in high tech industries in seven European countries. He reinforced it with additional data sources, and was able to run a comparison of the performance of firms that received public venture capital backing and those that received no venture capital. The data sets covered 25 years.
The result: no statistical difference between the performance of the two sets of firms. Public Venture Capital had no effect. It was a waste. This was true across all possible variables: productivity, whether total factor productivity or partial factor productivity like labor or capital, sales growth, employment growth, innovation outcomes, exits.
The opposite is the case for private venture capital backed firms. In the same kind of analysis, private venture backed firms are statistically superior on every dimension. The overall impact of private venture capital is very clear and highly positive.
There is one possible step in the right direction: government becomes a limited investor. Public venture capital can syndicate with private venture capital, and so long as the investment is less than 50% of the fund total, and has no say on selection of investments, on due diligence, on governance, on monitoring, and on timing or type of exits, it is possible that the investment outcome can be positive. The European Commission is currently considering this role for Public Venture Capital.
Additional Resource "Public vs. Private Venture Capital" (PDF): Mises.org/E4B_129_PDF
Austrian economics helps entrepreneurs to develop and implement more effective business strategies, and to open up streams of continuous innovation. As Joe Matarese, CEO of Medicus Healthcare Solutions, said about Austrian economics in relation to business: It just works (see Mises.org/E4B_126).
In episode #127 (Mises.org/E4B_127), Matt McCaffrey outlined the Austrian strategy process of Explore and Expand, and its logic development. This week, he helps us dig deeper to identify the principles of Austrian economics that underpin our distinctive approach to business strategy.
Key Takeaways and Actionable Insights Realism: real people, real markets, real entrepreneurs in real firms. Mainstream economics has never been able to help business, because of its focus on math, models, and prediction. Real people and their decisions and interactions and motivations and emotions can not be captured in equations and mathematical functions.
Austrian economics has carved out a particular area of focus in the behavior of real people in its study of entrepreneurs and entrepreneurship. Austrians examine real entrepreneurial decision making day-to-day; they highlight real people experiencing value and entrepreneurs’ role in generating that value. From this base, Austrian economics investigates how individual actions and choices and interactions lead to the formation of markets.
Dynamism: The market is a process. Austrian realism sees the market as a dynamic process, continuously unfolding in interaction and innovation and change. Mainstream economics, with its preference for the greater mathematical tractability that comes with abstraction, has no capability of dealing with this real world dynamism. The embrace and study of dynamic processes gives Austrian economics much of its applicability in business. The business world is never static. It can’t be understood in abstractions. It’s real and messy and changeable and unpredictable.
Uncertainty and complexity: embrace emergence.
Uncertainty is a keyword for Austrian economists. It’s a term that describes the real world in which entrepreneurial businesses operate. They can never know for sure what comes next; they can’t anticipate all of the interactions between competitors, changing customer preferences, technological advances and social and economic trends. There is no sure-footed way to plan for the future. Austrians recognize uncertainty, and help businesses think about how to cope with it, how to narrow it, how to accumulate knowledge to lighten it, how to weigh decisions in the environment of uncertainty.
The new scientific term for uncertainty is complexity: in any system, the interactions are so many and their results are so unpredictable that modeling and forecasting are impossible, and outcomes are defined as emergent (i.e., outputs happen in a way that is not predicted by merely combining inputs). Austrian economics helps businesses deal with emergence.
Subjectivism: People are people, both as consumers and as providers. One of the realistic principles of Austrian economics is to deal with people as people: we are all subjective in our valuations and judgments and emotions. We are not homo economicus: perfectly rational (in the mainstream economists’ definition of rational) in objectively weighing benefits and their opportunity costs. If all we are doing in producing goods and services for consumption is trashing the planet, then we can’t be rational, in their eyes.
In order to understand business and understand entrepreneurship, it is absolutely necessary to begin with subjectivism. Consumers’ subjective values ultimately determine what is produced; if consumers don’t value something, producers won’t make it. On the producer side, entrepreneurs’ subjective valuations of the resources they have available to them to assemble in a production process affect the value of their business.
It is entrepreneurs’ subjective evaluation that results in the identification of new uses for a resource, and the introduction of new innovations. Subjective values lie underneath every new business relationship with customers, from streaming movies to google searches to online travel booking. Subjectivism is everywhere in the economy and in business.
Time: How to plan in the present to satisfy customers in the future. Austrians are unique in their understanding of the economic role of time in business. Entrepreneurs deal in future time. They imagine better futures in which customers enjoy greater satisfaction, and then they imagine how to bring it about and act on their imagination. Production — getting from imagination to consumption — takes time. Entrepreneurs are dealing with buying decisions in the present (such as hiring and buying inputs) for selling decisions in the future. They can’t know future prices or future customer preferences, so it’s a bet.
The consumption decisions customers make today reflect entrepreneurial decisions that were made weeks, months, years or decades in the past. Austrian economics helps entrepreneurs manage the contingencies of time.
Time makes the customer the boss.
Austrians utilize the concept of consumer sovereignty as an analytical tool. It means that consumers are the ultimate decision-makers in all economic systems, because what they buy or don’t buy determines what is produced. Their power is a result of the time it takes to produce. The value of resources that entrepreneurs assemble today depends on what consumers think and feel in the future.
Forecasting is tricky and best avoided, but patterns can be recognized. A consequence of time and consumer sovereignty is the fragility and inaccuracy of forecasts. How is it possible to forecast consumer tastes in the future? There are some exceptional entrepreneurs who get it right. What’s their secret? Austrians’ understanding of dynamics and complexity can help point to the processes most likely to be associated with success, without attempting to forecast it.
One alternative to forecasting is pattern recognition. Jeff Bezos said that consumers are unlikely in the future to ask for higher prices, lower quality or slower delivery. That’s pattern recognition. It’s generalized and broad based and lacking in precision and specificity. But there is a consistency to some patterns that entrepreneurs can recognize and act upon, adding their own idiosyncratic insights and guesses to shape the actual value propositions they will make to consumers.
Out of all this emerges the Austrian entrepreneurial method. We’ve all been educated in the scientific method. It’s utopian: experiments conducted with strict controls will yield the truth.
The entrepreneurial method is different, but with equal status, and greater applicability in open — i.e., human — systems where control is not an option.
It’s a bit messy and hard to characterize with precision, but it’s nonetheless real. It starts with imagination — imagining a future in which customer dissatisfactions are addressed and resolved. Their world is made better. This is proactive creativity on the entrepreneur’s part, triggered by existing highly dispersed knowledge, including tacit knowledge, held by the entrepreneur and others.
The entrepreneur designs a business model that might be able to resolve the identified customer dissatisfactions in the future and assembles resources that he or she believes, in the right combination, could accomplish the task. There’s no correct way; the entrepreneur draws on the realism of Austrian economics to best understand the challenges and how to address them.
The entrepreneur then advances with her or his own form of experiment. It’s not controlled in a closed environment. It’s a hard commitment of resources in a definite format to make a value proposition to customers. The experiment consists in ascertaining the customer’s response: like or dislike, buy or not buy, use and enjoy or use and reject? The experiment does not end there. It is continuous — receive the result, decide on how or whether to change the proposition, and try again.
Gut feeling or intuition or personal subjective heuristics all have roles to play in entrepreneurial decision making. Austrian economics captures these phenomena in the concept of judgment under conditions of uncertainty.
Organizing for the exercise of judgment. Since judgment is the ultimate generative energy in producing value for customers, and since it’s personal and individual, how do firms grow? If judgement rests with a single entrepreneur, such as a founder, growth can’t scale, and will quickly reach its limits. Austrians have the organizational design solution: delegated judgment. Austrian leaders are able to design and implement non-hierarchical organizations in which every employee is empowered to exercise entrepreneurial judgment.
They do so by substituting value codes for authority. Value codes are the unwritten codes (although they might be found in the employee handbook) and conventions of “how we do things around here”, how we generate value for customers, the mission and purpose and internal methods of the firm.
Additional Resources "Austrian Entrepreneurial Principles" (PDF): Mises.org/E4B_128_PDF
Austrian Perspectives on Entrepreneurship, Strategy, and Organization by Nicolai J. Foss, Peter G. Klein, and Matthew McCaffrey: Mises.org/E4B_127_Book
Strategy is not the formulation of a plan. It is emergent from a process of exploration and discovery. Austrian economics is the best guide for entrepreneurial firms to put in place the methods and organization that unleash the power of emergence. Matt McCaffrey joins Economics For Business for a detailed exposition of the Austrian approach to Business Strategy.
Key Takeaways and Actionable Insights A firm is a vehicle for entrepreneurial action to generate value. All businesses and all firms are entrepreneurial. They start from — and continue with — an aspiration to generate value for both customers and the firm, and they act on this intention by assembling assets (resources, people, cash, machines, software, etc.) that are required to realize and deliver value. The goal is to bring a good or service to market that is valued by others. Value is the ultimate goal.
There are clear conditions for this action to take place. There must be a decision-making authority for the firm, because someone (or some collaborative group) must decide how to select and assemble just the right combination of resources and make a specific product or service from the assembly. We call that decision-making authority the entrepreneur.
A second condition is that someone or some group must bear the uncertainty of the action. It may not turn out the way that was expected. It may not be profitable. Less value may be generated, or none at all. This bearing of uncertainty is also the role of the entrepreneur.
It's hard to get the operations of the firm just right, because of complexity and change. Why is all this so hard, and the outcome so uncertain? Two reasons: change and complexity. The subjective valuations of customers, who decide what is more valuable and what is less valuable, are changing and reshuffling continuously, depending on situation, mood, the choices of others, and a myriad of other influences. These changes can become trends, fads, segments, and competitive advantages and disadvantages.
Continuous change contributes to the complexity of the resource assembly puzzle: there are innumerable ways in which resources can be combined and recombined in a firm, and getting the assembly just right is a difficult challenge that is never perfectly resolved.
Therefore, the Austrian view of capital as a flow is a fundamental contribution to rethinking firm strategy. The resources assembled in an entrepreneurial firm are not valuable in themselves, but because they produce a good or service that the customer values and is willing to pay for. This value — translated into revenue through the customer’s willingness to pay — flows back to the firm as income. The flow of income is affected by each element in the firm’s capital combination and by the degree to which the combination is well-integrated for the value generation task. Customers drive the capital formation task. The entrepreneur is engaged in a never-ending process of combining different capital goods to find the combination that is the most serviceable in generating value. Treating capital as a value generating flow helps entrepreneurs in practice to manage the persistent process of applying resource combinations in the market to ascertain what value they generate. It’s dynamic process with no pauses.
There are four implications for firm strategy — and they all contrast starkly with the traditional business school view of strategy. The business school view of strategy takes the form of sophisticated data-fueled top down planning models. Only a few special minds can take on this intellectually and computationally difficult challenge. Historically, the list of models has included Michael Porter’s Five Forces Model (a model of industry structure and how to create barriers to entry and competition); SWOT analysis (a model of strengths, weaknesses, opportunities and threats from the firm’s point of view, with strategic implications for the management of each element); PESTEL analysis of the business environment (political, economic, social, technological, environmental, legal factors) and how they affect firm performance. The common thread for these models is that they are implemented top-down: the strategists apply the tools, draw conclusions, and instruct the rest of the organization how to act.
Matt McCaffrey’s contrasted this top-down strategy approach to the Austrian strategy approach across four dimensions.
Learning versus Rational Design The top-down models attempt rationalization: they view strategy as a rational design problem, to shape a distinctive internal competence to seize an external opportunity and evade external threats.
This approach overlooks the crucial problem of learning. In circumstances of uncertainty, unpredictability, complexity and change, learning is the essential method of making progress. Changing conditions can never be known fully enough or fast enough by people at the center (in the strategic planning department) compared to front line employees. Firms must find a way to make use of this front line knowledge, through learning.
Dispersion versus Centralization To enable the freedom to learn and to apply learning, decision making must be dispersed through the organization. A single mind or single planning unit can not centralize all the knowledge and can’t centralize decision making. A strategic plan is not feasible. Organizational design and decision-making processes must be decentralized and dispersed.
Implementation versus Formulation. A comprehensive plan is impossible. Firms must seek a more adaptive framework. Processes and methods and forms of organization must be capable of adaptation to unforeseen events and new information. Continuous deliberate adjustments must be made in the light of new circumstances, which may arise every day. Therefore, Austrians see strategy as emergent not formulated via a planning process. Adaptive firms implement entrepreneurial actions, and then adapt to the learning, new knowledge and new circumstances that present themselves as a consequence.
Structure versus Strategy The business school approach is that strategy must be fully formulated, and only then can it be used to shape the structure and processes of an organization. Austrians take the opposite approach: the structure of the firm (its organization, processes and interfaces with the external environment) shapes strategy. Hayek used the term “structure of production”. This structure can be changed, but not instantly or seamlessly. Structure and strategy influence each other to some extent, but business schools tend to make strategy prior: that a firm is organized in response to the CEO’s vision. Austrians understand that this is not realistic because it’s not possible to restructure an existing organization every time a new vision comes along. There’s a high cost to structural change, and strategy must adjust.
Emergent strategy is based on business rules. What, then, replaces top-down strategic planning? Austrians use the term “rules”. Rules are an internal device to help managers and employees make decisions on the spot in response to learning and new knowledge. Matt McCaffrey gave an example: whenever there is a break in the supply chain, repurpose old capital goods and bring them into the production process as a low cost way to fill the gap. It’s a broad and simple rule, and it enables decision making to go forward at the point of the supply chain break. People close to the action can use their local knowledge to solve the problem within the guideline of the rule.
Another example was given by Bob Luddy, CEO of CaptiveAire, who set the rule for his firm to always have the best price in the marketplace. It’s a simple rule that requires tremendous local knowledge about prices of systems and components, of competitive offerings, and about turnaround time (a cost element of price) among many others. Sales and marketing people as well as engineers can make decisions following this rule.
Rules sustain firm uniqueness. Business school strategists often focus on competitive advantage as the goal of strategy. But the concept of competitive advantage comes from neoclassical economics and the depiction of markets as bounded cage-fights for market share between similarly-resourced rivals.
Austrian strategy focuses more on firm uniqueness. A firm’s distinctive rules can result in a unique mode of delivering value, and a unique perception in the eyes of customers. A brand is a set of rules that generates such a unique perception.
The ultimate distinction: strategy is exploration. Strategy is emergent, not planned. Strategy is entrepreneurial. It’s a continuous process of learning through action and discovery. Sometimes, firms discover things they really wish they hadn’t. That’s part of the process through which, eventually, strategy evolves. It’s emergent. Over time, a firm can adopt some simple rules that seem to bring some order, but adaptation to new circumstances is always required. Profit is the signal that adaptation is successful.
We use the term explore and expand to capture the Austrian approach to strategy. Firms are always exploring, seeking ways to improve performance. When some experiments yield promising results, they can be expanded. Explore and expand is a trade-off: how much of the available resources should be allocated to each type of activity. Entrepreneurs manage the trade-off in order to succeed. There’s no strategic plan from on high to make the trade-off for them.
Additional Resources "Emergent Strategy Process Map" (PDF): Mises.org/E4B_127_PDF
Austrian Perspectives on Entrepreneurship, Strategy, and Organization by Nicolai J. Foss, Peter G. Klein, and Matthew McCaffrey: Mises.org/E4B_127_Book
"Entrepreneurship and Firm Strategy: Integrating Resources, Capabilities, and Judgment through an Austrian Framework" by Matthew McCaffrey and Ulrich Möller (PDF): Mises.org/E4B_127_Paper1
"'When Harry Met Fritz': Rules as Organizational Frameworks for Emergent Strategy Process" by Nicolai J. Foss, Matthew C. McCaffrey, and Carmen Elena Dorobăț (PDF): Mises.org/E4B_127_Paper2
Download the slides from this lecture at Mises.org/MU21_PPT_15.
Recorded at the Mises Institute in Auburn, Alabama, on 20 July 2021.
Entrepreneurship is a general feature of the market economy.
Download the slides from this lecture at Mises.org/MU21_PPT_04.
Recorded at the Mises Institute in Auburn, Alabama, on 19 July 2021.
Firms that can unlock the deep secrets of subjective value can unleash powerful, long-lasting value streams. When these flow in a confluence with well-identified market drivers, revenue and profit growth can be greatly accelerated.
Joe Matarese tells Economics For Business how he conjoined these two forces for his medical staffing service firm (MedicusHCS.com), creating a dynamic market leader from a three-person startup.
Key Takeaways and Actionable Insights Market Drivers are strong, lasting forces capable of projection. Austrians are skeptical about prediction, but it is reasonable to project some forces into the future. Demographics is one — the progression of age cohorts through the demography of a country can be mapped quite accurately. Increasing longevity is another, based on ongoing increased investment in health care and advances in the associated technologies. When Joe Matarese identified a shortage of doctors, he was able to confidently assume the shortage would continue.
When customer problems result from these forces, a market segment opens for solutions. One customer problem fed by these forces is staffing for critical roles in hospitals — doctors, anesthesiologists, nurses, etc. Staffing complements need to be assembled, absences caused by holidays, maternity leave, etc. need to be covered, and the natural churn of individuals taking new jobs, retiring, or moving requires flexible response. Not only staffing but scheduling is required — the right medical team for the specific operation at the appointed time.
The problem-to-solve is functional. The deep value is subjective and intense. Joe’s core insight was about the intense emotional need, not just the functional need. He observed his client — an operations executive in a busy hospital system — stressing out about the problem. Operating room staffing is life-and-death. Unfilled team roles would often arise at the last minute, threatening the healthcare mission of the hospital.
Temporary staffing service providers would sometimes fail to deliver the scheduled stand-in. Stress for the executive intensified.
The solution for a deep-seated and intensely felt emotional need is to transfer the burden to the service provider. Think of the intense burden the administrative executive bears when she’s not confident that her staffing plans are secure, and her routines and methods are not foolproof. What if there is a failure at the time of a scheduled operation and it can’t go forward? Or patients can’t get nursing care because of under-staffing? How much value is there in a service that can relieve the stress?
Joe Matarese conceived of the emotional solution: take the responsibility off the shoulders of the executive and take it on as a service of his firm. How is that achieved? Bulletproof processes and routines. Comprehensive databases of people and their skills and attributes, and of client facilities and their needs. The latest technology for profile matching and precision scheduling. Impeccable implementation. And, most importantly, intense listening to continuously monitor customer feelings, combined with the responsiveness to act on those feelings.
Growth follows when these market drivers, functional drivers and emotional drivers are aligned. Medicus Healthcare Solutions quickly gained market share in its initial geography. Growth comes from adding new customers, expanding territory and the underlying forces of an aging population consuming more healthcare.
But growth is a management challenge. One area of great challenge is managing people. Those who signed on for the early stages of growth and development may not have the skills — or the interest — for the later stage tasks of management like strengthening processes and systems. Making sure the team is perfectly tuned to the demands of the current stage is difficult but critical.
Further acceleration of growth is driven by innovation. Medicus Healthcare Solutions has always grown faster than the market. How? Through an intense search for new knowledge and its application in the form of unrelenting innovation — never resting in the search for better ways to provide client service. For example, in addition to continuous improvement in precision tailored scheduling, Medicus added a consulting service. Scheduling solves the client’s immediate short term problem, and does so again and again. Consulting can examine the client’s systems and solve the problem in the long term by designing and installing internal systems as good as Medicus’.
Joe has a long experience with innovation and how to manage it, and promised to come back to the Economics For Business podcast in the future to share his knowledge.
Additional Resources "Driving Growth With Core Customer Value Insights" (PDF): Mises.org/E4B_126_PDF
"Medical Staffing and the Revolutionary Innovations We Need," presented by Joe Matarese at the Mises Institute's Medical Freedom Summit: Mises.org/E4B_126_Video
Medicus Healthcare Solutions: MedicusHCS.com
Entrepreneurs seek to provide markets with new value through innovation wherever they can identify an opportunity. Their vision is broad enough to include free market institutions such as contracting, where they identify new and better ways to expand the mutuality of value and better relationship models than those in the traditional legal approach.
Key Takeaways and Actionable Insights Traditional contracting starts from an adversarial mindset. Traditional contracts are written in anticipation of conflict. They aim to anticipate everything that can go wrong. Then they try to put every contingency in black-and-white. Clauses are inserted to give one party the upper hand over the other. This approach fosters negative behaviors that undermine the relationship and the contract itself. Often, little room is left for flexibility when conditions change in unexpected ways, leading to costly problems like litigation, mediation/arbitration, renegotiation, churn, and shading (withdrawal of effort by one party due to lack of trust).
A new form of contract called a relational contract aims to address the problem. A relational contract approaches negotiation not from a transactional perspective but from a relational perspective: what are the best provisions to ensure a lasting and mutually beneficial relationship between the two contracting parties? Instead of focusing on how the value pie is divided between two parties, the shared goal is to maximize the total amount of value that can emerge from the partnership. There is a genuine good faith effort to align the two parties’ interests and to develop a fair and flexible framework to handle unexpected changes and events in the future.
The relational contract is designed to try to solve what economists call the hold-up problem. Contracts refer to future events, and specifics (such as delivery times) can never be determined with certainty beforehand. The contract is said to be incomplete — not every contingency can be specified. The hold-up problem occurs when one party uses this situation to extract concessions from the other party, knowing that it would be costly for that party to change the arrangement.
Defense contractors, for example, are notorious for under-bidding costs and then adding to their revenue and profits via change orders. A contract may call for “best efforts” but this can never be defined specifically or completely.
The new approach is said to produce healthier and more sustainable partnerships. In the article A New Approach To Contracts, the authors call for a “what’s in it for we” partnership mentality in contracting, where both parties have a vested interest in the other party’s success. Included relationship-building elements such as shared vision, guiding principles, and “robust governance structures” to keep the parties’ expectations and interests aligned.
Our guest, Steve Phelan, has written extensively about expectations management in negotiations (see Mises.org/E4E_22), and concurs that contracts can perform as instruments of expectations management. However, they can’t be perfect, and the authors’ integration of trust building mechanisms into contracts (e.g., regular scheduled trust-building meetings) seemed to him to be a bit artificial.
A better approach is to focus on identifying good faith actors — those who work hard to follow both the letter and the spirit of the agreement. As is always underlined by the “Think Austrian” approach, subjectivism (in this case good faith actors) brings better business solutions than hard and fast rules and mechanisms regarding how to build contractual trust.
It’s important to get there by the best route, since trust lowers transaction costs.
The new approach to contracting extends to psychological contracts. Psychological contracts are unwritten relationships in which an individual holds a belief in mutual obligations between themselves and another party. An often-cited example is an employment relationship. There may be a written employment contract but, beyond that, an employee may have tacit expectations about job security, personal development, recognition, promotion, growth, personal well-being and respect. If these are not met, they may withdraw effort. Employers are well-advised to empathize with the unwritten expectations of the psychological contract in order to optimize employee motivation.
A brand promise can be a similar psychological contract. Brand make overt promises regarding the benefits they claim to bring to users. In turn, users create their own expectations — as we always emphasize, value is subjective and customers engage in a value learning process when they interact with brands. Their subjectively-defined expectations undergo continuous change, especially as they make comparisons with alternative offers and alternative sources of satisfaction. It’s imperative for brand owners to monitor the evolution of customer-perceived mutual obligations. Customers hold a strong perception of how much consumption work they have to do to receive the benefits that the brand promised, and if the equation gets out of balance, they’ll withdraw their effort.
Additional Resources "Contracting In The New Economy" (PDF): Mises.org/E4B_125_PDF1
"A New Approach To Contracts" (PDF): Mises.org/E4B_125_PDF2
Value-as-experience is an insight from Austrian economics. Value is not inherent in objects or even in services. Value is not derived from functional use, but is the good feeling the consumer experiences during consumption. Consistent with the Austrian understanding of the market as a process, value is a process. It plays out in time in the consumer’s mind. Consumers learn what is valuable to them in the process of choosing and consuming and evaluating.
These insights add some under-appreciated marketing considerations to a firm’s capabilities, such as an appreciation of situational traits and of the importance of context. Irene Ng provides the E4B podcast audience with a set of contemporary tools to design new experiences and even create new markets in the era of the "Internet of Things" (IoT).
Key Takeaways and Actionable Insights. To design experiences, start by thinking in terms of ecosystems. Ecosystem thinking pays attention to how knowledge, people, technology, processes and the environment are connected and work together. Systems awareness is becoming wider and wider, observing the interaction and value creation among multiple service systems. Consumers’ value experience occurs within a service system, and thus the service ecosystem worldview is increasingly important for entrepreneurs in an ever more connected, digital and data-driven world.
The subjectivist viewpoint is fundamental to designing consumer experiences. We are taught from the youngest age to have an object view of the world. We describe situations using nouns: for example, in a room, there is a chair and a piano. Meaning and purpose are identified via the nouns we use. Economics shares some of this noun-based view of the world: assets, knowledge, material things, property.
For the design of consumer experiences, verbs are more relevant, not just as descriptions but as connections between objects and people and behavior and thinking. If I play the piano or drink tea, I am connecting objects and people in action. The world becomes a matrix of verbs and interactions. What individuals do impacts on objects and on other individuals. Design becomes a matter of what a system of objects and people and connections and actions and flows can do.
IoT brings new capacities and new affordances to service ecosystems. Irene listed 4 new capacities of IoT that contribute to new ways to design experiences:
Liquefy information: A physical object’s information can be sent across space and time. When several information flows are combined for greater information density (e.g., from multiple objects in a kitchen used during cooking) we have more knowledge on which to base an experience design.Turn objects digital: Software and sensors embedded in an object give that object new capability. For example, a running jacket can communicate location and speed, measure temperature and heart rate, and provide programmability.Assemble individual objects into a service system: Objects and devices connected and working together exhibit abilities that they don’t have individually. A door lock plus a camera plus a tablet plus the internet can perform as a remotely monitored security system.Enable transactions between separate task spaces: A task network (such as cooking in a kitchen) can be linked to another task network (e.g., grocery shopping) and a transaction between the two enabled (deliver fill-up ingredients when inventory runs low). Now a designer can think about a new set of affordances: properties of a system that show users what actions they can take. Ideally, the consumer will perceive the new affordances without the need for complex instruction.
Marketing changes its focus from consumers’ personal traits and segmentation to situations and contexts. The design of an experience shifts from the use of objects to connected things with information flows in a system. A customer’s perception of the experience within the system may be affected less by their personal traits (as is often assumed in segmentations such as “early adopters” or “social approbation seekers”) and more by situational traits and context.
For example, the situation of “taking my morning coffee” affects an individual’s perception of how well a coffee mug meets their needs (how well does it fit under the spout of the coffee maker), along with a chair to sit in or a news service (paper or digital?) to read. How well do all these artifacts and services work together in this situation?
Similarly, context affects system perception. An individual might like a certain style of streaming music at home, consumed through a sound system while eating dinner, and an entirely different style for working out in the gym, consumed through a portable digital device and earpods.
The design of experiences considers situation and context, and can potentially accommodate a very broad range of people through personalization rather than cater to a narrow market segment.
The human being remains the best sensor in the system, and all design must support and enhance this role. There may be a temptation for digital designers and technicians to become immersed in the capabilities of an IoT system and forget that it is the human who judges the value of the system through the experience it enables and supports. The human is not outside the system, but is the master sensor, providing both inputs, outputs and judgment. IoT systems provide support, using data to enhance the human experience. Empathy is still the designer’s number one tool to identify the market drivers — the dissatisfactions to be addressed — that underpin favorable human perceptions of the value of IoT systems.
Additional Resources "Designing New Consumer Experiences in the Era of IoT" (PDF): Mises.org/E4B_124_PDF
"The Internet of Things: Review and Research Directions" by Irene Ng and Susan Wakenshaw" (PDF): Mises.org/E4B_124_Paper1
"Service Ecosystems: A Timely Worldview" by Irene Ng (PDF): Mises.org/E4B_124_Paper2
"Mimicking Firms: Future of Work and Theory of the Firm in a Digital Age" by Irene Ng (PDF): Mises.org/E4B_124_Paper3
Value & Worth: Creating New Markets in the Digital Economy by Irene Ng: Mises.org/E4B_124_Book
"Austrian economics is very much the economics of innovation, because we understand change, we understand uncertainty, and we understand that there is a constant search for betterment." A new world of medical entrepreneurship is growing. Concierge and cash-only practices, walk-in cash clinics, medical tourism, and cost-sharing plans are just a few of the ways free-market approaches are changing the landscape. Our expert speakers will discuss several of these developments, and more.
Recorded in Salem, New Hampshire, on June 17, 2021.
The proper selection of a firm’s financial source does not guarantee its success, but the wrong one assures its failure.
Austrian capital theory delivers actionable insights for business. Austrian theory emphasizes capital’s economic role in generating customer revenue flows. Since these flows are variable, entrepreneurial capital must exhibit a capacity for agile and flexible combination and re-combination to keep revenue flows refreshed and current, Since capital structure plays an important role in entrepreneurial judgment, decisions, and action, it must support fast, flexible and unconstrained decision making. Businesses can benefit from their understanding of capital through this Austrian lens. Sergio Alberich helps the Economics For Business podcast listeners, and business practitioners in all kinds of businesses at all stages for their development (see Mises.org/E4B_123_PDF1), to Think Austrian in matters of capital structure.
Key Takeaways And Actionable Insights. Entrepreneurs designing a firm’s capital structure should view their choices through the twin lenses of ownership and control. Ownership and control are tradeable assets for the entrepreneurial firm. In order to obtain capital financing, one or the other or both might be offered up by the entrepreneur or requested by the financier.
How will shared ownership play out now and in the future? Will ownership imply only a share in any future returns? How great a share is the entrepreneur willing to trade? What will it feel like to receive only a portion of the return the entrepreneur worked for? How much more ownership will be given up in future financing rounds?
Can ownership be traded without any loss of control over decision-making and future investments? Alternatively, how much control should be traded? A board seat? An investment committee? The financier wants the entrepreneur to be free to make the decisions for which he or she is best-informed and most capable, and yet wants to be protected from managerial error.
There are many factors that can stand in the way of capital flexibility, and organizational issues of ownership and control become paramount.
Debt and equity are the basic choices as building blocks of capital structure. Debt and equity are basically different kinds of contracts between the individuals managing / operating a project and those funding it. Debt is a fixed claim with a known annual return to the debt holder. Typically, the debt holder has no control over management decisions and is not involved in managing the company (although there are some covenants that can be written to provide some distant control).
The return on equity for the financial investor is residual, after debt repayments are made, leaving entrepreneurs relatively free to allocate costs and direct operations. But equity holders typically hold voting rights, and can therefore exercise some control in some circumstances. They may also exert strong influence on management decisions based on relationships. For example, family and friends investors may exert special relationship influence.
There are some debt-equity hybrids — most notably convertible notes, debt that is convertible into equity at some future stage or event. The negotiation of this instrument brings more complexity to the ownership-control debate, while giving the entrepreneur leeway to consider issues of valuation in the future rather than at the current financing.
Entrepreneurs must also consider human factors, especially the number of people in the capital structure. Another major consideration for entrepreneurs is whether to raise debt or equity from a few people or many (e.g., via IPO or a bond that hedge fund investors can buy). Raising capital from large numbers of investors creates categorically different situations for the entrepreneur. An IPO, for example, can not be a highly tailored instrument. Institutional conventions and regulatory rules impose many requirements about how entrepreneurs and their managers communicate, how they frame financial risk, and about the nature of widespread shareholder engagement they take on. Just think of the interaction of Elon Musk on Twitter, with the SEC, and with short sellers.
In general, the fewer the number of investors, the greater the operating flexibility for the entrepreneur. There are fewer people to convince when business seeks to make a major change, or to pivot.
Sergio Alberich outlined 4 levels of consideration for the financial investor providing capital to the entrepreneurial firm. Level 1: How are the factors of production combined in the firm, and how might the combination change in the future? Elements of this level of consideration include the stage of business in its growth journey and the assessed maturity of its business model, industry, and competitive set; the nature of the business’s relationship with partners, suppliers, channels and customers; and the state of knowledge regarding product, service and market development.
Level 2: What is the nature and scale of cash flows now and in the future? Are there mature, reliable cash flows? Is one part of the business a drain on cash resources? Is cash coming in from investments for operating expenses (which are not really flexible).
Layer 3: What are the possibilities for returns? Both entrepreneurs and investors seek profit - not just accounting profit on the P&L but returns on equity. At an early stage, a company may worry about generating future cash flows and less about the cost of equity (in terms of sacrificed future returns) to finance growth. A more mature company with cash flows in the present pays much more attention to the cost of equity, and to cost of capital in general, seeking to preserve as much return as possible.
It is often the case that entrepreneurs give up too much equity in order to secure early stage venture capital funding, whether directly of via convertible loans. To keep the entrepreneur motivated with equity that promises future returns, it is best for them to deal with just a few investors who understand this motivation.
Organizational design is relevant, too. For example, a law firm with 100 partners, each of whom own 1 share, and limit their business model collaboration to sharing real estate costs and IT expenses, while effectively running 100 projects, might be creating a politicized nest of vipers. A partnership with shared equity in one business, where everyone stands to lose a lot if there is a bad decision, is likely to be much more collaborative, conducting a unified business, rather than acting as a co-operative of individuals sharing costs.
In the end, subjectivism in entrepreneurship prevails. As we emphasized in episode #108 (see Mises.org/E4B_108), businesses perform best when entrepreneurs are free to make subjective decisions. The proper source of capital is one that most enables this subjective freedom, which may not be the optimum source based on spreadsheet calculations. Subjectivity and entrepreneurial judgement are not math. The best economic role of capital finance lies in helping entrepreneurs make better human subjective decisions. This is the essence of the means-ends calculation for both entrepreneurs and investors. Austrian economics gives by far the best guidance on this economic role of capital.
Additional Resources "Austrian Capital Financing" (PDF): Mises.org/E4B_123_PDF1
"Austrian School vs. Neoclassical School" (PDF): Mises.org/E4B_123_PDF2
Healthcare is inaccessible in many ways, and it is notoriously inefficient. There is a fundamental misalignment between patients and the system.
A new world of medical entrepreneurship is growing. Concierge and cash-only practices, walk-in cash clinics, medical tourism, and cost-sharing plans are just a few of the ways free-market approaches are changing the landscape. Our expert speakers will discuss several of these developments, and more.
Recorded in Salem, New Hampshire, on June 17, 2021.
There’s a middle class of businesses that are the backbone of the economy. Professor Saras Sarasvathy coined that term, and we’re pleased to adopt it.
These businesses sit between the big corporations of the major stock indexes and the VC-funded gazelles and unicorns of Silicon Valley and Silicon Hills. The watchwords for these backbone businesses are duration and durability. They last and prosper because they are well-run, following the entrepreneurial method.
Entrepreneurship is usually portrayed from the perspective of ends: identifying unmet customer needs, creating new and innovative solutions, taking them to market, making a success.
That’s all true. However, there is another perspective that comes from actually running a business, ensuring that operations are smooth and efficient, monitoring daily cash flows and monthly P&Ls, and managing people’s performance.
Often, running a business requires an intensified focus on means. Cash flow, operations, employee performance — these are means, and running a business is a science of managing means. Business advisor Andrew Frazier helped us focus on means in this week’s Economics For Business podcast.
Key Takeaways And Actionable Insights Knowledge is an entrepreneurs most important means. Accumulate it purposefully (but not by losing money). The more you know, the more you grow. That’s a mantra from Andrew Frazier. He advises thoughtful accumulation of knowledge. One way to learn is to lose money — you learn what doesn’t work, and what not to do. Avoid this form of learning by purposive knowledge gathering. This includes truly knowing your purpose — at least part of which is to build the business resiliency that delivers durability and duration.
Knowing your numbers is a critical component of durability and duration, and of shepherding your means. In his advisory and consulting roles, Andrew encounters many business owners who don’t know their own numbers intimately — their daily cash inflows and outflows, the precise identification of fixed and variable expenses, the condition of the P&L and the balance sheet. Some, he says, fear the numbers. They delegate accounting to an outside service, or even to an internal “back room” employee. Don’t delegate “knowing your numbers” to anyone. Be on top of them every day. They tell you your means.
Sales and marketing are the most important means of lasting business growth, and not necessarily expensive. There is no business without the sales and marketing activities that identify the right customer niche and tell your story to those customers in a credible, warm and persuasive fashion. Many business owners and entrepreneurs see sales and marketing as an expense to be incurred only if there is cash leftover from other variable and fixed costs that take precedence. This is wrong-way thinking. Sales and marketing are job #1.
Hiring employees is the biggest change you will make to your business and to your role in it. You want to hire employees for the growth of your business. As you do so, you are changing your business. You change its structure: it now needs organizational design. You change your role: you are now a leader. You change the business’s operational flow because it now needs detailed processes and systems. You change the culture: it becomes more indeterminate and therefore requires more of your attention. You stop working in your business and start working on it.
Duration and durability require sacrifices from you. One aspect of the entrepreneurial ethic is personal sacrifice today for market reward in the future. Sacrifice is part of your means. You’ll work harder and longer hours. Your business and social and family lives will become inextricably intertwined. Your business will become your identity. Realize this and embrace it.
A lasting business requires an exit plan. A business that prospers over an extended period needs an exit plan for its owner or founding entrepreneur. This can range from an IPO or sale to an acquirer to leaving it to your kids or turning it over to employees. Whatever the case, the owner needs to plan ahead for exit, almost from the beginning. For example, if you have a professional services business, what will make it saleable when you want to exit? Is there asset value over and above revenue flow? Will customers stay after you leave? Are your kids even interested?
Additional Resources "Running Your Business" (PDF): Mises.org/E4B_122_PDF1
Visit Andrew Frazier’s Website: RunningYourSmallBusinessLikeAPro.com
Running Your Small Business Like A Pro by Andrew Frazier: Mises.org/E4B_122_Book
"The Masterpreneur Playbook Summary" (PDF): Mises.org/E4B_122_PDF2
Value facilitation is a creative act of imagination, design, assembly, communication and agile responsiveness. Our Economics For Business model applies these actions in the pursuit of new economic value. Bill Sanders, an expert in contract negotiation in business, applies them in dealmaking and business relationship management. His book, Creative Conflict: A Practical Guide For Business Negotiators (Mises.org/E4B_121_Book), provides a highly actionable model for value facilitation in contract negotiations.
Key Takeaways and Actionable Insights Business negotiations are searches for shared value. Both parties in any negotiation are seeking value, and specifically subjective value. Each sees the eventual agreement on contract terms as a source of future value. Contract negotiation has often traditionally been viewed as a struggle for one side to capture the most value at the expense of the other.
But value facilitators view it differently. They first try to identify the total amount of value in a potential agreement, before thinking about the division of value.
Divergent thinking is a source of value. In his book, Sanders refers to Creative Conflict as a positive, to be embraced. There’s no predetermined solution, and no absolutely perfect price. There are many possible solutions, and good negotiators are able and willing to continue exploring the ambiguity, and welcoming contending ideas. They are open to uncertainty. It may lead to a solution that neither party might have seen on its own.
Value potential can be mapped in preparation for negotiation. Sanders introduces the concept of value mapping. Economists are somewhat familiar with this approach at the market level, but perhaps not at the level of individual exchange. Value mapping in contract negotiation is the mental connection of one side’s assets to the other side’s needs. The value map would include a list of concessions desired from the other side (with a subjective estimate of their importance) and a list of what can be given up by your side to generate more value for the other party. In some cases, the values can be quantified.
When presented, these lists become a value proposition for the shared outcome of the negotiation. Sanders provides a value mapping checklist as a tool to help negotiators think about all the assets they might have to bring to the negotiation, and all the areas where concessions might be sought in return.
Value mapping points to the productive end of the negotiation continuum. Bill Sanders presents types of negotiations on a continuum (see Mises.org/E4B_121_PDF2). On the left-hand end is bargaining, the traditional zero-sum exercise to capture value, a purely distributive process. At the midpoint is creative dealmaking, where value mapping is applied (see Mises.org/E4B_121_PDF1) to surface extra value so that both sides feel they gain more than they relinquish. On the right-hand end is relationship building, where the two parties enter into a partnership in which each works hard for the other party to succeed. The spectrum is one of ascending creativity from left to right.
Austrian economics has a big role to play. Many of the techniques Sanders proffers in Creative Conflict are firmly based in Austrian economics, as he himself emphasizes. Some of the relevant concepts are:
Subjective Value: Each party experiences value in their own mind, and anticipates future value in the form of expectations, based on their own evaluative criteria. While subjective value can’t be quantified, the concept of an expanding pool of value can be considered by both sides, each from their own unique perspective.
Empathy: The tool for understanding the other party’s mental model for evaluation is empathy, the exercise of which we often stress as the entrepreneur’s primary value facilitation skill. This is as true in contract negotiation as in any other exchange.
Trust: Negotiation takes time and requires the declaration of parties’ wants and needs, preferences, capabilities and capacities, and the full functioning of the goods and services being traded. Trust is the required underpinning for these declarations.
Distributed knowledge: There are always things that the seller knows that the buyer doesn’t, and vice-versa. This is the normal (non-equilibrium) position, to be recognized and welcomed.
Uncertainty: Uncertainty is the quintessential condition of entrepreneurship. The future is unknowable. Sanders recommends the full recognition of uncertainty and indeterminism in contract negotiations. Explore possibilities rather than imposing mandatory conditions.
Heterogeneity: Negotiators are different, firms are different and have different priorities, every deal is different. There is no standard way of business negotiations. Sanders does not try to lay down “rules”.
Real time: Time is the context in which change takes place. Every advance in time brings new knowledge and more change. Since negotiation takes time, it must be flexible enough to accommodate change and avoid rigidity.
Processual perspective: The market is a process, value is a process and negotiation is a process. Austrian economics recognizes the role and influence of time — time as the context of change — at a high level of impact. Contract negotiators take the same perspective, using the time taken for the process to unfold as a means of facilitating greater value whenever possible.
Additional Resources E4B Tool: The Negotiation Value Mapping Checklist (PDF): Mises.org/E4B_121_PDF1
E4B Knowledge Map: The Negotiating Continuum (PDF): Mises.org/E4B_121_PDF2
Bill’s Book Creative Conflict: A Practical Guide For Business Negotiators: Mises.org/E4B_121_Book
Economists recognize the phenomenon of increasing returns. Knowledge markets such as those for software, operating systems and platforms, tend to tilt in favor of a product or service or brand that gets ahead, even to the point of lock-in. There is a growing body of theory — often under the heading of complexity theory, and supported by computational simulation — underpinning the concept of increasing returns.
Mark Schaefer is expert at bringing economic theories of this kind into vibrant contemporary life. He coined the term Cumulative Advantage, and wants all entrepreneurs to know how to harness it (see Mises.org/E4B_120_PDF).
First of all, it’s not new. It’s in the Bible: For whoever has will be given more. Sociologist Robert K. Merton therefore called it The Matthew Effect.
How can entrepreneurs and their firms take advantage of increasing returns to achieve cumulative advantage? Consistent with the processual approach to value of Austrian economics, Mark has a five-step process.
Key Takeaways And Actionable Insights Identify an initial advantage. How do entrepreneurs identify a small initial advantage that sets momentum in motion? There are unlimited sources within complex economic systems. Mark tells us to look for collisions of events, ideas, people and circumstances from which entrepreneurs can derive their unique advantage. He calls them “click moments”. They are happy, random, emergent phenomena. He gives the example of Bill Bowerman’s experiment with latex in a waffle iron to create a new type of running shoe — the click moment for Nike.
Importantly, these random outcomes are spurred by action — acting on curiosity, and pursuing an energetic quest to establish how ideas and imagination can be exploited to solve customers’ problems.
Discover a seam of timely opportunity. Mark rejects the concepts of strategy and planning. Business success can’t result from 50-page documents and elaborate spreadsheets. Momentum is a consequence of action. Entrepreneurs replace strategy with their own subjectively defined opportunity to exploit speed, time and space. A seam is a fracture in the status quo through which the entrepreneur sprints. Relentless searching for an open seam is the core activity of entrepreneurship. Seams are always opening as a result of the continuing, ongoing change of business and the economy, best understood through the dynamic lens provided by Austrian economics. Often the timing of the opening is the key factor in the success of an entrepreneurial initiative. Timing cannot be predicted, and so continuous experimentation is the best approach, to create the maximum possibility for “click moments”.
Create significant awareness through a “sonic boom” of social proof. Once a business has entered a seam, it’s the occasion to search for amplification. Mark Schaefer proposes the leverage available through influence and influencers, those who can provide social proof to a broader audience that a new entrepreneurial offering is sufficiently worthy to command widespread demand. The customer is the marketer in this construct of social proof — which is a development, of course, of the Austrian theory of consumer sovereignty. People believe each other more than they believe advertising, promotion or PR.
Gain access to a higher orbit by reaching out and up to powerful partners and allies. Once awareness and social proof of the entrepreneurial offering begin to build, the next process step is to seek partners and allies who can provide access to higher-level resources: powerful connections, better channels, financial capital, value-multiplying alliances. Network theory applies: denser and more active connections through bigger and more strategic network nodes can result in accelerated business expansion.
Maybe it’s distribution in Walmart or Target, or endorsement by a celebrity athlete, or presence on a FinTech trading platform, or access to new resources. Reaching up is an exercise in finding partners to expand an entrepreneur’s market potential.
Build momentum through constancy of purpose. Ultimately, says Mark, the killer app is constancy of purpose. Discipline, resilience, purpose and persistence accompany entrepreneurs on the path to achievement. There’s flexibility and adaptiveness and agility of course, and these can bring changes in direction, but the goal and the purpose always retain their primary role in the narrative of success.
Additional Resources "Cumulative Advantage — The Theory of Increasing Returns" (PDF): Mises.org/E4B_120_PDF
Cumulative Advantage: How to Build Momentum for your Ideas, Business and Life Against All Odds by Mark Schaefer: Mises.org/E4B_120_Book
Mark Schaefer’s website: BusinessesGrow.com
B Squared Media: BSquared.media
Cronyism is not Capitalism We often hear that capitalism is under fire: in contemporary politics, in journalism, in popular discourse, and even in some business schools and among some management scholars and their students. But the criticism, upon examination, is not about capitalism but cronyism. The two are entirely separate systems, and the corruption and corporate political activities of cronyism are not exhibited in capitalism, and will never appear if we can adhere to capitalism’s purest form, entrepreneurship.
I had a great conversation with @petergklein on the absolute distinction between cronyism and capitalism - one that not all management scholars are willing to make. Listen to @econ4business podcast tomorrow May 25, 2021 to hear the entire conversation. pic.twitter.com/dGCxWTgLva
— Hunter Hastings (@hhhastings) May 24, 2021 Defining Capitalism Capitalism is a system in which factors of production are privately owned, resources are allocated through markets, i.e., voluntary co-operation among individuals, and individuals and groups are free to engage in economic activity without centralized control or interference from the state.
Capitalism includes the monetary system that enables entrepreneurs to engage in economic calculation, and the institutions that support property rights, and the rule of law. There are high levels of individual freedom of people to form groups and act without state coercion or compulsion.
Defining Cronyism Cronyism is a system in which the state takes charge of, or has a high degree of influence in, allocating resources to firms, and some firms derive advantages over other firms based on their relationship with and influence with government officials, rather than their ability to satisfy customer wants via superior capabilities. The supporting ideology favors high levels of state interference in the allocation of economic resources, with institutions and practices favoring the manipulation of public policy as a strategy for increasing profits.
The benefits of capitalism and the vices of cronyism The advocacy for capitalism in the paper we discuss with Professor Klein in this episode of the Economics For Business podcast ("Capitalism, Cronyism, And Management Scholarship: A Call For Clarity": Mises.org/E4B_119_Paper) is not pure theory, but rather the greater benefits for everyone in society that result from capitalism compared to alternative systems.
Current critics vent their dissatisfaction with some aspects of the status quo, such as issues related to the natural environment or reactions to measurements of income inequality. It is not only an illogical leap to believe that taking decision authority away from private individuals and firms and giving it to government will result in greater benefits for society. It is also moving the system towards cronyism, so that unscrupulous people, whether they be executives, investors, labor unions, politicians or government bureaucrats can benefit themselves at society’s expense.
The nuances of cronyism and the maleficent influence of size Bribery, blackmail, extortion and other forms of criminality are widely deemed inappropriate. The problem of cronyism lies in practices that are legal and encouraged by the intelligentsia and business school academics as sources of commercial advantage via the manipulation of the political system. These include activities such as lobbying, political contributions, or awarding board seats to retired government officials.
Peter Klein noted that there was a time when Microsoft, as an up-and-coming high growth tech company, did not even have a Washington DC office. Politicians couldn’t help them and didn’t understand their business. But the politicians reminded Microsoft who was really in charge, via an expensive, threatening and long drawn out anti-trust suit. Now Microsoft and the rest of the mature high tech industry have extensive Washington DC offices and very large lobbying budgets. Levels of cronyism parallel the scale of the modern corporation.
The costs of cronyism The costs of cronyism are both direct and indirect. The direct costs are misallocation of resources and the production of goods and services that the free market would not want but politicians favor. The skills of executives and managers are applied to the influencing of government officials rather than to seeking the rewards of the marketplace via consumer acceptance and consumer value. Firms develop in much different ways than they would under capitalism.
Some of the misallocation of resources are most highly visible in the build-up of bureaucracy in corporations. Bureaucrats are not strategic decision makers and not producers of goods and services. They are devoted to compliance, government relations, and working with regulators and lawyers. Their salaries and office space and equipment are all misallocations of resources.
An indirect cost of cronyism is the undermining of institutions. A well-functioning market has institutions for integrity of contracts, resolving disputes, and protecting private property. The institutions are neutral: they enforce general rules that apply to all. The effect of cronyism — its whole point, in effect — is to override general rules in favor of privileging those in power over those who lack power. Confidence in institutions consequently erodes.
Business schools and management scholars are part of the problem Trendy developments in management practice such as stakeholder capitalism, ESG (Environmental, Social, and Governance considerations for investment) and DEI (Diversity, Equity, and Inclusion requirements) are forms of cronyism, diverting business activities away from meeting the wants of customers in voluntary free-market exchanges to aligning with government directives, some current and some anticipated.
Business schools have been party to encouraging this non-market behavior, and to developing the associated indexes and scales and processes, all of which are murky and ambiguous, as well as very costly to implement. Executives welcome the ambiguity that makes accountability more difficult.
Business schools and universities are, in fact, vulnerable to the practices and measures they have encouraged, and their staffs are now bloated with middle managers, administrators and compliance departments. It’s all highly costly and a waste of resources.
Corporations exhibit similarly destructive economic behavior with their “woke” advertising campaigns and corporate training programs. Gramsci’s long march through the institutions seems to have reached the corporate HR departments who are the source of much of this uneconomic, anti-capitalist behavior.
Entrepreneurship is the pathway to lead us out of the cronyist morass The budding entrepreneurial movement is the way out of cronyism and corporatism. Entrepreneurial businesses focused on consumers and customers, on innovation and betterment, and on producing ever-improving goods and services, have no time for cronyism. They are not looking for political protection.
Newer firms, newer business models, and those harnessing newer technologies are less invested in lobbying and corporate political activity. They don’t have the time or the resources for it, and slow and sclerotically reactive government can only get in the way.
Entrepreneurial innovation can trigger the separation of business from government and reverse the processes of cronyism, encouraging an open, dynamic, vibrant economy in which firms of all sizes engage in the full-time pursuit of innovation and new economic value, and devote no resources to lobbying or government relations.
Additional Resources "Capitalism, Cronyism, And Management Scholarship: A Call For Clarity" (forthcoming in Academy Of Management Perspectives) by Peter Klein, Michael Holmes, Nicolai Foss, Siri Terjesen, and Justin Pepe (PDF): Mises.org/E4B_119_Paper
What use is economic theory in business? It’s indispensable. It’s the necessary starting point for all businesses, brands and projects. Only when you have mastered theory can you master the navigation of specific situations, and be confident in your good decision-making and judgment. Per Bylund explains.
Key Takeaways And Actionable Insights Good business starts with good theory. Any type of study of people — how they act, how they interact, what they are trying to achieve, how they make decisions — requires a theory. That includes business, by definition. There must be a conception of what it means to be a human actor in the marketplace, what it means to act and to choose. We can’t understand merely through observation. Businesses must, therefore, have a theory of human action.
Austrian economics provides that theory in the action axiom: human action is purposeful behavior. Via action, human beings are trying to accomplish something. When they choose means to achieve that accomplishment, we can observe their choice. But we need theory to understand the ends they have in mind. Since they don’t always succeed, we can’t always observe the ends. Theory provides us with a framework of understanding: we can interpret what they were trying to accomplish, and why they went about it the way they did, and the situational variables influencing their action, and how they might respond to the outcome.
Empirical observations and measurements are not only often impractical, they can also be deceiving. We can’t always know what people are aiming for. Moreover, theory tells us that they are acting with respect to whatever they are perceiving — i.e., subjectively — which is not observable to a third party. It’s the same phenomenon if we try to observe the actions of a firm, perhaps a competitor, because firms are not observable. Institutions are not observable.
Yet, there are patterns of behavior that can be deduced from theory. And that is the great power of Austrian economics for business: to uncover what is actually happening that observation can’t tell us.
With a framework of theory in place, businesses can add data to explain specific situations. Theory can’t fully explain any specific situation. And pure inductive observation of data can’t provide any understanding without theory. Therefore, a balance between those two is called for.
This was the advice of economist Frank H. Knight, and Per Bylund calls the balanced position between pure theory and pure data “Frank’s Way”. There’s a continuum from pure theory to pure history (i.e. facts only). Pure history starts from facts and tries to make sense of them. Pure theory explains the structure of a market or the economy and then fits actual phenomena into the theoretical structure in order to understand them.
The balanced position between the two extremes applies particularly to entrepreneurial economics. Entrepreneurial economics aims at an understanding both of customer choices and actions and of entrepreneurs acting on their own judgment. It’s not abstract. Entrepreneurs develop a theory so as to be able to apply it effectively in order to build business, and they judge the sufficiency of the theory by business results.
Entrepreneurs have an Austrian understanding of how the market works. They have a good theory — subjective value theory (see Mises.org/E4E_13) — about what customers value, and how they determine that value. Entrepreneurs have an Austrian understanding of capital as a flexible and variable source of consumer revenue streams. There are several more components of entrepreneurial theory that we cover in the Economics For Business series (see Mises.org/E4B_113_PDF2).
With their theory in place, entrepreneurs gather feedback from customers in specific situations. They gather responses to a value proposition. They test different prices to apply the theory of Exchange Value. Business is not a theory. It’s based on theory, applied in a specific situation, and it is the specific situation that must be well-managed in order to make a profit.
A sampling of some theories of entrepreneurial economics. The Means-Ends Chain. Customers choose means to achieve ends. Different customers have different ends. Means-ends theory (see Mises.org/E4E_01_PDF) helps entrepreneurs understand the ends their customers aim at. Some customers in the car market seek admiration of others by signaling social success. They might choose a Ferrari or Bentley as their means. A construction company owner might be seeking efficacy and efficiency in hauling materials, and chooses a pick-up truck. Both customers make choices via the same means-ends model, and their specific situations point to different choices on their respective routes.Diminishing Marginal Utility. This theory posits that in certain markets, a customer, having purchased a product or service, may perceive a lower value in the next unit. Having bought one Ferrari to meet the need for social approbation, to continue our analogy, the customer may not find a second one equally as desirable as the first. The construction company owner, on the other hand, may see equal value in adding another pick-up truck as business grows. Where that same pick-up truck buyer may find diminishing marginal utility is in the proliferation of accessories and bundled features in which he or she does not perceive value. Too many features bundled together may deter a purchase for reasons of diminishing marginal utility. These considerations are important to entrepreneurs in the design of loyalty programs and multiple-purchase discounts.Uncertainty Theory. Entrepreneurs exercise judgment under conditions of uncertainty. Austrian economists employ uncertainty theory to focus their theorizing about entrepreneurship in action. In specific situations, entrepreneurs must apply the theory by choosing the tools to use to overcome uncertainty, such as the explore and expand tool, which identifies the many experiments to run (explore) and then the broad deployment of those experiments that work (expand).Network Theory. Economies and markets are networks, and theory looks into the attributes of densely and loosely connected networks, and those that are wired in different ways. The theory can identify the possibility of “structural holes” in networks, where there are nodes that can be productively connected, yet stay unconnected. Entrepreneurs in specific situations can establish whether such a gap exists in their own network, and work actively to fill the gap and increase their productive capacity, e.g., by connecting to a new vendor or a new customer or a new resource.Entrepreneurial Process Theory. Entrepreneurship is a process, and theory can identify the most productive processual methods, and can employ entrepreneurial history to reconstruct how productive processes have worked well in the past. Entrepreneurs operating in the present, and designing processes for the future, can utilize process theory and its illustrative histories (Per Bylund calls these “biographies of processes”) to help them make the best design choices for the most robust processes. As an example, our N-A-B-C process for innovation (see Mises.org/E4E_37) is a theoretical framework that every entrepreneur can apply in their own specific circumstances to arrive at unique innovative solutions for their business and their customers. Take time to think and time to theorize. Theorizing is hard, rigorous work. It requires identification of the theories you are actually using (consciously or not) in your own mental model, and then relentlessly questioning them and examining them for internal consistency and external validity. Are there gaps or soft spots? Is there something that doesn’t quite sit right with you? If so, you then work to change your assumptions or figure out better elements to add, or extending the theory further.
It requires thinking, and thinking requires the allocation of time. Per Bylund urges us all to be good thinkers. "Think better, think Austrian," as he says.
Additional Resources "Let ’ s do it Frank ’ s way: general principles and historical specificity in the study of entrepreneurship" by Marek Hudik and Per Bylund (PDF): Mises.org/E4B_118_Paper
"Entrepreneurship in Theory and Practice" (PDF): Mises.org/E4B_118_PDF
Few people can be said to be the originator of a new science. Jim Spohrer is one of those rare beings. The science he originated is Service Science. You can read about the origination process at IBM Icons Of Progress (Mises.org/E4B_117_Icons). Jim currently is the Director of IBM’s Cognitive Opentech Group (COG). On the E4B podcast #117, he shares some of his knowledge and insights, especially on the subject of the wonderful new directions in which the combination of service science and artificial intelligence is going to take entrepreneurship in the near future.
Key Takeaways And Actionable insights A new science of service. Service science is combinatorial innovation: it combines service innovation, technology innovation and business model innovation. At the time of its origination it was also a challenge to the then-dominant logic embedded in the product mentality; that is, what is produced in the economy is products. As services began to take over the economy, the kinds of assumptions inherent in goods-dominant logic needed to be changed. The famous 1994 paper by Steven Vargo and Robert Lusch (Mises.org/E4B_117_PDF) was one of the sparks that lit a fire of change.
Looking at the world through the Service Science lens means seeing things differently, seeing all the knowledge that is embedded in products and services and people and exchange, and seeing that what is produced is a value experience for customers. This view opens the door for service innovation, serving people in better ways by facilitating more preferred experiences.
Service systems. Just as Austrian economics is a systems-based view of the economy — with a diversity of interdependent consumers and entrepreneurs interacting and adapting to each other in the co-creation of value — so Service Science is a systems-based view of service. A lot of people, processes and technologies have to come together and interact to generate service value. Service is no longer viewed as one person helping another. Service systems consist of responsible entities interacting across networks to co-create value.
Service systems are people. Service systems are businesses. Service systems are governments. These are value networks. But these systems can become smart, and ever smarter, by the application of new technology.
Technological agency. Just think how many service offerings might be limited by the number of employees with the requisite skills that can be deployed. And now think about how A.I. and automation and new technology could supplement human capacities.
One of the most significant new and accelerating capacities of technology is to act. Given a certain input (such as a service request) a technology or software can act in response, and deliver the requested service to the customer. We don’t need a librarian to retrieve a book for us, or a checker to check us out of the store. Perhaps in the future, we won’t need a doctor to diagnose our condition, or a driver to drive our Uber. We’ll rely on technological agents.
And, in turn, the technological agents will change people’s skills.
All kinds of innovation. But technological innovation is not the only source of service innovation. Business model innovation is just as important. How do we pay for something? How do we recruit employees? There are existing models for these systems that can be innovated.
Institutional innovation is also going to be taking place, including in the operations of government.
At all levels — services, business models, institutions — systems are going to become smarter, which means using resources more efficiently, and getting results with less material, less effort, less time, and less use of space.
Smart systems can become wise systems. If we add artificial intelligence to systems and human beings get dumber as a result, is that wise? No it’s not. For entrepreneurs, this means thinking through the delivery of betterment to the customer on a long term basis, thinking through all the secondary and tertiary effects, and aiming at long term benefits.
This thinking also embraces ethical considerations and the impact on future generations. Systems should become both smarter and wiser.
Cognitive assistants and cognitive mediators. A.I. brings us cognitive tools. A tool typically does one thing, but an assistant can do many things. And perhaps the cognitive assistant can become a coach, and then perhaps a collaborator. Perhaps the best collaborator is one you can debate with, in order to sharpen your ideas. IBM is investing in debating technology so that, in the future, you can have a good debate with your cognitive collaborator.
One way to think about this is that the hundreds of apps we have on our smartphones grow up and become digital assistants, and the human owner of the smartphone is the manager of all these assistants.
The next step, perhaps 20 years into the future, perhaps more, will be to a cognitive mediator, an artificial intelligence you trust to make good decisions on your behalf. Perhaps it can negotiate better than you can. Perhaps it will know you better than you know yourself. Some innovators refer to the idea of a cognitive mediator as a “digital twin”. It’s possible today to have a digital twin for a piece of equipment. Tomorrow there may be a digital twin for all responsible entities, including people, businesses and even government.
All of these developments will have profound effects on service science, and the kinds of services we can imagine, design and deploy. And they’ll have a profound effect on identity — who we think we are, and how we think of ourselves.
Trust, Emotion and Empathy. Trust in a digital twin takes us into the world of emotion and empathy. We all wonder if artificial intelligence can ever have empathy. Empathy is a way to unlock the ability to see the problems others are experiencing and to identify ways to solve them. A.I. will be able to build models of any particular individual, using data about the individual and data that the individual has generated. Amazon is already building a model of your preferences and Facebook is building a model of your social interaction.
Perhaps individuals will build data twins of themselves, and perhaps there will be a way to monetize the digital twin. There will be many, many new opportunities in evolving service science and the kind of value co-creation that is possible. So empathy comes down to digital twinning. Empathy is having a better model of others. Innovative entrepreneurs will tap into the best digital models they can of their prospective customers.
Parallel entrepreneurs replace serial entrepreneurs. When we are all managing 100 digital workers on our smartphones, we’ll be able to initiate multiple innovations in parallel. This suggests we are on the verge of profound entrepreneurially-driven change. To do this wisely will require trust in artificial intelligence and trust in our digital twin. It will require an understanding of our own biases. And perhaps the digital twin will be able to point out these biases and correct them. If we trust it to.
Billions of responsible entities, trillions of strategies, higher aspirations. W. Brian Arthur talks about complexity economics (Mises.org/E4B_117_PDF2) and a future in which the multiple strategies of billions of individual entities can be run in a simulation to see how they interact and what outcomes emerge. Such capabilities enable us to raise our aspirations to higher levels. What innovations can one entrepreneur introduce? How about 1,000 entrepreneurs or 100,000 entrepreneurs, or 500,000 entrepreneurs each with 100 digital assistants? We shouldn’t be thinking of mundane trivial things in this context. We must find higher aspirations. We should be thinking about augmented reality, new energy systems, biological innovation, institutional innovation and new mindsets to go with our new skillsets.
Our best selves can become better. For each of us, our future self is our customer. How do we make the future better for ourselves? How does that kind of thinking change the decisions we make every day? How does a business become a better future version of itself? How does an institution do so? How are businesses creating new customers by making them better future versions of themselves?
The best way to answer these questions is to be an entrepreneur and start, grow or re-purpose a company to do so.
Additional Resources T-Shaped Professionals: Adaptive Innovators by Jim Spohrer: Mises.org/E4B_117_Book
"T-Shaped Individuals" on Slideshare: Mises.org/E4B_117_Slides
Service Thinking: The Seven Principles to Discover Innovative Opportunities by Hunter Hastings and Jeff Saperstein: Mises.org/E4B_117_Book2
IBM Icons Of Progress: Mises.org/E4B_117_Progress
Welcome To The Cognitive Era (PDF): Mises.org/E4B_117_PDF3
We can gain useful insights by winding business models back in time to see how they emerged and evolved. In the case of competing business models, we can analyze the different outcomes and perhaps assign some cause and effect analysis to interpret why one model variant performed better than another. How do we do that? Through the technique of entrepreneurial business history.
Alan Payne conducts just such a historical business model re-enactment in his excellent book, Built To Fail: The Inside Story of Blockbuster's Inevitable Bust (Mises.org/E4B_116_Book). It’s the dynamic story of two competing business models in one industry, a comparison of outcomes, and the resulting emergence of a new, third model.
Key Takeaways And Actionable Insights. Business models are discovered by experimenting entrepreneurs. The video cassette recorder (VCR) and playback device was a technological emergence in the 1970s. Movie studios saw the opportunity for new sales but worried about diverting revenues from the theater channel and therefore priced movies-on-cassette quite high from a consumer perspective (about $65). The experience of viewing movies at home was valuable to consumers but the exchange value was not aligned with the price. A few enterprising entrepreneurs discovered the rental option (don’t buy the cassette, rent it, and return it). The unit rental price emerged at around $3. The video rental business was born. Individual rental stores were profitable and some of the entrepreneurs started to open multiple stores and build small chains.
Capital-advantaged shareholder value-focused owners recognize emergent business models that are scalable. Alan Payne’s story of business model evolution in the video rental industry describes a great leap in industry growth led by another kind of entrepreneur. Wayne Huizenga was an entrepreneur experienced in a certain kind of growth model. He had built Waste Management, a Fortune 500 company, from a one truck garbage collection route, largely through acquisition and subsequent expansion of local operators. He knew how to finance and run high growth expansion of a templated operating system. He bought Blockbuster for $18.5 million and sold it nine years later for $8.4 billion. That’s a huge amount of shareholder value generation.
Under Huizenga, the consumer value experience did not get better. It was frozen. We know that consumer experience is dynamic, not static; Huizenga’s Blockbuster let more and more consumers into a static experience (through geographical expansion) but was not generating new value for those or any other consumers.
More consumer-oriented businesses evolve more responsive business models. In Alan’s story, HEB Grocery was a different kind of entrepreneurial business that approached consumer value in a different way. Alan describes the company as “obsessed with being the best” at meeting the ever-changing preferences of food shoppers. An effective grocery retailer must be highly responsive to changing consumer needs and adept at providing selection and value at low cost, with operational excellence in inventory management and customer service.
HEB decided they could offer video rental service in-store and brought their grocery operations skills to bear on designing a consumer-preferred experience. They tested different value propositions – Alan called their stores laboratories for the video rental experience – and let the consumer decide which were the best. They experimented with inventory (number of movies available), the in-store selection of new releases versus classics, different pricing schemes for different movies, different return dates for different products, and offering snacks alongside movies, among other variations. The result was a differently-tuned business model, one that built a more satisfied and loyal user base and generated more revenue and more profit per store than Blockbuster.
Business models are tools for economic exploration and advancement, so long as there is managerial and organizational flexibility to learn and improve. When Alan Payne went to work for Blockbuster as an executive to run a panel of franchised stores, he transferred the learnings from the HEB video rental business model. He demonstrated that the model could be applied successfully in this new environment, achieving similar levels of growth, profitability and consumer satisfaction and loyalty in his panel of stores.
The issue for Blockbuster was not business model transferability, but the managerial, organizational and decision-making environment into which it was transferred. Blockbuster was a top-down hierarchy in which knowledge flowed one way — from the top of the hierarchy to the stores in the form of commands. When there was learning at the store level about new and better ways to organize, to manage, to operate, to please consumers and to make profit, it was impossible to transmit it upwards and share it. Blockbuster lost money and entered bankruptcy even while a significant number of stores in Alan’s franchised panel were operating profitably and were growing.
Alan eventually raised the money to buy the franchised stores from Blockbuster and operate them independently, which he did successfully and profitably for over 20 years. Blockbuster never was able to learn any of his techniques, nor modify its business model to the more successful version that was in plain sight.
Sometimes, an outsider from the industry comes along to seize the opportunity of the next business model evolution. Alan makes it clear that technological change did not kill Blockbuster or the video rental model. When DVDs were introduced to (eventually) replace video cassettes, Alan’s franchised stores thrived by offering both side-by-side and thus appealing to two sets of consumers in one store.
Netflix was able to anticipate a future in which the digital data stored on DVDs became streaming data downloaded at home by consumers. This was not so much an act of prescience as one of exploration. The next new video-at-home experience began to emerge and Netflix captured much of the consumer value.
There is more value to be captured today because the consumer finds new experiential benefits in streaming, and the accompanying data analytics deliver insights that a consumer-centric firm like Netflix can utilize to further improve the experience. The same opportunity would have been available to Blockbuster, but their lack of business model agility and their failure to build learning channels from the consumer back to the corporation meant that they could not take it.
Additional Resources Built To Fail: The Inside Story of Blockbuster's Inevitable Bust: Mises.org/E4B_116_Book
"Consumer Value vs. Shareholder Value Models" (PDF): Mises.org/E4B_116_PDF
Bart Jackson is a CEO, and has studied the job and the people in it via thousands of survey responses and hundreds of interviews and multiple collaborations all over the world over many years. He’s distilled his findings in two books, The Art Of The CEO (Mises.org/E4B_115_Book1) and CEO Of Yourself (Mises.org/E4B_115_Book2), as well as his radio show The Art Of The CEO (Mises.org/E4B_115_Pod).
From all of this data, processed via his empathic diagnosis, Bart takes two perspectives: the job and the person in it.
Key Takeaways The CEO job threatens to take more of one individual’s time than is available. The firm’s value proposition guides the CEO to the right priorities and allocation of personal resources. How do CEOs organize their time among the multiple priorities of the job? The answer is: by embedding the value proposition of the firm into their mind. With a clear view of the customer and of the customer service mission of the firm, every competing priority can be ordered. The CEO can design a framework for every day, week, month and year. They can continuously review their mission and goals and assess their own contribution, and the stamp they are putting on the firm, through the value proposition lens.
The set of priorities importantly includes “time to think,” both on your own and with others.
Leadership style can be adapted to each individual’s strengths. Bart asks, “Are you a king or a prime minister?” Are you the one who inspires your team to demanding feats of achievement, or the one who provides them with the tools to encourage the emergence of their own capacities? Or both? When the CEO is totally devoted to the firm’s mission, this devotion becomes the lens through which others’ efforts will be focused. No team member will withhold effort when the purpose and mission are clear and shared. Leadership style is devotion to mission.
Communication is a key CEO tool, and there are many ways to accomplish great communication. Devotion to the mission requires clear communication of that mission to employees. There is no one way for the CEO to communicate. Bart told the story of one CEO who committed to travel to meet every one of his employees in small and large groups, armed with a whiteboard and a personal presentation. Communication is inclusive — address by name all the people who are going to be involved in the mission, approach all the departments, inventory all the internal strengths available as resources, and describe all the innovations that will open up new ways to leverage those strengths.
CEOs make communication a four-dimensional flow. Communication does not just flow in one direction to the employees. It must travel in two directions, so that the CEO can receive a continuous flow of ideas and information from the frontiers of the company. Bart talked about 4 dimensions: horizontal across the company from the center to the edge and back, through every department; vertical from top management to front line employee and back; then the third dimension of reaching outside the company box to vendors and suppliers and other external knowledgeable sources; and the time dimension of identifying ideas early, evaluating them, giving them a chance to bloom and thrive and the enthusiastic energy to move them along quickly.
CEOs press knowledge into action. In Austrian theory, entrepreneurship is a knowledge process. Bart calls it “pressing knowledge into action”. The information flow can be overwhelming, and the CEO manages it by taking action more than by analyzing. The entrepreneurial instinct to “just do it” is valid for CEOs of any size undertaking. Once there is enough information to support an action, take that action. Then all new information can be channeled into furthering the action, adjusting or correcting, or even terminating it in favor of a new and more preferred action. Knowledge is not for its own sake, it’s for the sake of action.
The CEO is an incessant questioner and interviewer, ascertaining the knowledge that is available for action.
CEOs don’t create a company culture. It emerges. Bart defines culture as how individuals feel when they are at work for the firm, and how they behave as a consequence. CEOs can try to create an atmosphere in which more desired feelings and behavior are nurtured, but they can’t control or guarantee it.
The best tool for the creation of such an atmosphere is concern for each individual. Respect is not enough. Genuine concern will motivate people to put their shoulder to the wheel at all times.
Hiring becomes a core CEO skill. Assembling the best team is a most difficult challenge. It’s hard to hire the right individual for every position, but hiring is a skill that a CEO can actively cultivate in order to develop greater mastery over time. CEOs train themselves to hire well.
One key to success, according to Bart, is not to fill a slot but to look for a person. Identify character, look for intellectual curiosity, look for people of high merit who can potentially fill many slots on the organization chart. Utilize the pursuit of diversity to investigate a broader pool of human resources from which to draw.
Great CEOs build their personal brand in order to achieve company goals. They make individuality the whole point. Bart approaches the process of building a personal brand in the same way as he would approach building a product or service or corporate brand. Start with the customer. A corporate brand, he says, is built in the production and service departments, not in the PR and marketing departments.
For personal branding, therefore, look to the resources you have for production. What’s in your personal “warehouse”? Great CEOs inventory their personal strengths and interests. They listen to what people praise them for and thank them for and find their strengths in that data.
Then they examine their own principles. What do they truly believe in? Bart recommends we write down our own inventory of strengths and interests and principles
In the end, he says, individuality is the whole point. Each of us is a marvelous person. We’ve got to be able to see that. Being the CEO of yourself opens up the pathway to doing the best possible job of CEO of your firm.
Additional Resources “CEO: The Position and the Person” (PDF): Mises.org/E4B_115_PDF
The Art Of The CEO: Mises.org/E4B_115_Book1
CEO Of Yourself: Mises.org/E4B_115_Book2
The Art Of The CEO Radio: Mises.org/E4B_115_Pod
Veteran venture capital investor Pete Farner distills experience from four decades of entrepreneurship and investing on the Economics For Business Podcast #114. Passion, perseverance and intelligence are the three critical attributes he looks for in investable entrepreneurs, an insight drawn from a broad survey that we summarize here.
Key Takeaways 1. The entrepreneurial mindset develops in youth. It is averse to the restrictions experienced on the subordinate levels of the corporate hierarchy. In an early experience that several E4B podcast guests have shared, Pete grew up in an entrepreneurial household and absorbed the approach. He created several independent job opportunities in high school and college, including house painting and taxi driving and trading classic cars. When he joined a corporation, he quickly understood that a life in the hierarchy requires you to do as exactly as ordered by superiors, an experience incompatible with the entrepreneurial mindset.
In that brief corporate experience, Pete was able to observe that even the highest levels of the executive ladder are occupied by mere humans, with all their quirks and flaws, and not by superhumans. This observation can translate into the self-confidence of being able to tackle any business undertaking oneself.
- Taking the entrepreneurial route is not risk-taking. In fact it’s the opposite. Pete suggested that entrepreneurs are not risk-takers. They are, in fact, risk-averse. They typically do not take great personal risk or financial risk. If their business does not achieve the success they imagined, they seldom “lose all”, and their financial risk is often shared with others or syndicated in some way.
Entrepreneurs deal with business uncertainty. They embrace it. They are comfortable with what Pete called the ambiguity of entrepreneurship. That’s not risk.
- Develop a knowledge space from which to begin your entrepreneurial journey. Pete’s corporate experience was in the beer industry. That knowledge space included the use of neon signs for advertising and display purposes. He was also able to observe the use of etched mirrors in bars along with other forms of decoration and display such as sports memorabilia.
He launched his first entrepreneurial venture with a technological improvement on the conventional (and also expensive and fragile) neon sign. He merged this venture with a mirror and sports memorabilia company to give it greater breadth and market penetration. His first investor was a beer company.
We all curate a knowledge space as we go through life, and that space can provide the foundation for entrepreneurial initiative.
- Entrepreneurial success lies on a time-and-place continuum. What are the determinants of success for an entrepreneurial business? For a venture capitalist who is financing the business, the appropriate metric is a sale to an acquirer, who validates the worth of the entrepreneurial initiative. Surveying his experience of such acquisitions, Pete emphasized the relevance of time and place: being in the right place at the right time. Acquirers are ready for their own reasons at their own time. He discussed the sale of Minute Clinic, a walk-in in-store clinic staffed by nurse practitioners, to the CVS drug store chain. Minute Clinics were under-developed and unprofitable on their own, but a great marketing device to drive traffic to CVS’s highly profitable pharmacies.
On the other hand, Webvan, one of the most spectacular venture-financed startup bankruptcies, was ahead of its time in 2001, but could have been a standout success in 2021.
Business brilliance has a role to play in entrepreneurial success, but so do luck and timing.
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Entrepreneurs widen and deepen their own knowledge space by making far and wide knowledge connections. Entrepreneurship is a knowledge process. One entrepreneur, one team, one firm can have only partial knowledge. There might be a surrounding network of investors and partners to supplement the available knowledge. Successful entrepreneurs reach further, making connections in as many directions and to as many knowledge sources as possible. Syndicated investments with a wide range of partners can yield a lot of knowledge sources.
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Specialization must be balanced with a broad-based understanding of business. Differentiation can come from a specialized body of knowledge that the entrepreneur and partners bring to bear. In addition to this deep specialization, there must be a broad interest in starting, running, growing and managing a business. Entrepreneurs are T-shaped people — able to combine their specialist knowledge with boundary-crossing interest and capabilities in everything from accounting to HR to marketing, and especially the development of motivational purpose.
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Personal qualities — and especially integrity — play an important role in success. In Pete’s summary of success factors, “People are the real key”. As an investor, given the choice between a great business plan, a great idea, and a great person, “I’d choose the great person”. Integrity is a core attribute: the strength to go through growing pains, pivots, disappointments and adverse situations, and maintain belief.
Certainly these personal qualities can be more important to success than what Pete called “pedigree” — the degree from the right school, or the resume with the right corporations, or the well-credentialed board of directors.
- Different personal qualities are appropriate for different stages of the entrepreneurial journey. Pete observed that it is rare that the same individual who launches a business or manages it in its earliest formative stages is the same one to manage it to and through maturity. From start up to 8- or 9-figure revenues is a difficult transition for most people to make. It requires both decentralization of decision making and rigorous, detailed and disciplined operational management that are not always the strengths of originating entrepreneurs.
Nevertheless, the founder’s continued presence — in a significant role, not just a symbolic one — is a very important factor in the maintenance of mission and purpose for a young firm.
- Revenue is king, especially when efficiently generated. Revenue is the most important indicator of marketplace acceptance for an entrepreneurial service — proof that customers will buy what the business is selling. It’s a harbinger for the future: if there is a revenue stream, it can be grown.
Revenue — assuming cash flow is well managed — is the guarantor against the worst sin of entrepreneurial businesses, which is running out of cash.
Austrians know that the value of capital is the NPV of the flow of customer revenue it generates. Venture capitalists respect capital efficiency — a high ratio of revenue to capital.
- Empathic customer understanding underpins revenue generation and capital efficiency. It is the deep understanding of the customer and market that ultimately is the key to revenue generation. Pete talked about the medical device market where a misunderstanding of the incentives for surgeons — that they might not adopt a superior-performing device if they don’t make as much money using it as they do with the incumbent device — as an example of the battles that have to be fought and won for market acceptance, and might be lost with poor customer understanding.
Revenue generation is the primary indicator of customer understanding at work.
Additional Resource "10 Attributes of Investable Entrepreneurs and Businesses" (PDF): Mises.org/E4B_114_PDF
This week on the Economics For Business Podcast we were gifted the opportunity of reviewing and assessing a completed entrepreneurial journey, courtesy of Jacqui Boland, founder, CEO and now alumna of Red Tricycle, following the acquisition of the company by the corporate owner of tinybeans, a family photo sharing and journaling app.
Red Tricycle is a brand — "a lifestyle brand that fuels the parenting universe with daily inspiration for family fun." In the "Economics For Business Value Proposition Template," the Red Tricycle proposition would be:
FOR: Fun Moms
WHO: Search for and utilize ideas for family activities for parents and children to enjoy together.
VALUE PROMISE: A unique daily source of ideas and inspiration for family fun
VALUE RATIONALE: Every day, Red Tricycle finds and presents all the best local and in-home family fun opportunities and makes them easy for Moms to research, evaluate and act.
BENEFIT > COST: In one daily web visit, Moms have easy access to a unique curation of new ideas and inspirations, simply formatted, and requiring a minimum of their precious time.
Jacqui was generous in helping us map her entrepreneurial journey to the stages of the Economics For Business GPS.
Key Takeaways And Actionable Insights. Imagination The pre-design phase in which entrepreneurs develop the imaginary construct of their business idea.
Jacqui was a new mom in a new and unfamiliar city. She wanted to identify all the opportunities for fun with her family. She became an avid online searcher. A few conversations with some other moms revealed that many moms are searchers — with intensity and determination and a commitment to find and evaluate all the relevant information in their field of search. The idea of an online one-stop location for information about local family-friendly fun activities was born.
A useful tool for the Imagination phase of entrepreneurship is "Entrepreneurial Empathy": Mises.org/E4B_113_PDF3
Design The phase where a validated imagination is transformed into a more formal business model.
Jacqui capitalized on her existing knowledge field. She knew magazine publishing and the power of content, and how to source it. She knew the advertising revenue model for magazines. She was able to design a crisp business model of content creation, content presentation, consumer engagement, and attractiveness for local and eventually national advertisers.
One of the tools in the Design tool set is the "Means-Ends Chain," helping entrepreneurs to align their business design with customer values: Mises.org/E4E_01_PDF.
Assembly The phase in which design is operationalized by selecting and combining assets: people, technology, content, operating processes.
Assembly for Red Tricycle began with people: content producers, editors, salespeople. Jacqui found investors, initially angel investors, then angel groups, and, later in the business’s evolution, institutional venture capital. In turn investors and investor groups like 500 Startups were very useful in providing connections and recommendations for technology and software resources. Comparisons between different operating models that the investor groups were able to provide were useful guidance in making resource selections.
Consult our "Austrian Capital Theory" tool for capital assembly of resources: Mises.org/E4E_19_PDF.
Marketing The phase in which the designed and assembled entrepreneurial offering is presented to the market for consumer consideration.
Red Tricycle adopted a city market-by-market rollout strategy, starting in Seattle, proceeding to San Francisco, then systematically adding more cities. The killer app for market introduction was “Mom Word Of Mouth”. Moms have friends in other cities, and travel between cities, and are excited to share family fun ideas with others. The best sharers were subscribers to the Red Tricycle newsletter, so the brand worked hard to build up a subscriber list.
Red Tricycle KPIs were traffic, subscribers, and revenue. As a result of a system of creating and testing content, Red Tricycle could seed new markets with say 20 or 30 stories that drove good SEO traffic. And then the job was to convert that traffic to subscribers to the newsletter.
Building brand uniqueness is fundamental for the Marketing Phase. Use our "Brand Uniqueness Blueprint": Mises.org/E4E_30_PDF.
Customer Experience The phase of the value learning process in which customers try the offering, experience its benefits, and assess the subjective value.
Red Tricycle designed a very specific customer experience, which Jacqui described as: "Quick, get an idea and inspiration to spend time with your kids, and then go offline and do it, and then come back two days later and do it over and over again." The model was distinctive in not asking for too much time (“the infinite scroll”). Red Tricycle helped Moms focus on the lighter side of parenting and having fun with their kids.
Social media came into play as an aggregator of subjective value anecdotes. Moms would share a picture of themselves at the zoo and use Red Tricycle’s recommended hashtag, "Best weekend ever." And not just everyday moms, but even celebrity moms, like Randi Zuckerberg, Pink, Ivanka Trump, sharing that they found a great idea for a campsite or a restaurant. These were subjective value data points.
Facilitate great customer experiences with our VUCA tool: Mises.org/E4E_41_PDF.
Management and Growth The phase where the business model is scaled and the marketing and customer experience reach is expanded, with continuous innovation accelerating growth.
The major growth pivots for Red Tricycle were the transition from local to national advertisers, and hiring and assembling and empowering the new team members best suited to lead the way in the new business environment that this entailed.
The goal for the management and growth phase was to roll out multiple local markets, and build a strong foundation of local advertising revenue until Red Tricycle had enough scale to interest national advertisers. The transition was a 5 year process. As Jacqui described it: "We put a plan in place and then we adjusted and adjusted and adjusted."
A core element of the transition management is hiring. Skilled national advertiser salespeople are expensive, and sometimes it might take a year of that salary before a new salesperson can close a big national deal. There's a lot of foundational work that needs to be done. Scaling the business was a delicate process. A fully staffed company would have a sales team across the U.S. in every market, but if you can't afford that, you have to stretch and think, "Can this person sell local and national? Could this person cover Chicago, and L.A.?" And then once you start to get a little bit bigger, and you can hire an L.A. staff, what happens to that Chicago rep?" It's a constant adjustment.
How does growth feel? “You're always looking for the next milestone. And you have about a minute after you hit a goal or a milestone to celebrate, and then you run into the next quarter and you have another goal that's even higher. So it's a constant stretch.”
"Upsizing a Customer Need" is a useful tool for the Management and Growth Phase: Mises.org/E4E_47_PDF2.
Disposition When the entrepreneur decides to sell the business, merge it into a larger business and relinquish the founder / owner role, or to turn it over to the next generation.
Selling a business is just as much a marketing task as establishing it and growing it. And that means seeing the business through the eyes of an acquirer — empathic diagnosis of their needs, their preferences, their goals and desires, their constraints.
Jacqui had made the economic calculation that the best path forward was not to raise additional venture capital for continued high growth, but to demonstrate solid and sustainable profitability and look for either a strategic partner or an acquisition partner. She didn’t use a banker (whose process she compared to a dating app) but conducted her own search for a firm that would recognize a complementary asset that could be a marketing engine for them. She found a partner in an adjacent field (family photo sharing) that was strong in technology and would benefit from Red Tricycle’s content creation and sales expertise. The deal was made quite quickly.
Additional Resources Map of Jacqui Boland’s Entrepreneurial Journey (PDF): Mises.org/E4B_113_PDF1
eGPS Handbook (PDF): Mises.org/E4B_113_PDF2
Innovative entrepreneurship is the segment of the entrepreneurial economy that is especially highly focused on innovation via new products and services. Within innovative entrepreneurship there is an even brighter spotlight on NTBF — new technology-based firms that are cutting edge, scalable, and fast-growing. They represent only one form of entrepreneurship, but one that is very interesting. Indeed, they attract the interest of government and government policy-makers. A recent special issue of the Strategic Entrepreneurship Journal, a top journal for which our friend Peter Klein sits on the editorial board, examined the impact of policy on entrepreneurship itself and on the institutional and social challenges of these policy interventions (see Mises.org/E4B_112_SEJ).
Key Takeaways Government policy-makers take an interest in innovative entrepreneurship when they are trying to grab some credit for economic growth and improved goods and services. Both micro policies and macro policies aim at stimulating successful entrepreneurial and innovative outcomes. Policies to encourage the growth of green energy supplies, for example, are a micro policy; they apply only to firms engaged in particular activities. Changing bankruptcy laws (so that the reallocation of assets can proceed faster and more smoothly) or an educational initiative to support entrepreneurship teaching in school would be classified as macro policies: trying to create a new set of conditions that apply to all firms, all entrepreneurs, all technologies.
Government doing nothing to intervene is another — highly desirable — kind of macro policy: maintaining a social order in which entrepreneurs can operate with the least uncertainty about the future regulatory environment.
At minimum, government interventions in favor of entrepreneurship fail to properly consider trade-offs. Analysis of policy starts from trade-offs. Every policy has trade-offs. Economists are the ones to point this out. Politicians just want one button to push to achieve one specific goal. All that is needed, they presume, is a piece of legislation that provides a tax break or a subsidy to the firms they want to succeed. But there are always trade offs. Directing funds or capital to one group of firms diverts it from another group. The consequences are unknown and can’t be known. What if the current crop of battery technologies, for example, do not include the one that will emerge as a more efficient alternative in the future? By subsidizing today’s technology do we constrain the emergence of a better one in the future?
Evidence suggests that neither macro policies nor micro policies are successful or effective. One example of ineffective micro policy is intellectual property protection for selected technologies or firms. One of the papers in the Strategic Entrepreneurship Journal special edition looks at fast tracking patents for particular technology areas. One of the outcomes identified is the diversion of resources to overinvestment in legal protections and excess litigation with all its attendant economic costs.
Regulatory systems are another form of macro policy. An example is the number of days it takes to get the permits to open a new business. Reducing this would be a macro policy that could be effective. Peter Klein made the comparison between Singapore vs India on this variable, pointing out the correlation with greater speed of innovation in the former, encouraging new and unintended applications of technology.
But often, regulatory permissions favor well-funded and well-connected firms over the young and agile, and certification signals may not be completely accurate about underlying quality.
Micro interventions are targeted to boost outcomes by helping a particular firm or technology. Bureaucrats claim they can make better decisions than the market about resource allocation. They identify so-called “market failures” to be corrected (like fossil fuels causing pollution), and market decisions that they believe should be over-ridden. They don’t want to let consumers buy the gas-powered SUVs they prefer.
There’s no reason to believe these policy makers will get their decisions right. They certainly don’t have the incentives to do so, since they are not governed by profit and loss. They can easily pick the wrong projects.
Some interventions may be dismissed as irrelevant, but they may still produce distortions. The papers in the Strategic Entrepreneurship Journal special edition point out that many of the cash payments / subsidies / tax breaks are given to firms that would have launched any way and been successful anyway. One paper (not in this collection, but cited by Professor Klein) found that the major effect of research grants in STEM is to increase the salaries of scientists rather than encourage scientific experiments that wouldn’t otherwise take place. The result is not better science, but a better life for scientists (that is, those who know how to win grants).
The private sector can stimulate basic science and government subsidies are not needed. For example, pharma companies encourage basic research at private companies via the incentives they provide via M&A strategy — an exit plan from the lab for basic science. In general, firms trying to develop new products and services for the market do a lot of the scientific discovery in the early stages of production. The government is not needed.
When government does provide venture capital (more frequently in Europe and Southeast Asia than in the US), the researchers reporting in this journal edition identified the receipt of such funds as mostly a marketing signal, enabling firms to enroll bigger partners, or get a prestigious underwriter for their IPO as a consequence of the positive imagery derived from being a subsidy winner.
Non-policy is a more promising and potentially more effective approach to encouraging entrepreneurship. Culture is an example of non-policy. A culture that encourages experimentation and creativity, and assigns a low level of stigma to boldness whatever the result, is likely to attract more investment and accumulate more capital than a culture of more traditional norms favoring continuity. Cultural evolution like this is less likely to occur in a system where the state directs investment and chooses industries and sectors for support. One outcome is a negative view of business when business success is determined by getting close to government: in those cases, individuals tend to think badly of all business, including entrepreneurial businesses.
The verdict: maintain a healthy skepticism about the case for interventions to support entrepreneurship. Overall, the evidence is not in favor of either macro-interventions or micro-interventions to stimulate innovative entrepreneurship. How should the individual entrepreneur think? It may be an ethical issue: whether or not to accept government subsidies or support. Nevertheless, the entrepreneur must make the best use of available knowledge, which includes knowledge of the regulatory regime. One of the papers in the collection finds that entrepreneurial businesses can make better connections with the right kinds of capital and partners as a result of government involvement. At some level, this kind of knowledge is a defensive mechanism for the real world.
And at least the regulators and policy makers are recognizing entrepreneurship as a positive force for growth and for good.
Additional Resources Read the management summary of the Strategic Entrepreneurship Journal special edition (PDF): Mises.org/E4B_112_SEJ
"Effects of Institutions and Policies on Entrepreneurship" (PDF): Mises.org/E4B_112_PDF
Austrian economics provides new insights into value: what it is, how it is created, and who creates it. The insights are summed up by Professors Per Bylund and Mark Packard in our E4B podcast episode #108 (see Mises.org/E4B_108). One of the most vivid images they paint is the picture of entrepreneurship as “the two-sided navigation of radical value uncertainty, both by producers and consumers, in that never-ending quest towards higher value states”.
The market for healthcare provides us with a pertinent example of co-navigation of radical value uncertainty. For consumers, there is no certainty available — they can’t know which doctors or providers will give them the best experience, they don’t know the right means to choose to attain their end (health), and they can’t use the usual market price signals in the search for value since the price of healthcare is not visible to them. The don’t purchase the product, they purchase insurance, a different financial product than the healthcare experience they really need.
Thus, the healthcare market is a natural medium for the co-navigation of value uncertainty that Professors Bylund and Packard described. In E4B podcast episode #111, Shawn Needham, a healthcare entrepreneur dedicated to helping the consumer in their navigation task, lays out 6 principles for entrepreneurs.
Key Takeaways & Actionable Insights 1. Help consumers to be proactive about their own health. The healthcare system wants consumers who are sick. Chronic sickness is their most profitable line. A good way to help consumers is via what Shawn calls Pro-Health: encouraging the consumer mindset and commitment to actively make good health and lifestyle choices in diet, exercise, quality sleep and stress reduction. Entrepreneurs can share valuable knowledge and tools to help good decision-making, and to facilitate health creation by consumers.
- Enable consumer sovereignty via cash, pay-out-of-pocket options. It’s hard to discern the operation of consumer sovereignty in healthcare systems. End-users can become locked-in to a limited set of choices. Entrepreneurs can help by developing more choices, so that expressed consumer dissatisfactions can be actualized as new options.
Examples that are already in motion include Direct Primary Care (DPC), an arrangement whereby doctors charge a set monthly fee for access to primary care, and consumers pay cash in return for an improved experience, including more time with the doctor, easier scheduling and lower cost prescriptions.
DPC doctors are healthcare entrepreneurs who are enabling consumer sovereignty, having alertly discerned the signals of consumer dissatisfaction.
- Entrepreneurial empowerment in employer health financing options. Employers offer ways for employees to finance traditional healthcare insurance, usually via benefits programs. In episode #109, Professor Desmond Ng described the Austrian-inspired movement among employers to empower their employees to be more creative and entrepreneurial and less centrally-directed: he called the movement Entrepreneurial Empowerment.
Entrepreneurial empowerment can be granted to employees to unleash their creativity in searching for financing options for their healthcare. The use of Health Savings Plans provides consumers with an alternative approach to meeting healthcare expenses through dedicated savings. There may be other ways to re-direct the funds devoted to funding healthcare insurance through centrally-directed employer programs, such as freeing employees to opt out of company-paid insurance premiums, and to take the same amount as a deposit into a 401K, leaving the employee with a freer choice in healthcare financing.
- When the consumer pays the bill, the benefits of free markets can emerge. Another pay-out-of-pocket option development is Cash Fee For Service, which is a straightforward payment whenever a specific service is required. We’ve highlighted Surgery Center Of Oklahoma as a pioneering example.
When the consumer pays the bill, lower prices tend to result because of competitive free market processes, and the quality of care tends to increase for the same reasons. In his book, Shawn Needham cites cosmetic surgery and lasik eye surgery as two examples of free market forces at work to generate higher quality and lower costs.
- Entrepreneurial initiative combined with consumer search for betterment can create new solutions. Shawn identifies medical cost sharing programs as an innovation emerging from the consumer-entrepreneur co-navigation of value uncertainty in healthcare. In medical cost sharing, a voluntary community pools funds so that any unexpected major medical cost can be shared across the community. The firm that co-ordinates the community typically also offers services such as bill negotiation, concierge medical services, health coaching, and discounts on health-promoting resources. There’s a greater degree of consumer sovereignty than is typical in healthcare arrangements, such as a freer choice of which doctors and labs to use. Similarly, doctors who participate in these programs are freer to set their own rates and to compete for patient trust in lasting relationships.
The healthcare market is a process. The healthcare market may appear to be an inflexible structure, built over many years to impede organizational innovation. But viewed in an Austrian way, as a process governed by consumer sovereignty and responsive entrepreneurial creativity, it is possible to discern emerging trends in favor of greater consumer choice, market flexibility, and the inevitable role of the price mechanism to disperse blockages and lower barriers to better consumer experiences.
Additional Resources “Navigating Healthcare Uncertainty” (PDF): Mises.org/E4B_111_PDF
Sickened: How The Government Ruined Healthcare And How To Fix It by Shawn Needham: Mises.org/E4B_111_Book
Check out one example of medical cost sharing: Mises.org/E4B_111_Example
Read about Direct Primary Care: Mises.org/E4B_111_DPCare
Does economic knowledge help you manage complex IT projects? Yousif Almoayyed thinks it does. He combines management knowledge with careful project management and principled economic thinking.
Economic thinking utilizes foundational principles to integrate knowledge management and business task management for all kinds of projects. IT projects provide a representative example.
The economic principles for IT project management include:
Ends-Means analysis.Marginal benefit — marginal cost analysisThe law of returns — savings, investment and future benefit flowsCombinatorial productivityKnowledge-based processesIncentives alignmentTrust and reliability as institutional enablers Ends-Means Thinking Your ends are business ends: to generate new economic value by serving customers with continuously improving and continuously innovative services. Technology can be a means to achieve those ends, if properly harnessed. It can help with value delivery, it can help lower costs, eliminate waste and increase efficiency.
The key to economic thinking is to keep business ends and customer experience primary, and manage technology to serve those ends. Don’t let technology be the business’s master.
Marginal Benefits and Marginal Costs, and The Law Of Returns The so-called Law of Diminishing Returns theorizes that, after a firm or a production process has attained some optimal level of performance, each further addition of an input will tend to achieve a smaller and smaller output increase. This can be true of technology projects and repays careful benefit-cost analysis. You probably already have considerable technology resources in your business, including access to services via the internet. Examine each additional tech input, at the margin, and identify just how much additional business benefit you can anticipate as a result of the new input. A rigorous approach to this analysis can be helpful in ordering priorities and understanding trade-offs.
Combinatorial Productivity Economic thinking recognizes capital as a flexible, continuously changing combination of elements. Some combinations are capable of generating higher productivity than its individual components can achieve separately. This combinatorial productivity may not be intuitively predictable in advance, and so experimental combinations are appropriate, e.g. of old and new systems.
Don’t be afraid of mistakes in your experiments. If you don’t encounter some surprises, you are probably not experimenting enough. Don’t permit technology vendors to constrain your experimentation. Proprietary systems can force you to work within their boundaries; there are plenty of routes to new productivity outside these boundaries. Yousif mentioned his experiments with Raspberry Pi — the single-board computer used by many for experimental applications such as robotics — as an example.
Knowledge and People As Critical Assets. Economic processes are knowledge processes: bringing the right knowledge to bear at the appropriate step. Much of the knowledge is tacit – in individuals’ heads, based on their own individual experience. Consequently, assembling and preserving the right team with the right knowledge — both inside and outside the firm — is the primary task in IT project management.
How much tech knowledge do you need? It’s certainly not the most important knowledge for your project. That position is reserved for business knowledge: your project team, in order to attain the business ends you have established for the initiative, must have complete understanding of your firm’s business mission and purpose, and of the customer service context of the current project.
If you are clear in communicating business ends both internally and externally, you will be prized customer for IT suppliers, since this clarity is often lacking and can lead to confusion and conflict.
You will always be able to assemble the appropriate tech knowledge when your business aims are clearly stated.
Choose the outside vendors who best demonstrate their ability to understand and absorb your business ends, in combination with mastery of the specific technology means you require.
Incentives Alignment and Scope Specificity Economic thinking pays special attention to the roles of multiple players in a system and the incentives under which each player is operating. For example, a systems integrator salesperson or project manager may be incentivized by his or her company to sell more units, or more customization that requires more installation hours now and more upgrade complexity in the future.
Your internal project management includes the alignment of roles and incentives to guard against this kind of conflict. Best to have your own internal project manager.
A big part of the internal project manager’s role is to think through the project scope in great detail, to give the business ends clear dominance over all other ends, to be as specific as possible on the technology means, and to guard against mission creep and the opportunistic exercise of power by IT managers internally or IT vendors externally who might use their technical knowledge to force choices that are inappropriate to business ends.
Big data analytics projects and A.I. projects can be examples of inappropriate technology choices. Big data projects that include extensive data gathering (e.g. through sensors or via cameras for visual data) can promise new insights through analysis of the newly acquired datasets, but a careful analysis of the potential value facilitation of the output might tell a manager that the marginal benefit is inadequate. Always ask whether the project facilitates new economic value for customers or in the firm’s capacity to serve customers. Make sure the incentives to install new technology are truly business-aligned and not simply to be modern or up-to-date, and staying close to the technological edge.
Trust, Reliability and Institutional Guardrails All economic systems are collaborative networks of individuals, strategies and artifacts. Economists examine systems not only for efficiency but also for integrity, which often comes via institutional factors such as trust between people, and reliability of input performance from people and groups. Without these institutional factors, collaboration can become impeded and frictions can arise, slowing down projects or even rendering them unsuccessful. Great project managers check for these intangibles as well as for the robustness of the technology.
Technology Combined with Economic Thinking Can Open Up New Business Horizons Some of these economic factors sound restrictive but they’re not. They help guide you to efficient and effective choices by thinking through resource allocations, trade-offs, system optimality and the long term consequences of invisibles such as incentive alignment.
Technology is capable of changing the economics of the firm. For example, it can change the constraints of size and resource availability via new connections to a vast array of external resources that were not previously accessible and that can boost your firm’s effective scale. Yousif pointed to applications such as Upwork to add global specialized talent at variable cost, and also made reference to his collection of previously unavailable commodity supply data that was once shielded but now is made available by technology and can provide early warning signals about market price movements, making his firm better informed that it was before, and therefore better placed to serve customers.
Use technology economically to expand your capabilities so that your marginal benefits exceed your marginal costs in reaching expanded and elevated business ends.
Additional Resources A Guide To The Project Management Body Of Knowledge (May 2021): Mises.org/E4B_110_Book
"Economic Thinking About IT Projects" (PDF): Mises.org/E4B_110_PDF
The Henry Hazlitt Memorial Lecture, sponsored by Yousif Almoayyed. Recorded at the Mises Institute on March 19, 2021. Includes an introduction by Peter G. Klein.
The Austrian Economics Research Conference is the international, interdisciplinary meeting of the Austrian School, bringing together leading scholars doing research in this vibrant and influential intellectual tradition. The conference is hosted by the Mises Institute at its campus in Auburn, Alabama, and is directed by Joseph Salerno, professor of economics at Pace University and academic vice president of the Mises Institute.
Austrian economics offers a wide range of knowledge and applications for better business performance. One of them is the design of high-value organizations (see Mises.org/E4B_109_PDF).
Austrians understand the function of entrepreneurial businesses in the economy is to pursue and generate new economic value. That value is subjective, experienced by individuals as an improvement in their feelings of well-being. We also understand that subjective value applies not only to consumers but also to producers, including employees in firms whose purpose is value facilitation.
To fully realize the skills and talents of their employees in the pursuit of the organization’s visions and goals, entrepreneurial businesses look for the best ways to empower employees to utilize their Hayekian individual knowledge for the innovation and adaptation that leads to marketplace success.
Dr. Desmond Ng uses the term Entrepreneurial Empowerment to describe this approach to designing an organization that best unleashes the creativity of its entrepreneurial employees.
Austrian economics is particularly suited to addressing the organizational challenges faced by today’s entrepreneurial firms. Businesses understand that they need to be more responsive to customers and the market. Firms are moving from a top down decision-making structure and searching for ways to move to a more decentralized firm structure. They are aiming to take advantage of all the different knowledge experiences that may be inside the firm, to be more adaptive to changing market environments and to acknowledge the importance of empowering employees.
Austrian economists like Friedrich Hayek fully recognized the benefits of decentralization in adapting to changing market processes. Today, Austrians can apply that same understanding at the firm level, in the pursuit of unleashing the subjective experiences and individual knowledge of each employee to greatest economic effect.
The organizational design tool to achieve maximum decentralized value generation is Entrepreneurial Empowerment (EE) A firm that organizes using Entrepreneurial Empowerment focuses at the leadership level on clearly defining the ends of the company (which can be packaged in the form of vision or mission or goals or objectives) and on ensuring that internal communications are strong enough and effective enough to ensure complete and fully distributed understanding and buy-in among the employee base.
The means for each individual to contribute to the achievement of these ends are left open to employees; they are not dictated or bound with managerial or administrative constraints. Leadership in an entrepreneurially empowered firm is non-interventionist, free of the strictures of central planning.
EE has two components: the first is structural empowerment (SE). The structural empowerment element of EE refers to the communication structure that delivers employee empowerment. Se informs them about their opportunities for taking action and making decisions, and provides support for them to utilize their own knowledge in doing so.
Professor Ng used the example of design firm IDEO, which provides a fully-available repository of all the firms designs and ideas from all its engineers and teams, along with information about how past teams tackled the solutions to design problems, with what outcomes. Designers on today’s teams can utilize this shared knowledge, learn from the pooled experiences, and enjoy the freedom of embarking on new design paths by combining their own knowledge and skills with the corporate knowledge repository.
Structural empowerment also requires a policy to regard failure as an acceptable part of the innovation process, in order to foster greater risk-taking behavior among employees, and a greater willingness to experiment with new and unproven ideas. SE is a process that leaders and managers must actively and persistently support. The danger is that leaders may succumb to the temptations of power and control, and to seek to centralize their authority. This can be fatal to entrepreneurial empowerment and negate all its benefits.
The second core component is psychological empowerment (PE). Employees perform best, innovate best and contribute the most creativity when they enjoy psychic rewards from their work. One important aspect of psychic reward is the search for and successful achievement of meaning and purpose. Research is clear that these high values are found in work when it is conducted in an environment that encourages their development. Professor Ng used Chick-Fil-A as an example where, because the company subscribes to a set of values, employees in what might appear to observers as the simplest and most repetitive service and production jobs can find meaning in their work. The result is unrivaled customer service ratings. Psychological empowerment comes from leadership conveying a set of principles.
Monetary incentives, rewards and the awarding of titles can not match psychological empowerment in effectiveness for motivating employees. The Austrian perspective delivers some quite revolutionary policies and approaches for organizational design.
Rethinking the concept of leadership. In recent years, business schools have commanded a lot of attention by marketing and selling leadership studies, with products ranging from executive education to books and online courses. However, Austrian economics suggests skepticism about the underlying concept of leadership in business. Firstly, structural empowerment and psychological empowerment are the antithesis of business school style leadership — they suggest non-leadership, letting go of control, and abandoning hierarchy.
Secondly, as Professor Ng pointed out, the centralized authority suggested by business school style leadership tends to lead to the corruption of seizing power and control, clouding the ethical considerations that are at the heart of entrepreneurship, and undermining the trust of employees lower down the hierarchy. The results can be both a loss of legitimacy for the bosses and a loss of business performance for the firm.
The Austrian perspective on organizational design and management can lead us to a higher performing firm, a more innovative firm, a firm that facilitates purpose and meaning for those individuals who work there, and trust and legitimacy for founders and executives.
Additional Resources "Entrepreneurial Empowerment" (PDF): Mises.org/E4B_109_PDF
Professor Ng’s Research Paper Entrepreneurial Empowerment: "You Are Only as Good as Your Employees" (PDF): Mises.org/E4B_109_Paper
In a recently published paper titled "Subjective Value In Entrepreneurship," Professors Bylund and Packard apply the principle of subjective value to generate significant new avenues of thinking for entrepreneurial businesses to pursue.
Watch the "Value Generation Business Model" video at Mises.org/E4B_108_Video.
Key Takeaways and Actionable Insights Re-think value. Business schools teach value creation. But their definition of value is faulty, based on a profound misunderstanding. Value is not objective and measurable, as in the business school paradigm of generating more of it. Value is subjectively understood and experienced. It’s a motivation for action (people have a desire to achieve experiences that they value) but it’s immeasurable. It is emergent from complex social systems and patterns of interaction between individuals, not something “created” by businesses.
Re-think the economics of value and value creation. Value is created by consumers via their experiences. Producers are servants to consumers and their preferences; producers seek to convince consumers to allow them to provide for their wants. Since consumers have alternative courses of action, producers must scrutinize and revise their plans continuously to conform with consumers’ changing choices. This is consumer sovereignty, an essential element of a value-centric business model.
Re-think the role of the consumer in the economic system. Consumers facilitate their own consumption. They pursue their own individual well-being, including by expressing their wants and needs to producers. The demanding of solutions is the task of the consumer, as is the choosing between available and expected alternatives. They experience value uncertainty (their preferences may end up dissatisfied) and they actively assess and learn about entrepreneurially produced alternatives that are available. They learn cumulatively as they amass consumer experience. Thus the role of value innovation and solution discovery is, actually, the consumer’s and not the producer’s. Innovations are generated by consumers in their never-ending pursuit of higher-valued satisfactions. Consumers’ own imagination and understanding shape their subjective experience.
Re-think the role of the firm. The producer’s role can be divided into value proposition creation, value facilitation and value capture. Producers respond to consumers’ dissatisfactions with the status quo by devising and assembling new value propositions – features and benefits responsive to consumer wants, aiming to generate feelings of well-being and satisfaction. Producers become partners in the consumer’s value learning process, providing a comparatively better offering than others, so that the consumer prefers it.
The consumer generates a willingness-to-pay, when they feel that the use value of an entrepreneurial offering exceeds the price they are asked to pay. The offering now has exchange value to the consumer. This money magnitude does not indicate the actual subjective value to the parties, but it does generate profit (if it covers production costs) that can be used in the market.
Re-think business models. A business model captures the fundamental idea of consumers and innovative businesses jointly navigating a shared experience of value uncertainty, in a never-ending quest for higher value states from which they can both profit. This co-navigation process must be built in to business model design, and business model innovation consists of new co-navigation pathways and new ways of sharing. For example, the concept of generative business models we explored in E4B episode #104 gives a greater role in co-navigation to consumers as a way of generating new value.
Management without measurement. Subjective value represents a challenge to theories of business that adopt a “make the numbers” approach to performance. When value is immeasurable, business processes must be assessed via variables such as the quality of understanding of the consumer and their preferences, the quality and accuracy of empathic diagnosis, and the trust generated with consumers to adopt the business as a co-navigator of value uncertainty. It is possible that survey data can be helpful. More fundamentally, Austrian economics can provide a set of principles for management without measurement.
One approach is qualitative models, which can be designed and subsequently calibrated with marketplace activity. One form of such models is simulation, using agents that represent the emotions and uncertainty felt by consumers in markets. This is a direction that technologically-augmented entrepreneurship may take.
Re-think output metrics. Similarly, in a world of subjective value and qualitative assessment, concepts such as KPI’s (key performance indicators) can’t realistically be applied. Concepts such as profit and free cash flow continue to apply, given full recognition that they are reflections of accounting conventions, because they indicate the sustainability of the firm and its business model. But new output metrics for subjectively-experienced consumer value and for satisfaction and well-being remain to be invented.
Re-think organizational design. Subjective value applies not only to consumer activities but equally to entrepreneurial activities. Professors Bylund and Packard present entrepreneurship as an individual journey, one that is primarily mental. The journey is a series of imaginations, judgments and learning over time regarding what problems to solve, what resources are available, what those resources can do, what can and should be done with them (in combination), how to do it and why (i.e. what are the goals and ends the prospective entrepreneur aims for).
Entrepreneurship is chosen. In an entrepreneurial business, many individuals are engaged in — choose — entrepreneurship. Much of their motivation lies in unleashing their imagination, processing their own learning, and finding purpose and meaning. Organizational design becomes the search for the best structures to free the individual to make entrepreneurial choices, to apply their individual imagination and explore the co-navigation of uncertainty with consumers. The firms that do this best will be the ones that succeed in value facilitation and value capture.
Re-think motivation and incentives. Why do individuals choose entrepreneurship? As Professors Bylund and Packard point out, money magnitudes do not express much of entrepreneurial motivation. Subjective values of purpose, meaning, achievement, personal fulfillment and others are primary. These can not be captured in salaries, bonuses, awards, promotions and titles. The firms that master subjectivist motivations will be able to attract the best talent.
Re-think the social contribution of business. Entrepreneurial capitalism is under fire in America today. Profit is seen as exploitative, and employment is often viewed as restrictive and oppressive. The ends of business are sometimes portrayed as conflicting with those of society.
An understanding of subjective value would generate a perspective of business as the facilitator of satisfaction and well-being in society. Business creates jobs and incomes for consumers, enabling them to facilitate their own value both in the form of psychic reward in their work and user satisfaction in their consumption value experiences. Individuals, families and communities are all beneficiaries of this value generation.
Businesses provide consumers with continuously improved goods and services at ever-lower costs, providing the means for consumers to achieve their desired experiences and satisfactions. This provision of means is generated entirely in response to consumers’ expressed wants and preferences.
Contribution to societal well-being is therefore the sole end of entrepreneurial business.
Additional Resources "Subjective Value In Entrepreneurship" by Mark Packard and Per Bylund (PDF): Mises.org/E4B_108_Article
"The Value Generation Business Model" (video): Mises.org/E4B_108_Video
Corresponding PowerPoint (Mises.org/E4B_108_PPT) and Keynote Slides (Mises.org/E4B_108_Key)
"The Austrian Business Model" (video): Mises.org/E4B_108_ABM
Austrian economics has always been on the leading edge of innovative thinking applicable to business. Back in the last century, there was a group of American economists of the Austrian school who greatly advanced theories related to subjectivism; that is, the role of human beliefs and preferences, and of the market as a process. Here are some of the insights (Mises.org/E4B_107_PDF) they gave us about entrepreneurial business.
The function of entrepreneurship is the generation of new subjectively perceived value. These economists got the name The Psychological School, because they understood that value is a function of human feelings, preferences and beliefs. The secrets to the successful pursuit of new value are not found in data and mathematics, but in human motivation.
The activity of entrepreneurs is the development and implementation of value-generation business models. The twentieth century economists we talk about on the podcast this week would probably never use the term business model. But their concept of the market as a process governed by subjectivism would embrace this modern term. A business model is a recipe for identifying value potential — an analytical outcome of understanding customer preferences — assembling a value proposition — a creative act of the entrepreneur — and enabling the customer to experience value, some of which can be captured by the entrepreneur via exchange if the business model is well-constructed.
Who are entrepreneurs? Historically, some economists have debated whether entrepreneurs play the role of managers of the assets and activities of firms, or the role of owners establishing the asset base and purpose of the firm, or the role of capitalists providing the enabling financial capital. From the subjectivist point of view, it’s not a difficult question. Entrepreneurs are those engaged in the business of pursuing and generating new value. They might play one or more roles (manager, owner, capitalist) at different times in the pursuit.
Those in business firms who do not have an entrepreneurial role are the bureaucrats engaged in governance actions with no customer value, imposed by external influencers, usually government.
How do entrepreneurs generate value? These economists understood the market as a process of individuals interacting to exchange. Therefore, they were able to establish that entrepreneurial value generation is a process and that it can be systematized (which is the essence of our Economics For Business project). A process has a beginning — in this case the identification of value potential, which requires a deep understanding of subjective value) and an end — the facilitation of value to the point where the customer can easily exchange for it, activate it, and experience it. It’s not necessarily linear, rather it’s recursive and dynamic, a continuous creative flow of knowledge gathering and learning and responding via innovation.
How are entrepreneurs compensated? These economists realized that it represents a poor reflection of real life to identify the compensation of entrepreneurs solely with profit. On the monetary axis, they can just as well be paid in wages or dividends or other forms of monetary compensation. On the non-monetary axis, these subjectivists fully understood the concept of psychic profit: that entrepreneurs can do what they do for their own individually-perceived motivations, including achievement, fulfillment, the reward of serving others, and the purpose and meaning found via the entrepreneurial journey.
Additional Resources "Entrepreneurship Drives Markets, Innovation, and Value Generation" (PDF): Mises.org/E4B_107_PDF
Professor Jankovic’s Book, Mengerian Microeconomics: The Forgotten Anglo-American Contribution to the Austrian School : Mises.org/E4B_107_Book
Entrepreneurship is the best pathway for all people out of unsatisfactory economic circumstances. Mauricio Miller, who arrived in the US as a poor immigrant from Mexico, and who also experienced living in some of America’s worst neighborhoods, spent over 20 years running social services for people growing up and living like he did. His conclusion: social services are the worst policy for such people. It is entrepreneurship that will open up the pathway out of the neighborhoods and out of the traps of low income and limited prospects. Entrepreneurship lifts up individuals, families, and communities.
Job creation programs are not the answer. In the US, people can get jobs, but they are often on a dead-end track that doesn’t generate learning or leverage-able experience — waiter, assistant, security guard, etc. Outside the US, even these jobs might not be available. Often, people with these jobs are entrepreneurs “on the side”, exchanging in the informal economy. This is just another indicator how important entrepreneurship is to upgrading people in low income situations.
Entrepreneurship is inherent in people. Is entrepreneurship hard? Is it too daunting for some? Does it require skills that only special people possess? Absolutely not. People have the capacity, the capability and the creativity. They are typically smart and determined. The requirement is simply to let that come out — to remove the constraints. The entrepreneurship is already inherently there.
Furthermore, people are motivated for entrepreneurship. Everyone has a particular talent, or at least their own interests, and they always perform better when they’re working on what interests them. And people want to run their own life, and make their own decisions.
Release the constraints. The constraints that face them trace to being stereotyped and labeled, and these are barriers to credibility. Reduced credibility makes it hard to institute relationships, establish partnerships, to get loan financing, and generally to build the network support and capital required to advance their businesses. Mauricio says that if we don’t label them, and simply let talent and commitment shine through, all kinds of people can demonstrate entrepreneurial potential and achievement.
Entrepreneurial achievement and success will emerge when people are unconstrained. How does the entrepreneurial movement get started? Naturally, and without intervention. In any community, there will be one or more individuals who become “leading lights” in the sense of trying something unusual or unprecedented, and succeeding. The definition in sociology and innovation diffusion theory is “positive deviants” — those who deviate from the norm or from history with a successful outcome. Leading lights is a better term.
The leading lights are followed by early adopters, who see a strategy that is successful and copy it or follow it. Then comes community support, which Mauricio characterizes as mutuality — everyone in the community eager to help anyone who can demonstrate success.
In his book The Alternative (Mises.org/E4B_106_Book), Mauricio tells the story of Ted Ngoy, a Cambodian immigrant to the Los Angeles area of California who got a job at Winchell’s donut chain. He quickly absorbed the techniques of donut making and decided to open his own shop. Members of the community pooled savings to provide equity capital to buy equipment. The single store became successful and Ted opened more. The mutuality of the neighborhood was activated and neighbors became delivery drivers and ingredient wholesalers and came together as a supply chain and value creation network.
The word spread across California and Cambodian immigrants in San Francisco and elsewhere started reproducing Ngoy’s strategy. In a more general sense, the learning is: people, whoever they are, can start and run a business and make some money and become independent.
A new mindset: No plan, no policy, no structure, no institutionalization. Mauricio’s key insight is that any intervention by government or charities or social services that aims to provide a plan or a process or a structure or to configure institutionalized support is not only not needed, it is destructive. It distorts and undermines the natural human motivations and drives that people draw on in entrepreneurship. The opposite approach — or no approach — is the best. Honor the natural preference of communities for self-help and sharing — mutuality as Mauricio has named it — and let them discover the pathways for themselves, find the knowledge, pool the savings, get access to the technology, use their network to connect to the needed skills.
Entrepreneurship is catching. Once the bright lights shine, once the positive deviants emerge, once the early adopters find follow-on success, once the natural mutuality builds the supply chain and the support network, no intervention or encouragement or policy is required. Stand back and admire.
Additional Resources The Alternative: Most of What You Believe About Poverty Is Wrong by Mauricio Miller: Mises.org/E4B_106_Book
Family Independence Initiative: FII.org
Community Independence Initiative: CIIAlternative.org
Mutuality Platform: Mises.org/E4B_106_Mutuality
For any size and any type of business, the generation of value requires more than strategy, planning, and executional excellence. It calls for the establishment, communication, and internalization of value-generation principles (see Mises.org/E4B_105_PDF), solidly founded and consistently applied.
This concept of the long term, dynamic application of unchanging principles is the essence of the Austrian approach to business.
In a podcast conversation, Professor Per Bylund reviewed and critiqued the popular business book The Science Of Success, and focused on these principles or guidelines.
A Vision For Long Term Value Vision in this context is not the transcendental futurism of a CEO-with-superpowers often envisaged in business school texts. This is Austrian vision: a deep understanding of what constitutes value and how to act to realize value over time, rejecting short-term opportunism.
Value, of course, is subjective, determined by consumers, and so businesses that generate long term value can be seen as creating value for society, a laudable ethical contribution to social well-being.
Virtue and Talents It’s unusual to encounter the word virtue in a discussion of business. In this context, it applies to the selection and hiring of a team that will collaborate on the long term creative task. This requires dynamically melding people with the right values, skills and capabilities, and the capacity to develop skills and capabilities even further. Hiring becomes one of the most important and most value-generating business functions.
Knowledge Processes Entrepreneurial value creation is a knowledge-based and knowledge-intensive process. Knowledge is actively pursued, curated, combined, and processed. Knowledge advantages may be available, where firms are able to craft uniquely superior processes, methods and technologies. Crucially, these are never permanent. They can always be competed away, and rendered redundant by changing markets and evolving consumer preferences, although some forms of knowledge advantage, such as brands and culture, can be more long-lasting. Knowledge processes must include not only knowledge management but also the creation of new knowledge.
Decision Rights Business books often talk about organizational design, but less often about the details of the processes of decision making. Whether the organization is hierarchical or flat and networked, it must still be able to make decisions and have them accepted and supported and implemented. Putting people in the right roles with the right degree of authority and accountability is the business challenge. This is different from the mythical business school idea of “leadership”; it’s a more a matter of productive collaboration among multiple individuals and teams, all of whom have some authority. The concept of decision rights breaks the ties and the logjams and enables corporate dynamism.
Incentives The idea that behavior is responsive to incentives is core to the science of economics, of course. The same is true in business, and it’s important to use economic reasoning to get incentives right and avoid adverse incentives. The proposition given in the Science Of Success is that people are rewarded according to the value they create. Thus, we come full circle, back to the vision of value that constitutes the first of these 5 principles. If a business is clear on its definition and understanding of value, then it can be successful in incentivizing its people to generate that value.
Additional Resources "Long Term Value Generation as a Science of Business Success" (PDF): Mises.org/E4B_105_PDF
QJAE Special Double Edition on Entrepreneurship: Mises.org/E4B_105_QJAE
Our metric for business is value generation. The scope of Economics For Business is not determined by business size or type — we don’t label firms as small, medium or large, or by the stage of their development, or by industry.
We see business through the lens of entrepreneurship, defined as the intentional pursuit of new economic value. A reasonable proxy metric we can use is growth. Business growth is consequence of generating new economic value. That value is determined by customers, and a growing company is creating more customers and/or adding to its share of customer dollars spent in value exchange.
The changing dimensions of business growth. The economic route to growth is changing. In today’s markets, we often see speed of growth that goes beyond historical expectations. Business models can expand their reach and accelerate their performance over networks faster than ever before.
An Austrian perspective on business enables entrepreneurs to perform in a high-growth environment: Austrian entrepreneurs recognize the boundaryless-ness of markets, the flexibility of capital combinations, and re-combinations to respond to the rolling flow of value learning signals from consumers, and the benefits of shedding control in order to accept complexity and emergence. Austrian entrepreneurs are well-placed to enjoy success in today’s markets.
Professor Mohammad Keyhani sums up the Austrian entrepreneur’s advantage in the term Generativity. The generativity of a system is the capacity to produce unprompted, unanticipated change through unfiltered contributions from a large, broad, and varied audience. The concept of generativity is closely aligned with the Austrian ideas of spontaneous order and emergence.
By way of an example, the concept has been applied to technologies, where the characteristics of generativity can be identified as the increase in participation as an input and the increase of innovation as an output. One of the results of this thinking has been open innovation: anyone can participate (e.g., when corporate research is not limited to a corporate R&D lab, ideas can come from anywhere outside the corporation), and more and better innovation is an outcome.
One of the potential effects of generativity is to overcome knowledge constraints. Open innovation is an example: even the biggest corporation with the best minds in its employment can not possibly have a majority of good ideas. They don’t even know what answers they should be looking for. With generativity, the part of the agency for the search for knowledge and entrepreneurial action is carried out by the product itself. Importantly, whereas open innovation is an organizational technique, generativity is a product characteristic. It gives the product itself some entrepreneurial agency in the Austrian sense of the word.
Detaching the search process from the searcher. When we face knowledge constraints, we search for answers. But a searcher only knows to search in certain places. Generativity can separate the search from the searcher, unleashing the search process to look in places that would be blind spots for the searcher. Similarly, generative design can generate product ideas that the human designer could not.
The incentives of the market can take control of the search process. The demand side (via broad, unfiltered participation) defines the problem to be solved and the supply side (via equally broad and equally unfiltered participation) creates solutions.
Generative characteristics can be built-in to a product or service. 5 characteristics of generativity in products are:
Leverage: the product can be put to many uses, and users can do many things with it, including those that the product designer could never anticipate.
Adaptability: the product can be further modified to broaden its range of tasks even further; new code can be contributed by users, accessories can be added, and so on.
Ease Of Mastery: there are no or low barriers to broad usage and broad adoption due to unusual or hard-to-acquire skills.
Accessibility: the product is accessible to everyone and its usage is not limited to a specific set of users.
Transferability: The advances in and changes to the technology made by some users are transferable to all users; new users can build on what previous users have contributed.
Generative products are tools for entrepreneurs. Generative products are a little hard to describe or categorize. They’re more like toolkits rather than specific use products. Professor Keyhani started a website to curate some of these kinds of tools / toolkits for entrepreneurs: Entrepreneur-Tools.Zeef.com/Keyhanimo
Some examples he mentions:
Zapier.com and Integromat.com link web apps and digital tools together via API’s to assemble automated workflows.
Airtable.com — flexible and powerful cloud-based relational database for regular users.
No-code software development tools like Adalo.com (build your own app), Voiceflow.com (build your own voice app) and Bubble.io (anyone can be a software developer).
There is a broad future growth path in generativity. Let users generate innovations; let them accumulate (new users can build on the innovations of earlier users); focus on capturing as much of the value as is appropriate for the entrepreneur-as-orchestrator.
Additional Resources "How Generative Is Your Business?" (PDF): Mises.org/E4B_104_PDF
"A Theory of Digital Firm-Designed Markets: Defying Knowledge Constraints with Crowds and Marketplaces" by Mohammad Keyhani, et al (on JSTOR): Mises.org/E4B_104_PDF2
Professor Keyhani's website: MohammadKeyhani.com
A rapidly advancing strand of theory has enabled great advances in the understanding of complex adaptive systems. Austrian economics is quintessential complexity theory; Austrians recognize that economic systems exhibit emergent outcomes as a result of the myriad interactions of consumers and businesses, value propositions and value perceptions, technologies and channels, and the innumerable transactions and exchanges that take place. The future is unknowable — we can’t know what will happen, and we don’t even know what can happen — and the system can sometimes feel turbulent and chaotic.
How should businesses manage complexity? They shouldn’t. It’s not manageable. No plan survives the first contact with customers is the way Steve Blank famously puts it.
What’s the answer? Don’t plan. Implement an Austrian Business Model (see Mises.org/E4B_103_Video) and embrace the complexity of the marketplace.
How do you do that? Professor Steven Phelan uses the complexity theory metaphor of the dancing rugged landscape. Think of the market or business sector in which you are operating as a landscape of peaks and valleys. You can see some of them but not all of them. Your view may be improved if you have more knowledge about where you are and where you are trying to get to, but knowledge is never complete. And the landscape is not stable — new peaks form, old peaks move and crumble, valleys become deeper. The pursuit of new economic value is the search for peaks, locations of high value that your business can capture, if you can get there. A plan won’t get you there, because you can’t see a pathway and the destination is going to move and change anyway. And you might identify another, better peak as you explore, and you’ll make an unplanned change in your journey to switch destinations.
Professor Phelan sums up the many choices open to entrepreneurs in complex environments under two approaches.
Approach 1: I believe I can see a peak, and identify a pathway to reach it. You will never be right. But there are smart actions:
Be humble: be conscious that you may be proven wring.Act fast: test, test, test to prove the peak and the path.Be agile: prepared to change or pivot when circumstances and data change.Be aware of competition and fast followers and adjust accordingly.Refine / redefine your niche to further differentiate.Build fortifying uniqueness around any peak you find.CultureBrandBuild-in continuous change and innovation.Assemble multiple peaks, reducing dependence on any single one. Approach 2: I don’t know where the peak is, but I believe I am in an opportunity-rich landscape. Don’t get trapped — and waste all your resources — in blind random searching.
Run multiple experiments — small, medium, and large.High speed of sorting through outcomes.Example: Big Pharma seeds multiple biotech startups, acquires winners.Choose customers to serve first, rather than choose products or services to produce.Customer need is the beacon to guide the searchThe customer need is never fully understoodAnd it’s always changingThe work of identifying it is never completeBut it is the guiding lightThere are no events (like product launches) only the continuous flow of searching, responding to customers, and changing in response. As Professor Phelan states: the work is never done. No landscape is unchanging. No peak lasts forever.
Additional Resources "The Entrepreneur In A Dancing Rugged Landscape" (on Twitter): Mises.org/E4B_103_Twitter
"The Complexity of Opportunity" by Steven Phelan (PDF): Mises.org/E4B_103_Paper1
"Austrian Theories of Entrepreneurship: Insights From Complexity Theory" by Steven Phelan (PDF): Mises.org/E4B_103_Paper2
Can entrepreneurship be a collaborative undertaking across multiple firms? Entrepreneur Zones are an idea from Dale Caldwell to boost the economic performance of cities, and represent one form of collaborative entrepreneurship. The business platform the Mises Institute is building — Economics For Business — represents another: an online collaboration of entrepreneurs to share knowledge, experience, and practices, while competing individually to be the best at serving customers.
How will this work? We can answer this question using our "5 Cs Framework" (Mises.org/E4B_102_PDF1).
Key Takeaways & Actionable Insights 1. Consumer Sovereignty / Customer First The first principle of entrepreneurship is that value is subjective, and one way to express that principle is that consumers determine value. Entrepreneurs facilitate value for consumers. That principle is never relaxed. Deviation from it is fatal for entrepreneurial businesses. Therefore, even in circumstances where we see opportunities for entrepreneurial collaboration, it is never in violation of consumer sovereignty. Any collaboration is directed towards the facilitation of consumer value, and does not detract from it.
- Collaborative Efficiency. In an Entrepreneur Zone, as envisioned by Dale Caldwell, there is the opportunity for a group of entrepreneurs (geographically co-located in a city in his case, but potentially grouped along other dimensions) to search for shared advantage. To speculate, the shared advantage in an Entrepreneur Zone might be found in shared services, reducing unproductive overhead for all firms and releasing resources for exploration, innovation, and customer service. It could be found in shared or pooled marketing.
In the case of Economics For Business, we aim to provide shared knowledge (reducing search and knowledge acquisition costs and overcoming knowledge constraints), processes and tools that can be applied by all for greater effectiveness, and shared experience that can speed up learning.
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Competitiveness "Collaborating to compete" sounds contradictory on the surface, but is the essence of capitalism. While firms look for shared advantage where it is available, they equally search for individual advantage through innovation, better ideas, better customer service and stronger relationships. The rivalrous drive to serve customers better and therefore enjoy the resultant revenue streams is primary. It’s the energy of economic growth. Success can be replicated by imitators, which is one of the ways the system works for all. By that time, the innovators have advanced to the next stage of competitive advantage. The system never stops and progress never ends, because of the competitive drive.
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Creativity Behind competitiveness is creativity. New ideas and new knowledge, the result of new experiments, provide the fuel for continued growth. The collaborative entrepreneurial group can share ideas, bounce ideas between them, pursue their own ideas, ask for help, and merge ideas into new combinations. Creative ideas remain the original source for all entrepreneurs.
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Cumulative Improvement Entrepreneurship is a journey, with many twists and turns. It calls for learning, which might often require abandoning a path that once looked promising and taking up another. Success comes over time, via more and more learning, more and more feedback from the marketplace, more and more experiments run and recorded, more and more customer experiences logged. Improvement accumulates over time. For a collaboration such as Entrepreneur Zones or Economics For Business, participating entrepreneurs can anticipate long term success without any certainty about the length of the timeline.
Additional Resources "The 5 Cs of Entrepreneur Zones" (PDF): Mises.org/E4B_102_PDF1
White Paper: "New Jersey Entrepreneur Zones" by Dale Caldwell (PDF): Mises.org/E4B_102_PDF2
"Dale Caldwell Believes that Jobs Can Drive Societal Change": Mises.org/E4B_102_Article1
"Healing Divided Country with Entrepreneurship": Mises.org/E4B_102_Article2
"Opportunity Zones… We Need Entrepreneur Zones": Mises.org/E4B_102_Article3
"Trauma in Employment" (PDF): Mises.org/E4B_102_Article4
Key Takeaways and Actionable Insights Our goal at Economics For Business is to help entrepreneurs and their businesses succeed. Per Bylund and Hunter Hastings discuss the true implications of the current furor over the anti-market behavior of some of the Big Tech companies of Silicon Valley. They are destroying value and consuming capital. Why? How can this happen?
Read Per Bylund’s tweet stream: Mises.org/E4E_101_Twitter
Where Is the consumer? The Austrian business model emphasizes that the consumer is in first position. The goal of entrepreneurship is the creation of new value, and Austrian entrepreneurs understand that value is an experience, and evaluation is in the consumer’s mind. Entrepreneurs facilitate value experiences, via an understanding of what consumers will value, and of gaps or shortfalls in the value propositions from which they choose today. Business success lies in filling the gaps and solving the shortfalls.
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Technology-driven means not thinking about the consumer The histories of many Silicon Valley tech firms reveal that they started out to build a technology, one that performs efficiently, automates effectively, and exhibits cool features. There’s a pride in engineering, as there should be. But even the most beautiful technology can’t succeed without consumers in mind. The technology-driven approach to innovation must not contravene the principles of the consumer-driven approach to value.
When consumer value is not the business model Facilitating consumer value is a business model. Value is a learning process for consumers, of which exchange value (paying in dollars for value anticipated) is a component part. The revenue model for the entrepreneurial firm consists in earning this exchange. It’s all integrated. Some Silicon Valley companies (Google, for one) accepted investor funds and began operations without a business model in place. When consumer value is not integral to the firm, it’s quite possible that they lose their grip on the concept. They don’t create value for consumers, or for the economy. Or for investors, for that matter — they’re using investor funds in ways the consumer does not value.
In many Silicon Valley models, consumers are creators of content for the technology company to control, analyze and re-sell as data to the advertiser. Consumers are creating value for the platform, not vice versa.
Monetization as an afterthought We often hear the word “monetization” in descriptions of Silicon Valley business models. The word itself is quite revealing. It certainly doesn’t connote a commitment to serving the consumer. Monetization is the search for a revenue model after the technology is launched. Many of the monetization schemes are advertising-based, which can be problematic. They are often value-destroying for consumers, especially in the “interrupt and annoy” formats that are common on the internet today. Advertising is certainly not innovative — it’s been around for a very long time, long before Silicon Valley came into existence. When firms are selling consumers to advertisers, their commitment to consumer value becomes secondary.
It’s not that B2B business models are any less valid than B2C. The key is to remember the Austrian principle that value in any stage of the production chain is made possible only if there is consumer value at the end of the chain. Microsoft, for example, is a technology company primarily focused on B2B value propositions in areas like business productivity. They always have an eye on the next stage in the value chain: improved business productivity and efficiency enable Microsoft’s customers to, in turn, produce lower-cost consumer services and enhanced consumer experiences. Microsoft has its eye not only on the immediate B2B customer but also on the next stage of the value chain.
A cultural problem Ultimately, the kinds of Silicon Valley companies to which these observations apply face a cultural problem. Consumer value and consumer service are not a sufficient part of their DNA. They were founded and developed to nurture technology — in some cases, brilliant technology, in others more mundane; they found technical ways to reach mass distribution based on the new power laws of digital networks; they found bolt-on monetization schemes that responded to mass reach. Culturally, the idea of consumer value has never been central to them.
Perhaps that’s why, today, we see Twitter censoring its users and throwing them off the platform, angering many more.
Generative products versus central control The value promise of today’s digital products and digital markets is exciting for consumers. The term “generative” has been coined to describe the new characteristics of products that give consumers leverage – make their jobs easier; that provide adaptability so that consumers can change them to suit their own purposes; and that are easy to master and easy to access. The spirit of generativity lies in unleashing end-user creativity.
Some Big Tech companies don’t seem to believe in the generativity of their products and their consumer relationships. They prefer centralization and control. They want to collect and control consumer data and turn it into their own closed products. That’s why they need so many engineers to build the algorithms and the data banks. That’s why they need so many content monitors to project their control. They are centralizers in a world of decentralization. This leaves them open to disruption by the next generation of entrepreneurs who start their journey from the point of view of what consumers value.
Additional Resources "Silicon Valley is Bad at Entrepreneurship" (PDF): Mises.org/E4E_101_PDF
Protocols, Not Platforms: A Technological Approach to Free Speech by Mike Masnick: Mises.org/E4E_101_PDF2
Economics is an animating science. Economics is treated by many as an arid field of mathematical modeling. Human beings are treated as data in the model, almost the way physics regards atoms and molecules. This approach to economics doesn’t help people much; it doesn’t help us understand the world, and isn’t helping us build a better future.
Austrian economics is humanistic; it treats humans as people, pursuing their hopes and dreams, frequently changing, seldom predictable, and never acting like data in a model.
That’s why we see our brand of economics as animating: helping people to understand better how to identify the best means for their chosen ends. For businesspeople, that translates into knowledge, processes and tools to help businesses grow and thrive.
The role of the entrepreneur Entrepreneurship is the animation of business. It’s action; the exciting process of turning business knowledge and market signals into commercial solutions with the application of imagination, insight, creativity, resource assembly, and agile adjustment.
A big part of what makes Austrian economics different and better for business application is the understanding of the role of the entrepreneur and the entrepreneurial function in the economy. Jeff Deist articulated this role as a nexus between capital and markets, and the entrepreneur as the individual taking risk, employing their own property and having skin in the game. It’s an exciting role.
Entrepreneurship and value Entrepreneurial business is the intentional pursuit of new economic value. The pursuit requires a deep understanding of the concept of value, an understanding that Austrian economics provides. Ever since Carl Menger established the concept of subjective value, Austrian economists have been deepening their understanding still further. Today, we recognize more than ever the role of the customer in value creation; since value is their experience, they are active collaborators. Entrepreneurs harness this collaboration. Think of an iPhone. Apple designs and assembles it, and then a large part of the value experience comes from the user adding apps, composing and sending and receiving messages and e-mails, choosing videos to watch and podcasts to listen to, eagerly contributing to the value experience that they themselves enjoy.
Value is what users make it.
Individualism and diversity Entrepreneurial economics recognizes the role of the individual. It respects and honors the individual choice. Each individual, in the role of both consumer and producer, exhibits different preferences, personality, and psychology; we live in different places and in different contexts; we each have different needs and wants.
There are many favorable outcomes from individualism. One is the vast global diversity of the marketplace, whether exhibited on amazon or Alibaba or Grainger.com for industrial supplies. Another is economics as an engine of humanity and peace, which is the context for entrepreneurs providing goods and services globally to customers.
Specialization, achievement and satisfaction Economics For Business aims to help all businesses and all entrepreneurs to find their specialization in this global ecosystem. We apply the economic principles of the specialized division of knowledge and division of labor. We all have knowledge that is unique to us, and we can all find an application of that knowledge in business.
Bob Luddy, who has been a guest on our podcast, founded CaptiveAire, a company that specializes in restaurant ventilation systems, providing benefits of safety, comfort, clean air and regulatory compliance to a broad range of foodservice customers. Bob stresses the value of specialization to become the leader in a category - a share leader and a knowledge leader and an innovation leader. And he’ll tell you that the non-material rewards of economic specialization are delightful, including satisfaction, achievement, earned respect.
CaptiveAire is a great example of considered specialization – it’s not in a high tech category (although there is a lot of tech incorporated in CaptiveAire’s product and service bundle), or an internet business or a software business. Find your customers, find a need that is not being filled, and build from there.
Big data versus big empathy and big insights We live in an era where more and more data is being collected, compiled, processed and analyzed by producers (as well as non-economic actors such as governments, of course). As the sources of data, many of us have concerns about this trend. The economic principle that is more important for businesses, however, is that, no matter how “big” the data sets are, they do not have value (they are not causal data) until they provide or reveal some qualitative understanding of customer feelings, motivations or attitudes. These are the data that are genuinely useful to businesses. The Economics For Business method to develop this understanding is empathy, and we have a full toolset to help entrepreneurs apply it.
MBA-ization versus products, people and active learning Jeff quoted Elon Musk on the subject of MBA-ization of business: too much focus on financial modeling and spreadsheets, and not enough on deploying engineers on the factory floor to develop, introduce and continuously improve great products that provide the customer with a delightful experience. Jeff concurred that MBA programs and business schools have become bogged down with a lot of dead weight, and have obscured some of their market-facing functions. They don’t provide the value they ought to provide for the tuition charged.
Economics For Business can provide the 20% of business school knowledge that’s actually valuable, and add new content – informed with Austrian insight - that’s even more relevant, plus the methodology and tools to apply the knowledge in business practice.
This approach is based on the educational science of active learning. In this view, learning is not achieved via books and lectures (which are necessarily backward-looking) but via the receipt of tools and methods and techniques, applying them oneself in real-life situations, and learning from the feedback received from people and markets and business results.
Building experience and sharing experience. Active learning is the accumulation of experience. It is the unique experience of entrepreneurs and their teams gained from the operation of their businesses that constitutes the division of knowledge flywheel that continuously reinforces their advantaged position in the marketplace.
There is a time value to experience; it takes time to accumulate. On the Economics For Business platform, we’ll aim to identify ways to share experience to speed up the experience-gathering timeline. Q&A and discussion within our entrepreneurial community is one way. Another is mentoring, whereby experienced business people can share what they’ve learned over time.
Economics as a route to work and life satisfaction. In his book Dynamism, Economic Nobel prizewinner Edmund Phelps tells us that, according to individually reported life satisfaction scores (e.g. Pew Research Center surveys and other similar surveys), the greater part of life satisfaction results from production activities rather than consumer activities. The purpose and meaning of taking on challenges, achieving results, making discoveries, self-reliance, and success in meeting goals are found in participation in the production side of the economic system. We hope to play our part in the stimulus of those satisfactions via the Mises Institute’s Economics For Business project.
Entrepreneurial GPS Economics For Business utilizes a journey metaphor for the entrepreneurial process. Take a look at our visual summary at Mises.org/E4B_100_PDF.
Consumers are indeed sovereign, but the reason consumers can exercise their sovereignty is that entrepreneurs have already borne the uncertainty of production to make the goods available for purchase.
Original Article: "How Consumer Sovereignty and Entrepreneurship Work Together"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Why isn’t everyone an entrepreneur? Perhaps we don’t explain it well enough or in language that lets everyone in on the wonders and the thrills of the pursuit of new economic value.
Scott Livengood chooses reframing — thinking in new and different ways about an established concept — to widen the audience for entrepreneurship.
Reframing entrepreneurship in the context of popular culture. Scott recently published a multimedia e-book called The Startup of Seinfeld (Mises.org/E4E_99_Book1). In the book he articulates a comprehensive survey of concepts and principles of entrepreneurship, including the entrepreneurial mindset, risk and uncertainty, intellectual property, business models, planning, finance, and many more.
The cultural frame Scott selected is everyday city life as illustrated by the characters and situations and market interactions in 180 episodes of Seinfeld. In Scott’s hands, this is not a show about nothing, but about entrepreneurship.
The multimedia approach is facilitated by a series of links in the e-book to YouTube video clips of short scenes from multiple Seinfeld episodes that are illustrative of entrepreneurial concepts and principles. You’ll find the concepts of economic calculation, opportunity, product design, arbitrage, intellectual property, judgment, planning, uncertainty, and several more. The text accompanying the videos is an exposition of economic principles underlying these concepts.
There’s a lot to learn, and it’s fun! A major point to take away is that entrepreneurship is everyday life: people imagining new ways to serve others and meet their needs, and employing design and economic calculation, judgment under uncertainty and marketing and communications to facilitate a valuable exchange.
Reframing the teaching of entrepreneurship and strategy. The philosophy underpinning the teaching method in the e-book has been forged in the university classes and seminars that Scott teaches, and for which he prepares meticulously and conducts comparative research into learning and teaching effectiveness.
He has found that embedding the principles of entrepreneurial economics and business strategy in cultural iconography illustrated via multimedia technology results in a significant increase in student engagement, participation, learning, and understanding. Humor, for example, is a language and a style that can draw students in, engage them at a deeper level of curiosity, and help to deliver the serious economic message.
This kind of approach helps students think of entrepreneurship as more of a normal life choice for themselves — a life of creative problem-solving. Students can think about their ends and the means open to them in a different way. If they are inclined to “social entrepreneurship”, they can learn that that simply means a distinctive identification of ends, without any attempt to operate outside the profit-and-loss system of sound entrepreneurial practice.
Reframing entrepreneurship for the disadvantaged. Scott’s ultimate test for reframing entrepreneurship for a different audience in a different culture has been presented by his teaching for Education for Humanity. This is group associated with his university, Arizona State, and dedicated to helping displaced refugees. These students who are displaced from their homelands by war and conflict and find themselves in refugee camps in countries that are alien to them, like Uganda and Lebanon. Their prospects for further education are narrow. What are the pathways out of the poverty and restrictions of refugee camp life?
Scott’s chosen task is to teach them entrepreneurship. Where to start? The basis is empathy — digging deep to understand their situation, circumstances, and context, and understanding them as individuals and identifying their needs and wants. Language becomes critical — using concepts and examples they can relate to.
It’s contextually impractical to teach entrepreneurial finance in terms of bank loans and venture capital. But Scott can teach individual and family budgeting: how to calculate and manage income and expenditures, how to save, how to build up sufficient savings to make a capital purchase, and how to generate an income stream from that capital. The particular capital artifact may be a second cow for a head of household that uses the first one for feeding the family. The family has knowledge and skills in milking and animal husbandry that can be put to use in their new entrepreneurial business of selling milk and dairy products to other families, or bartering for other kinds of nourishment.
Eventually, the family may advance to the use of micro-loans or other forms of micro-finance and expand their entrepreneurial holdings. Scott can now teach about the trust nexus of paying interest and paying back loans, and about return on investment and capital accumulation. Progress comes quickly as a result of starting in the right place.
Entrepreneurial communities. One of Scott’s realizations has been the power of entrepreneurial communities. In the refugee camps, family entrepreneurs collaborate, learn together, assist each other, and seek to raise the prospects of the entire community. Failure to pay back a loan, for example, would be a setback for the group, and group norms and institutions arise to guard against such a loss of trust.
Scott sees direct application of this learning about normative entrepreneurial community action in other parts of the world, including rural communities here in North and Central America, and in the inner city initiative of Entrepreneur Zones in the US.
By embedding entrepreneurship in culture, the collaborative service ethic emerges more clearly and emphatically.
Additional Resources Enjoy Scott Livengood’s book about the culture, concepts, and principles of entrepreneurship: The Startup Of Seinfeld: A Multimedia Approach to Learning Entrepreneurship: Mises.org/E4E_99_Book1
Read the work of Nobel prize-winner Edmund Phelps, mentioned in the podcast introduction, on Mass Flourishing (Mises.org/E4E_99_Book2) and economic Dynamism (Mises.org/E4E_99_Book3).
Empathy, properly employed, is a robust business tool that smart entrepreneurs use to design winning value propositions.
Here’s why empathy matters for entrepreneurs. Entrepreneurs’ success depends on what others do — those others being customers. The entrepreneur has the goal of customers buying, as a result of listening to their preferences and meeting them.
But there’s a little more work to do than just listening. As we discovered in Dr. Mark Packard’s previous podcast episodes, the customer is engaged in a continuous, dynamic, and ever-changing value learning process: learning what they, subjectively, really want. So they can’t tell you what they prefer when they are still engaged in the learning process. So listening, while useful in gathering factual knowledge, isn’t quite enough for the entrepreneur to embark upon designing a solution.
The entrepreneur must develop a special kind of “needs understanding” for their chosen customer group. As Dr. Packard stresses — and as is foundational to the application of Austrian economics to business — the customer determines value, and that value takes the form of an experience: how customers feel about the experienced benefit of an economic exchange like buying a car, driving it, getting it serviced, and sensing the esteem of others for the choice they made.
There are two kinds of knowledge, factual and tacit. Your customers can communicate factual knowledge to you. They can’t communicate tacit knowledge, because it is derived from experiences that only they can feel.
So entrepreneurs must find a tool to represent the tacit knowledge that’s locked in the customer’s mind — a tool for “needs understanding”. The tool Dr. Packard proposes is a mental model the entrepreneur can use in the empathic process.
Importantly, empathy is not emotional mirroring — feeling what another person feels. It’s an active implementation of the entrepreneurial imagination, a cognitive act that the entrepreneur can plan and perform.
The process of modeling “needs understanding” starts with factual knowledge, purposely gathered and organized. What entrepreneurs must pursue is deep learning about why customers feel the way they do about their experiences The goal is to gain insight in order to be able to improve consumers’ future experience. This requires knowledge-based inference from your empathic imagination about the causes of the current experience.
To do that, entrepreneurs need substantial background information—especially the personal and situational context surrounding the experience: the specifics of who, what, when, why and how. It’s not about imagining the experience of random people; it’s about learning a lot about a specific person in order to be able to successfully empathize with them.
Factual knowledge can be run through the entrepreneur’s mental model. Once factual knowledge of the customer, their context and their current experience is gathered, the entrepreneur makes two runs of this information through their mental model. Think of it as running a simulation — a mental simulation.
The first run of the mental model is based on the entrepreneur’s own experience. Pick an experience that you’ve had and can self-analyze, so that you have a model of what that experience feels like. Now run the information you’ve gathered about the customer through that model — what does it suggest that they might feel? For example, think of an experience that you’ve had where you bought a product you expected to enjoy, and it disappointed. What did that feel like?The second run of the mental model is the empathic mental model based on the entrepreneur’s understanding of the customer’s current or recent experience as told during knowledge gathering. You can understand what you felt like when a product disappointed. Now you imagine what the customer feels like or felt like as a consequence of a comparable experience. The final step is to project the empathic mental model into the future. The ultimate goal is to imagine what the customer’s feeling would be like in the future, following an experience with a new product or service value proposition offered by the entrepreneur. This is a projection — one that can be carefully constructed from the two previous runs of the mental model.
Create a mental model from your own experiences.Run that mental model for an experience that a customer has reported to you that they have felt in the past.Then run a projection of that model for the new experience you are planning to offer. The more developed this skill becomes, the more confidence you can develop in your empathic projection, and the better you will be able to evaluate the business opportunity you are imagining you will design and create, and the value the customer will experience.
Just as the customer learns what to value, the entrepreneur can learn to project future value. Dr. Packard emphasizes that the customer is continuously engaged in a learning process — assessing value propositions, making decisions as to what to buy and what to try, then evaluating the resulting experience — was it better or worse than expected?
The entrepreneur must keep up with this learning process, monitoring the customer’s dynamic subjectivism, their ever-changing preferences amidst an ever-changing context.
By keeping up via continuous monitoring, the entrepreneur will be able to make multiple runs of the empathic mental model, and test the model results for increasing predicted value.
Additional Resource "Empathy as a Process" (PDF): Mises.org/E4E_98_PDF
With the development of the Austrian Business Paradigm and the Austrian Business Model, and tools such as the "Value Learning Process," businesses of all kinds can utilize the deep insights of Austrian economics to further enhance how they facilitate value for their customers.
John Boles — an avid listener of the Economics for Entrepreneurs Podcast — provides an example of how he applies these insights at his accounting firm. Here is a summary resource and a step-by-step outline: Mises.org/E4E_97_PDF.
1) Improved customer understanding. The Austrian business paradigm places the customer in first position. This contrasts with traditional business thinking that puts the firm or the product or service in first position and searches for ways (“strategies”) to sell or market that offering to a set of customers who are to be identified during the selling process.
The way to put the customer in first position is to make your top priority a deep and intimate understanding of the customer, demographically (who they are), functionally (what they do and how they do it) and emotionally (how they feel — about key issues and challenges, about vendors and service providers, about competition and every aspect of business).
The first question Austrian business practitioners ask themselves is: how deep and intimate is my customer knowledge, and can it be improved?
2) Calibrating the customer’s perception of value. Value is a feeling that exists only in the mind of the customer. The entrepreneur’s task is to facilitate that feeling of value — ease the way for the customer to arrive at that happy state of mind. It’s imperative for entrepreneurs to try to feel what the customer feels — to sympathize with their perception of value, rather than to focus only what the firm is delivering. We must know what the customer is buying, not just what we are selling.
The tools to use are monitoring of customer behavior (what they do — for example, shopping around for alternatives — is more important than what they say); making sure you understand their rankings of features, attributes and benefits, that is, what’s most important to them; and conducting interviews about the value experience. Ask the question: is the customer’s perception of value experienced aligned with the firm’s perception of value delivered?
3) Are value adjustments indicated? The Austrian view of the market as a process helps us think about continuous change. Customers are continuously interacting with other customers, competitors, ideas, new value propositions, environmental conditions, regulations and a plethora of marketplace changes. Consequently, their perceptions of value are in constant flux. It should not be a surprise that entrepreneurs need to make value adjustments. It may be necessary to change perceptions of absolute value (via an adjustment in the value proposition), of relative value (via an adjustment in comparison with alternative propositions), or of exchange value (via adjustment in pricing, bling terms, or discounts / rebates).
4) Communicating adjustments. It’s easy to overlook a critical component of value adjustments: communication. The Austrian business model advocates frequent in-depth conversations with customers at every level. These conversations, while always two-way of course, can be primarily designed for outbound communication, describing the adjustments made, and why they were made and ensuring the customer understands the responsiveness of the firm; or for inbound data gathering, primarily listening in order to further increase understanding of the customer and their preferences.
Customer communication is a component of perceived value.
5) Ongoing evaluation. The customer is always evaluating the service provider / vendor and their value proposition, through the lens of experience: did the value experience match the anticipated experience; and, if not, in what ways was it deficient? The service provider / vendor must also undertake continuous evaluation. Did the value adjustments succeed? Are more called for? What are the indicators of change?
Additional Resources The five steps of "Continuous Value Perception Monitoring" are described and annotated in our free downloadable graphic process map: Mises.org/E4E_97_PDF
For reference, match this monitoring tool with the customer’s "Value Learning Process": Mises.org/E4E_55_PDF. The two processes are complementary, composing a complete yet never-ending cycle of value.
Researchers into entrepreneurship have a powerful incentive to identify new insights about how businesses grow and thrive.
Happily for everyone involved in business and innovation, entrepreneurial research is thriving, blossoming, and flourishing. Professor Vishal Gupta’s book, Great Minds In Entrepreneurship Research, surveys thirty or more years of research papers that were awarded what is colloquially known as the Nobel Prize in Entrepreneurship Research (formally known as the Global Award for Entrepreneurship Research: GAER). The research field is deep, rich, dynamic and expanding.
Research identifies and examines entrepreneurship in every business size and type as a fundamental economic activity. In its earliest days, entrepreneurship research focused a lot on small business but, today, business size and stage are not the constraints. The research identifies entrepreneurship in corporations, non-profits, and many more business sectors.
Much of the research focus is on entrepreneurial contribution — to growth, to job creation, to innovation, to progress. Entrepreneurship is identified as the great economic contributor to betterment and well-being, measured via GDP growth in countries large and small, the creation of new and better jobs for people worldwide, new innovations and new business directions, and individual progress in general. As Mises stated, entrepreneurship is the driving force of the market system.
New entry, properly understood, is one way to characterize entrepreneurship. The search for a single characteristic of entrepreneurship risks missing critical insights. However, one that garners broad support is “new entry” — entering new markets, entering existing markets with new value propositions, entering established product fields with new innovations, or entering into existing customer mindsets with new ideas.
Economic productivity is another. A rich vein of entrepreneurship research has measured the efficiency that entrepreneurs bring to the use of resources — producing more with less. For example, research has measured innovation efficiency as the number of innovations per employee, and has found that smaller, more nimble firms are far more efficient on this metric than big corporations, even if the latter launch more new products in total (and generate more PR).
The research has uncovered a new type of firm and business model, and new business ratios that result. NTBF is the acronym for New Technology Based Firms, those that innovate with new business models and new ways to facilitate service experience via dematerialized delivery. One of the results of these new models is new sets of business ratios — for example, revenue per employees which, with software based companies on the internet, can now reach never-before realized levels. This evolution has forced researchers to re-think some of their models. For example, the biologically-derived product life cycle (PLC) model of business maturity — birth, life and death — has to be revised because dematerialized companies can easily be re-born, even after near-death experiences. Think Apple — the founder died and, at one time, it was thought that the company might, but it was reborn.
Research opens up entirely new ways to think about business. New research fields such as complex adaptive systems (or complex creative systems as Professor Todd Chiles prefers to call them) represent a new way to think about business — focusing less on individual firms and more on the value networks and service systems of which they are a part.
New ways of evaluating business potential are also emerging from research. Professor Gupta discussed characteristics of firms such as knowledge absorption and absorptive capacity. Extending the Hayekian concept of distributed specialized knowledge, researchers have identified the ability to quickly absorb and apply new knowledge as a critical capacity of successful adaptive firms, and have shed light on many of the internal constraints this absorptive capacity.
Research recognizes the role of entrepreneurial imagination and subjectivity, although it doesn’t always get it right. Austrian economics highlights subjectivity and views entrepreneurial opportunity as a subjective phenomenon, based in the imagination of the entrepreneur. Not all entrepreneurship researchers have been able to become comfortable with this idea, continuing to see opportunity as objectively identifiable. Austrians seem to be in the ascendancy on this controversy.
Importantly, entrepreneurship research is becoming interdisciplinary. Systems thinking requires an interdisciplinary approach. Researchers in sociology, psychology, finance and even anthropology are examining entrepreneurship via their own research lenses. This development can only help the advance of entrepreneurship across a broad front of society and culture, as well as economics.
Additional Resources "What Entrepreneurship Is (and Isn’t)” (PDF): Mises.org/E4E_96_PDF
Download our eBook, Austrian Economics in Contemporary Business Applications, featuring a chapter from Vishal (PDF): Mises.org/E4B_eBook
Abstract: The concept of entrepreneurial opportunity has undergone a period of useful critique and refinement since Venkataraman (1997) and Shane and Venkataraman (2000) employed the term as one of the defining features of entrepreneurship studies. This paper presents a novel Austrian reinterpretation of this concept as an intersubjective phenomenon that emerges from the dual entrepreneurial process of discovery and judgment. Just as markets can be described as price discovery procedures for existing goods, services, and resources, entrepreneurship can be usefully described as a price discovery procedure for future goods, services, and resources. This view retains the essential elements of Kirzner’s (1973) approach while also refining the opportunity discovery concept within an evolutionary realist framework for understanding entrepreneurial motivation and action.
Gregory M. Dempster (gdempster@hsc.edu) is Elliott Professor of Economics and Business at Hampden-Sydney College.
INTRODUCTION Since Israel M. Kirzner’s (1973, 1979) groundbreaking work on entrepreneurial discovery over forty years ago, the concept of opportunity has been central to the academic literature on venture creation and innovation. Sankaran Venkataraman (1997) and Scott Shane and Venkataraman (2000) made opportunity a primary operational construct in their definition of the field of entrepreneurship studies. Though some views, such as those of Frank H. Knight (1921), Joseph A. Schumpeter (1934), and Buchanan and Vanberg (1991) deemphasize the concept in favor of other factors such as uncertainty, innovation, and creativity, the opportunity discovery view has remained a primary construct, often integrated with these other concepts as separate but interrelated aspects of venture creation. Indeed, there is general agreement in the field of entrepreneurship studies that scholars need to “explain the role of opportunities in the entrepreneurial process” and to “clarify the central role that opportunities play in a framework for entrepreneurship” (Eckhardt and Shane 2003, 333).
Recent scholarship, however, has displayed a great deal of ambiguity toward the use of the concept of opportunity, and some have questioned the coherence and usefulness of the term altogether. Distinctions between “Kirznerian” and “Schumpeterian” opportunity are made to distinguish equilibrating from dis-equilibrating entrepreneurial innovations (Shane 2003); “discovery” and “creation” have been proposed as alternate views of how opportunities come into existence (Alvarez and Barney 2007); and both epistemological and methodological objections to the concept itself have been suggested (Klein 2008; Foss and Klein 2012; McCaffrey 2014). The fact that many of these objections come from scholars working in the Austrian scholarly tradition of Kirzner suggests that they represent serious challenges to the viability of the opportunity discovery construct as a research tool in understanding the nature, causes, and consequences of entrepreneurial activity.
This paper seeks to better define the role of opportunity in entrepreneurial discovery. It focuses on entrepreneurship as a collaborative process of intersubjective knowledge generation and integration, and reconceptualizes the idea of entrepreneurial opportunity as neither a purely “preexisting” entity nor a creation of the entrepreneur, but the emergent result of the collaborative process of discovery and judgment. Instead of things in the mind of an entrepreneur, to be either recognized or created as independent constructs, opportunities in this view are defined as decision alternatives that emerge from a set of collaborative procedures for uncovering and integrating localized knowledge, widely dispersed among potential stakeholders, into coherent mean-ends frameworks from which interdependent paths of value creation may be identified and potentially exploited for mutual benefit among stakeholders.This conceptualization of entrepreneurial opportunity echoes that of Shepherd (2015, 491), who calls for “thinking of a potential opportunity in terms of a process of social interaction (between a community and the entrepreneur) rather than solely as an outcome of thinking (in the mind of the entrepreneur).” In other words, opportunities are endogenous to the process of intersubjective experimentation, selection, and retention that characterizes the market process in general.
This paper places opportunity back in the limelight as a central concept for understanding the causes and effects of entrepreneurship. We argue that this is important for at least three reasons. First, there is the issue of how context affects both motivation and decision analysis behind entrepreneurial actions. Koellinger (2008) argues that examining entrepreneurial behavior involves at least two fundamental questions: (1) What motivates entrepreneurs to choose among alternatives, and (2) where do these decision alternatives come from? Profit motives under uncertainty (i.e., judgment) can, at best, offer only a general answer to the first of these questions, because in complex settings involving nonalgorithmic uncertainty, the very possibilities for ex ante profit cannot be “prestated” (Koppl, Kauffman, Felin, and Longo 2015); characteristics of latent demand and supply are not operational apart from the process by which they are discovered or enacted, and computability limits the effectiveness of policies that presume otherwise (Koppl 2008). In other words, before an entrepreneur can exercise judgment, he or she must hold beliefs in the present about the prospects of profiting from judgment in the future, and both the generation and validation of those prospects in the present is a matter, we argue, of entrepreneurial discovery. Ludwig von Mises (1949 [1996]), who served as one of the primary inspirations for Kirzner’s view, suggested that this role of the entrepreneur as both organizer and evaluator is the “driving force” behind the market process; entrepreneurs both “speculate” on uncertain futures and “promote” specific ways of exploiting prospects for advantage from those speculations (250).
Second, there is the issue of differentials among entrepreneurial strategies (see Hitt, Ireland, and Hoskisson 2013). Entrepreneurial strategies are methods by which decision alternatives are evaluated, selected, and pursued. There is a crucial distinction between these strategies and the conditions that motivate or enable their use, because the strategies’ attributes are contingent on the uncertain unfolding of the market discovery process over time. Not all strategies are equally effective in all contexts; external conditions have much to say about what strategies are effective and under what circumstances. Beliefs about the effectiveness of strategies can be correct or incorrect, and the context of entrepreneurial action, or the opportunity conditions under which it operates, is what ultimately affirms (or not) the correctness of such beliefs. In other words, the existence of opportunity validates not only entrepreneurial beliefs about consumer preferences (ends), but also their beliefs about the best ways to meet those preferences (means).
Finally, there is the issue of differential welfare impacts of entrepreneurial action. Research since Baumol (1990) has confirmed that the entrepreneurial process will produce variability in social welfare outcomes based on the extent to which policies and institutions incentivize value-creating (productive) versus value-dissipating (unproductive) forms of entrepreneurship. More generally, the results of the entrepreneurial process are not confined to the results experienced by individual entrepreneurs; there is a social dimension to entrepreneurial outcomes determined by the character of the institutional capital structure within which they are generated. This social dimension is defined, in part, by the “nexus” (Shane 2003) between the motivations, beliefs, and skills of individual entrepreneurs and the contexts that incentivize and constrain the expression of those motivations, beliefs, and skills. In other words, negative social outcomes do not always come from incorrect beliefs or faulty strategies on the part of entrepreneurs, but often from the limited array of decision alternatives produced by poor institutional contexts.
Simply put, without a meaningful opportunity discovery construct, it is difficult to properly understand the impacts of context, contingency, and institutional capital on entrepreneurial outcomes. This paper represents an attempt to further develop such a meaningful concept, drawing on the work of Kirzner but also on the rich literature that has developed in response to its ambiguous construction and role. The remainder of the paper is organized as follows. First, the role of opportunity in the study of entrepreneurship is surveyed, beginning with Kirzner’s seminal view and proceeding to recent developments. Both Kirzner’s approach and the more recent extensions and modifications of the opportunity construct are critiqued, including those that suggest an outright abandonment of the term. Next, a theory of opportunity development is provided that addresses the major shortcomings of existing versions while retaining their important contextual role, noting similarities to other approaches. Finally, some implications are outlined of this reconceptualization of entrepreneurship as an emergent, collaborative procedure of opportunity discovery and judgment for both strategy research and policy.
THE ROLE OF OPPORTUNITY IN ENTREPRENEURSHIP STUDIES Although the systematic study of the entrepreneur goes at least as far back as Richard Cantillon (1755), Jean-Baptiste Say ([1821] 1880), and John Stuart Mill ([1848] 1871), it was the work of Knight (1921), Schumpeter (1934), and, especially, Kirzner (1973) that did the most to incorporate the theory of the entrepreneur into economic and social analysis. Likewise, although the term opportunity has a long history in both academic and popular works on entrepreneurship, the primary theoretical role it plays in entrepreneurship studies derives from the work of the Austrian school, again most directly from Kirzner (1973). One of the best-known expositions of this view is presented in Kirzner (1979, 62), where he outlines the essential aspects of what he calls “entrepreneurial discovery,” which he describes as the “driving force behind [the] systematic process” of market equilibration.
Kirzner’s entrepreneurial discovery view developed primarily out of the insights of Austrian scholars Mises and F. A. Hayek, who were in turn heavily influenced by the ideas of earlier scholars in the Austrian tradition. From Mises ([1949] 1996) comes the concept of entrepreneurship as a process of action under uncertainty, while Hayek (1945, 1948) contributes the concept of knowledge acquisition as a fundamental aspect of market interactions (Kirzner 1997, 67). As Kirzner explains, Hayek conceived of markets as processes whereby “market participants acquire better mutual information concerning the plans being made by fellow market participants,” while Mises contributed the recognition that “this process is driven by the daring, imaginative, speculative actions of entrepreneurs who see opportunities for pure profit in the conditions of disequilibrium” (Kirzner 1997, 68).
There are two important aspects of the preceding views that come to bear on an examination of the opportunity construct. First, from Hayek, opportunities arise as the result of acquiring “better” information about what market participants intend than was previously possessed, a process that Hayek later described as “discovery” (see, e.g., Hayek 1978). Second, from Mises, it is the entrepreneur that recognizes opportunities and engages in actions designed to exploit them. Kirzner (1997) refers to these aspects as the discovery role and the entrepreneurial role, respectively.Kirzner (1997) also adds a third aspect, the role of rivalry, as a necessary component of equilibrating market processes. Since this paper does not focus on the equilibrating role of the entrepreneur, we do not emphasize this admittedly important concept. Thus, discovery in the Austrian view does not refer to the recognition of opportunities per se, but to the general role of markets as a knowledge acquisition process, from which entrepreneurs learn what opportunities might exist and how to act in order to profit from them. To quote from Hayek (1948, 97), markets and competition exist “to teach us who will serve us well: which grocer or travel agency, which department store or hotel, which doctor or solicitor, we can expect to provide the most satisfactory solution for whatever particular personal problem we may have to face.”The author thanks an anonymous reviewer for highlighting this passage.
The Kirznerian entrepreneur is one who looks for “opportunities for pure entrepreneurial profit created by temporary absence of full adjustment between input and output markets” (1973, 69), whether that absence of adjustment is in the present or the future. Full adjustment of input and output markets requires the absence of surpluses and shortages, but also the lack of profit above the opportunity cost of all resources employed in the process. So, for a forward-looking entrepreneur, the ability to correctly foresee a profit situation requires that he, in some way, be able to discover something that is not reflected in the current pricing of resources and/or consumer goods and services. The entrepreneurial roles of recognition and risk taking require the discovery role of knowledge acquisition. Hayek (1945, 1948) adds the proposition that this knowledge is often of the localized, tacit, and intersubjective type that cannot be uncovered without actions (experiments) that submit various ideas to market tests. The picture of entrepreneurship that emerges is very similar to the creative trial-and-error processes that characterize “constructivist” conceptions of venture development, like those of Buchanan and Vanberg (1991) and Sarasvathy (2001). It also bears resemblance to the role of the financial market speculator in Mises ([1949] 1996).This similarity is examined further in the final section of the paper.
Unfortunately, Kirzner (1973, 1997) illustrates this process by employing a framework that assumes an actual, existing supply and demand for consumer goods and services, thus reducing the entrepreneurial function to one of discovering current market inefficiencies, essentially as an arbitrageur. An important aspect of this characterization, as pointed out by Peter G. Klein (2008), is the lack of investment and, thus, risk taking on the part of the entrepreneur. By contrast, Knight (1921) suggests that only when characteristics of future supply and demand are uncertain will an entrepreneurial investment in current resources be necessary, so that the entrepreneur acts as innovator, speculator, and resource allocator in markets for future goods and services, not merely an arbitrageur of divergent market expectations.
Though Klein acknowledges Kirzner’s purpose in using the arbitrageur as an illustration, stressing the equilibrating aspect of entrepreneurship in the market process, and that Kirzner himself acknowledged the speculative role of entrepreneurship in other works (see, e.g,, Kirzner, 1985, 56), the focus on arbitrage is nonetheless problematic.An anonymous reviewer points out, correctly, Kirzner’s later employment of a multiperiod view emphasizing the psychological component of investment under uncertainty. Chief among the issues is the idea that entrepreneurs are defined by the characteristic of “alertness” to opportunities, that is, that their primary function is to look for situations where yet unrecognized market inefficiencies already exist. Not only does such a function ignore the important role of uncertainty bearing that creating new goods and services entails, but it is also difficult to operationalize apart from the very actions (investments) that create those goods and services. Essentially, we can only see the ex post results of alertness, and that only when risky investments in assets turn out to have been correct.McCaffrey (2014) also questions the suitability of uncertain profit opportunities as a motivating factor for the characteristic of alertness. By contrast, it is problematic to ascribe unsuccessful investments to “lack of alertness” to an opportunity, as there is no direct evidence that an opportunity existed in the first place; nor can one merely substitute the idea of alertness to a “nonopportunity” to explain unsuccessful investments, because the very idea of alertness implies that something exists to be aware of.
Nonetheless, there is a considerable literature in entrepreneurship that derives its emphasis from this framework. Drawing from Kirzner, Shane and Venkataraman (2000, 200) identify opportunity as a key construct in the definition of what entrepreneurs do and what those who examine entrepreneurship study. They define entrepreneurial opportunities as “situations in which new goods, services, raw materials, and organizing methods can be introduced and sold at greater than their costs of production.” Importantly, this definition is noncommittal on the questions of both the nature and sources of entrepreneurial opportunities. The opportunity discovery approach has been employed to fruitfully explore knowledge transfer (Shane 2000), the nature of entrepreneurial searching (Hsieh, Nickerson, and Zenger 2007), venture development in transitional markets (Mainela and Puhakka 2009), the role of transactions costs and property rights (Foss and Foss 2008), the use of intellectual capital (Puhakka 2010), and entrepreneurial networks (Shu, Ren, and Zheng 2018), among numerous other applications.
Management scholars have spent considerable effort trying to better formalize the role of opportunity in the framework of entrepreneurship studies. For example, Sarasvathy, Dew, Velamuri, and Venkataraman (2003) distinguish between three views of entrepreneurial opportunity they identify as allocative, discovery, and creative views. An allocative view of opportunity implies a current misallocation of existing resources; thus, the emphasis is on recognition of discrepancies in current supply and demand, much as illustrated in Kirzner (1997). A discovery view implies that there is one important aspect of a potential market that is undeveloped—i.e., a (latent) demand without a supply or a (latent) supply without a demand. The emphasis in this view of entrepreneurial opportunity is on “discovering” where latent supply or demand exist, such as a service without a provider (latent demand) or a resource without a use (latent supply), and completing the market by implementing the missing piece. Finally, a creation view implies that there is neither a supply nor a demand for the good or service in question; in this case, the entrepreneur creates the opportunity by providing both a new good or service and a new set of means by which the good or service is created.
Sharon A. Alvarez, Jay B. Barney, and Susan L. Young (2010) employ a similar approach in their article on opportunity formation. They also use a threefold categorization scheme, focusing on three philosophical approaches to opportunity: realist, social constructionist, and evolutionary realist. Despite the different nomenclature, their views essentially correspond to those of Sarasvathy et al. (2003), with their realist view corresponding to the recognition view, the constructionist to the creation view, and the evolutionary realist to the discovery view of the latter. Confusingly, they refer to methods of “discovery” as applicable to the realist framework, although their description of realism corresponds closely to that of the allocative view in Sarasvathy, et al., (2003); likewise, they ascribe methods of “creation” to the evolutionary realist framework, although their description of this framework corresponds closely to that of discovery in the latter.
A rich literature has developed around constructivist views linked to the “creation” approach since Alvarez and Barney (2007) proposed the basic dichotomy between creation and discovery, including Alvarez and Barney (2010, 2013), Wood and McKinley (2010), Alvarez, Barney, and Anderson (2013), and Alvarez, Young, and Woolley (2015).Though Alvarez and Barney (2007) are generally credited with the discovery- creation dichotomy, earlier research had identified important aspects of the distinction. See, e.g., Buchanan and Vanberg (1991), Chandler, DeTienne, and Lyon (2003), and Baker and Nelson (2005). The emphasis in each of these extensions is on the idea of “enactment,” rather than discovery, of opportunities; as explained by Wood and McKinley (2018), the “causal influence of the entrepreneur on the opportunity is more strongly highlighted” than in the discovery view (8). The opportunity creation literature has expanded considerably to include the examination of niche construction (Luksha 2008), information technology startups (Ojala 2015), entrepreneurial affect (Goss and Smith 2018), the conditions of uncertainty underlying entrepreneurial actions (Mitchell et al. 2012), and social entrepreneurship (Gonzalez, Husted, and Aigner, 2017). Several studies have also attempted to bridge and/ or reconcile the opportunity discovery and opportunity creation approaches (see, e.g., Zahra 2008; Edelman and Yli-Renko 2010; Martin and Wilson, 2016; and Chetty, Karami, and Martin, 2018).
Although maintaining the importance of opportunity, however, the essence of the creation view still locates it solely in the mind of the entrepreneur. In doing so, this view fails to address the important problems of where entrepreneurial beliefs come from and why entrepreneurs perceive the decision alternatives that they do, particularly those alternatives that ultimately prove successful. The idea that successful entrepreneurship requires some knowledge of future conditions outside the mind of the entrepreneur seems to also require that there be entrepreneurial methods of “discovering” what those conditions are. Thus, at the heart of the dichotomy between creation and discovery are the questions of what ultimately makes entrepreneurial profit seeking successful, and whether it lies entirely within the entrepreneur’s imagination or at least in part in the recognition of external realities that give it credence.
Other extensions of the opportunity literature have attempted to better integrate it with more traditional views in psychology and evolutionary economics, such as the cognition-based approach of “opportunity recognition” (see, e.g., Baron 2004, 2006; Baron and Ensley 2006; and Ozgen and Baron 2007) and the idea of opportunities as “propensities” (Ramoglou and Tsang, 2016, 2017). Baron (2004, A1) proposes opportunity recognition as a form of pattern recognition, the “process through which individuals perceive emergent patterns among seemingly unrelated stimuli or events.” As such, opportunity recognition is a form of discovery informed by theories of human cognition and perception. Similarly, Ramoglou and Tsang (2016, 2017) propose that opportunities are real propensities for a future, emergent state of the world and that entrepreneurs sometimes recognize these propensities and act to bring them to fruition, much as one who recognizes the future plant within a seed must act to bring the plant into being. This evolutionary-realist view of opportunities as propensities is further examined below.
One way to examine the validity and completeness of alternate views of entrepreneurship is to ask how entrepreneurial behavior would be different under the different approaches. For example, consider the distinctions between discovery and creation as illustrated by Sarasvathy et al. (2003) and Alvarez, Barney, and Young (2010). Under the realist approach of Alvarez, Barney, and Young, analogous to Sarasvathy, Dew, Velamuri, and Venkataraman’s allocative view, the entrepreneur acts as the Kirznerian arbitrageur; entrepreneurs seek pure profit by addressing an existing market disequilibrium. Although such a view is plausible in many cases, it does not address the important Knightian roles of risk taking and investment under uncertainty, which characterize ventures to provide future goods and services. By contrast, under Alvarez, Barney, and Young’s constructionist approach, analogous to Sarasvathy et al.’s creation view, individuals develop both the opportunity and the market for it through their actions. They “do not recognize opportunities first and then act; rather, they act, wait for a response—usually from the market—and then they readjust and act again” (Sarasvathy et al. 2003, 30, emphasis mine). The implication is that it is entirely the actions of entrepreneurs that produce an opportunity—no latent market characteristics (demand or opportunity cost) exist independently that can be employed as motivation for actions or justification for beliefs.
However, the idea that entrepreneurs act without either motivation from or beliefs about latent external characteristics does not hold up to logical scrutiny, because it dodges the question of why entrepreneurs act at all. Although it is true that a yet undiscovered objective opportunity cannot serve as its own motivation for discovery, neither can purely subjective perceptions of an opportunity do so. The real question here is one of incentives—why do entrepreneurs believe that there are ex ante profit opportunities available? Do they not expect that, in some objective sense, their actions will result in an expected benefit above the opportunity cost of the action? What is the basis for a belief of this kind, and from where does the feedback that potentially affirms or alters the belief come? Hayek suggests that it comes in the form of information (i.e., revealed preferences) about the subjective perceptions of consumers and resource owners regarding the expected benefits and opportunity costs of future goods and services. In other words, it reflects underlying realities of (latent) supply and demand as revealed by consumers and resource owners. If this were not true, it would be difficult to understand how one could explain market feedback as a test of validity of the entrepreneur’s actions—and, by extension, the validity of the opportunity—because the concept of feedback requires some revelation about preferences not previously obtained by the learner, who is the entrepreneur.This emphasis on the role of the entrepreneur in “discovering” the preferences of the consumer is also explicit in Mises ([1949] 1996).
Taking a different approach, Klein (2008) and Nicolai J. Foss and Klein (2012) introduce the concept of judgment, derived from the work of Knight (1921). Judgment is defined as “decision making when the range of possible future outcomes, let alone the likelihood of individual outcomes, is generally unknown” (Klein 2008, 177). In other words, judgment refers to the choice among alternatives when both the full scope of alternatives and their probabilities are noncomputable. The entrepreneurial function, in this view, is to evaluate decision alternatives for bringing future goods and services into being and, if necessary, make risky investments in assets with the aim of profiting from those evaluations. This approach, although in a younger stage of development, has produced a significant literature of analysis and critique in both management and economics (see, e.g., Sarasvathy and Dew 2013; McCaffrey 2014, 2015; McMullen 2015; Foss and Klein 2015; Godley and Casson 2015; Hallberg 2015; and Foss, Klein, and Bjørnskov 2019).
However, while adequately addressing the evaluation and exploitation of potential opportunities for profit, judgment does not address the motivation for such judgments or the generation of decision alternatives any better than alertness (of objective circumstances) or creation (around purely subjective beliefs) do. The problem centers on an important flaw that is common among constructivist critiques of the opportunity concept: the idea that, since the actual existence of opportunity can never be revealed except where (successful) entrepreneurial action confirms its existence, opportunity itself must be entirely subjective, i.e., it exists only in the mind of the entrepreneur. Klein (2008) states this succinctly when he writes:
Expectations about the future are inherently subjective and, under conditions of uncertainty rather than risk, constitute judgments that are not themselves modelable….[o]pportunities for entrepreneurial gain [and] are, thus, inherently subjective—they do not exist until profits are realized. (180–81, emphasis mine)
Consistent with this line of reasoning, Foss and Klein (2012) propose the alternative judgment-based approach (JBA) focusing on beliefs, actions, and results. Employing this approach, they suggest that the notion of opportunity can only be understood as an ex post construct and that the ex ante correlate is entrepreneurial beliefs, which are translated into actions stemming
from 1) more or less articulated business plans ultimately based on knowledge and beliefs about current conditions and 2) estimates of future profits and losses that result from realizing the business plans. (Foss, Klein, and Bjørnskov 2019, 1204, emphasis mine)
The problem with this and similar characterizations of the subjective nature of opportunities is that they confuse the existence of latent preferences in the marketplace, preferences that can potentially be discovered by entrepreneurs who are motivated to find ways to profit from their own subjective beliefs about those preferences, and the revelation of those preferences, which occurs when entrepreneurs submit their ideas to the market tests that produce feedback about the correspondence of their beliefs to actual circumstances. Although it is true that entrepreneurial beliefs are purely subjective, the feedback entrepreneurs receive from market tests of their ideas is not; it is more correctly considered intersubjective (Sarasvathy and Venkataraman 2011; Venkataraman et al. 2012; Garud and Giullani 2013), because it contains information about the congruence (or lack thereof) between subjective beliefs on the part of the entrepreneur and subjective preferences expressed by market participants. Nicolai J. Foss, Peter G. Klein, and Christian Bjørnskov (2019) implicitly acknowledge the problem when they refer to plans that are “based on knowledge and beliefs about current conditions,” but fail to provide an explanation of how (or why) knowledge of current conditions shapes the motivations for and accuracy of those beliefs without methods of discovery.
Treating opportunities as purely subjective entities ignores the most important aspect of what Kirzner was trying to convey with his entrepreneurial arbitrageur, namely, the systematic search for and recognition of situations, whether temporally located in the present or in the future, where the characteristics of latent supply and demand (i.e., preferences) do not match objective price conditions. These situations are what we refer to as opportunities, and they are revealed when market tests show entrepreneurial beliefs about underlying preferences to be accurate and/or when they provide additional information necessary to adjust entrepreneurial actions to accurately reflect or influence those preferences.Lewin (2015) refers to these intersubjective characteristics of opportunity as shared understandings. Discovery is the process that reveals this information to the entrepreneur.
Another approach, mentioned above, that has recently flourished is the idea of opportunities as propensities (Ramoglou and Tsang 2016, 2017). This approach conceives of opportunities as objective constructs of latent demand or supply but outside the mind or consciousness of the entrepreneur, who “actualizes” them through attempts to match their beliefs about the profitability of future goods and services to data provided via market tests. Opportunities, in this view, are not directly observable but “can be evidenced through their effects,” as Stratos Ramoglou and Eric W. K. Tsang (2016, 412) explain. Their view comes closer to the opportunity discovery view proposed here in allowing for a realist construct for opportunity; in contrast to the constructionist views, they reject opportunity as only existing in the mind of the entrepreneur. However, Ramoglou and Tsang’s actualization approach also rejects a purely empiricist view of opportunity, which they refer to as discovery. Nonetheless, one can take this as a starting point for a reexamination of exactly what discovery and opportunity contribute to the emerging conversation on entrepreneurship.
The two lines of research examined above not only propose to represent the “middle ground” between the discovery and creation approaches described earlier, but also place themselves as correctives or reconstructions of the Kirznerian approach based in Mises and Hayek. Thus, further refinements in the Austrian view of entrepreneurship must take account of their critiques and incorporate their positive developments. We argue here that these critiques, although useful, have nonetheless erred in failing to distinguish between two aspects of subjective judgment that are important to understanding the motivations for and results of entrepreneurial action: the beliefs and aspirations of the entrepreneur and the preferences of the consumers whose wants they intend to fulfill with their business plans. For example, Foss, Klein, and Bjørnskov (2019, 1198) state: “We think that what is often meant when scholars (and practitioners) use the opportunity construct is that entrepreneurs hold certain beliefs concerning what they think they can do with their resources….But, it doesn’t seem natural to call such beliefs, plans or projects ‘opportunities.’” Likewise, Ramoglou and Tsang (2016, 416) reject the “inapt” term discovery as “linguistic malpractice” because it lures us into “inferring that opportunities must exist as actualized entities that can be somehow observed.”
The opportunity discovery approach does not deny that both beliefs and preferences are subjective phenomena—in fact, no “Austrian” view could reasonably do so. The question is not whether they are individually subjective, however, but whether the conditions under which they happen to dovetail are subjective. In other words, does the fact that entrepreneurial outcomes are based, in part, on how well entrepreneurs understand or anticipate actual future conditions mean anything for understanding their beliefs, actions, results? Discovery means that when successful entrepreneurs explore “business plans” and “actualize” those plans into profits there has been recognition of something meaningful about the real world. Therefore, can we not meaningfully describe what they have recognized as a phenomenon (an opportunity) that, in part, framed those plans and shaped the actions by which they succeeded?
Foss, Klein, and Bjørnskov’s (2019) JBA framework concedes that entrepreneurial business plans are ultimately based on knowledge and beliefs about current conditions, but it is unclear from where that knowledge (and the corresponding beliefs) about conditions comes from. As pointed out by Ramoglou and Tsang, “[d]espite the subjectivity of goals, the conditions of their satisfaction lie in the objective conditions of the world” (2016, 417). Using a commonsense definition of opportunity as a set of circumstances that make something (like a goal) possible, or “a favorable juncture of circumstances,”Merriam-Webster, s.v. “opportunity (n.),” accessed June 1, 2020, https://www. merriam-webster.com/dictionary/opportunity. one might argue that correct knowledge about favorable conditions comes from discovery of at least some of those conditions; to argue otherwise would seem to leave “luck” as the only explanation for successful (i.e., profitable) entrepreneurship. Indeed, examinations of the actual processes employed by expert entrepreneurs suggests that they spend a considerable amount of time and effort both uncovering and manipulating the conditions of opportunity via means of effectual reasoning (Sarasvathy 2001).
DISENTANGLING BELIEFS, ACTIONS, AND RESULTS: ENTREPRENEURSHIP AS PRICE DISCOVERY The term discovery is as apt a word as any to describe the process by which entrepreneurs seek to verify the existence of opportunities and fits with the commonsense notion of opportunity as something that exists, in part, due to knowledge of external realities. Along these lines, Jeffrey S. McMullen and Dean A. Shepherd (2006) make a useful distinction between two types of opportunities, third-person and first-person. A third-person opportunity refers to a “potential opportunity for someone in the marketplace” (ibid., 137); entrepreneurs identify these potential opportunities by being attentive, or exhibiting what Kirzner (1973, 1997) refers to as alertness. Third-person opportunities are reflections of both the preferences of the entrepreneur and those of potential stakeholders; they are the basis for actions that may create something more concrete, a first-person opportunity. First-person opportunities can only exist in correspondence with actions on the part of entrepreneurs; they do not, in fact, exist independently of those actions. Tests of validity against “objective reality” (Alvarez, Barney, and Young 2010, 30), therefore, amount to tests of whether first-person (actual) opportunities envisioned by entrepreneurs reflect an underlying reality expressed in their beliefs about third-person (potential) opportunities; equivalently, they are tests of whether preferences revealed by entrepreneurial actions correspond to entrepreneurial beliefs about the existence of those preferences.
Disentangling opportunities into their exogenous, third-person and endogenous, first-person components goes a long way in clarifying the role of opportunity in motivating entrepreneurial action. Third-person opportunities may exist independently of entrepreneurial actions; they can be missed or misperceived; they can be well exploited, imperfectly exploited, or go unexploited; they represent the commonsense notion of opportunity as a set of conditions favorable to action that is value enhancing (i.e., produces benefits in excess of opportunity cost) for some set of stakeholders. They can serve as motivation (incentives) for engaging in actions intended to reveal characteristics of latent supply and demand for goods and services that are not yet in existence. However, first-person opportunities are not revealed independently of entrepreneurial actions; they are contingent upon those actions. They exist only in the sense that actions show them to be valid when entrepreneurs submit their initial and subsequent perceptions of benefit and opportunity cost to market tests. This conforms to the notion of opportunities as conditions of value creation revealed via correct judgments of future preferences.
The third-person/first-person distinction, however, does not go far enough in many ways. It does not address the generation of decision alternatives, nor the tendency (or lack thereof) for those alternatives to match actual preferences. This discovery of intersubjective agreement between entrepreneurial beliefs and consumer preferences, and the subsequent replacement of less correct prices with more correct prices for both resources and goods, is the sine qua non of the Austrian approach to entrepreneurship and is what distinguishes the role of entrepreneurship in the Austrian tradition from its passive role in neoclassical economics and its uncertainty-enhancing role in post-Keynesian approaches (see, e.g., Dempster 1999). The discovery approach of Mises, Hayek, and Kirzner thus conceives of entrepreneurship as an essential error correction procedure within the market process.
Entrepreneurship researchers in management, even some of whom adhere to a constructivist view of entrepreneurship, have recognized the problem with thinking of opportunity in a purely subjective sense. Per Davidsson (2015), though skeptical of the usefulness of the opportunity construct, concedes that opportunity exists in recognizing that subjective perceptions of market disequilibrium (an objective phenomenon) motivate entrepreneurial actions and provide an explanation for their success. Matthew S. Wood and William McKinley (2018), in presenting a case for retaining the opportunity construct as an umbrella concept in entrepreneurship research, argue that the construct is necessary to help researchers distinguish means from ends, to account for feedback from market tests (preference revelation), to avoid ambiguity (between beliefs, judgments, and actions), and to link entrepreneurship to practice, where the notion of opportunities—both successfully exploited and missed—is part of the generally accepted norms of language in entrepreneurship. This discussion supports these conclusions and provides an additional rationale for retaining the opportunity construct, namely, that it correctly describes the situation of congruence between the judgment of decision alternatives and the characteristics of subjective preferences that determine the correctness of those judgments. In this view, opportunities are neither merely “out there,” existing independently of entrepreneurial beliefs and actions, nor are they purely subjective creations in the mind of the entrepreneur. Instead, they refer to conditions under which preference revelation indicates disequilibrium between actual prices of resources and goods and their intersubjective (shared) values.
In this article the concept of discovery is refined as the processing of information into knowledge (Foss, Klein, and Bjørnskov 2019, 1204) that allows entrepreneurs to replace less correct prices with more correct ones based on the revelation of unsatisfied preferences for new goods and services in new markets. In other words, discovery and opportunity coevolve as mutually reinforcing components of the entrepreneurial process. There can be no recognition of opportunity without successful discovery, just as there can be no revelation of opportunity without successful judgment. In this sense, the idea of discovery as the result of alertness to preexisting (objective) opportunities is merely being replaced with a more plausible idea of discovery as a corollary to the emergence of (intersubjective) opportunities. Unlike the former, this view allows not only for the possibility that opportunities are real things, with real properties that correspond to actual states of the world, but also for the possibility that discovery fails to identify an opportunity, either because the characteristics of the opportunity were different from what the entrepreneurs imagined (a missed opportunity) or because there was never an opportunity in the first place (a nonopportunity).On the concept of nonopportunity, see, e.g., Ramoglou and Tsang (2016, 420–21).
The preceding discussion, therefore, highlights four important aspects of opportunity discovery for the study of entrepreneurship: (1) motivations for entrepreneurial actions, (2) generation of decision alternatives, (3) convergence of subjective beliefs and subjective preferences, and (4) welfare impacts of variability in entrepreneurial strategies. We address these aspects by employing a simple model of the entrepreneurial process. The model abstracts from admittedly important elements in the process. Nonetheless, it provides a useful framework for understanding the important differences between subjective and intersubjective phenomena, and the corresponding differences between discovery and judgment that are important for delimiting the role of the opportunity construct. Figure 1 below illustrates the model.
Figure 1. The Entrepreneurial Discovery Process
The entrepreneurial process begins with the subjective phenomena that make up the material for value judgments: the subjective preferences of individuals in the marketplace with respect to benefit and cost, and the beliefs of individuals that might profit from an understanding of those preferences, i.e., potential entrepreneurs. These entrepreneurial beliefs consist of evaluations of what others’ preferences are, what kinds of ventures and strategies might be profitably employed to satisfy those preferences, and what benefits and costs might be earned and incurred as the result of actions to implement such ventures and strategies. Importantly, these beliefs may vary widely in their accuracy concerning any of these things; potential entrepreneurs begin with only an imperfect understanding of preferences, strategies, and consequences. Nonetheless, if entrepreneurial beliefs suggest a value-creating allocation of future resources that differs from the current allocation that might earn an economic profit, the potential entrepreneur may be motivated to engage in a Hayekian discovery procedure, whereby they gather information to validate, modify, or falsify their own beliefs.
It is here that the conceptualization presented in this article differs from the standard Kirznerian view of opportunity discovery. At this point, the most that can be said of the potential entrepreneur is that they possess beliefs and motivation. However, an effectual (Sarasvathy 2001) process of discovery can reveal possibilities of convergence between entrepreneurial beliefs and the subjective preferences of individuals that represent decision alternatives. Among these decision alternatives may be opportunities for profitable actions. The process itself is collaborative, requiring that the entrepreneur interact with the market environment (and the individuals in it), identify and recruit important stakeholders, and learn from both direct and indirect experience to discover whether and how intersubjective convergence of personal beliefs and the realities of preferences might be achieved. If such an intersubjective convergence takes place—itself an uncertain proposition—an opportunity can be said to exist. Thus, opportunities arise as possibilities for profitable action among decision alternatives. Table 1 below illustrates this result.
Table 1. Outcomes of the Discovery Process
As indicated in the table, there are basically four possible outcomes of the entrepreneurial discovery process. One possibility is that the entrepreneur discovers that consumer preferences with respect to the area of investigation are in line with the opportunity costs of resources. In other words, there is no “third-person” opportunity to explore. This is what would most correctly be termed a nonopportunity; it refers to the situation where gains from entrepreneurial action are not expected under correct assumptions about the reality of the external environment, including both actual and latent preferences. A second possibility is that the entrepreneur believes an opportunity exists when it, in fact, does not. This would be an example of mistaken judgment on the part of the entrepreneur. A third possibility is that an opportunity for realignment of preferences with prices is possible but that discovery fails to reveal this to the entrepreneur. This is, quite simply, a missed opportunity. Finally, there is the case where entrepreneurial discovery correctly notices and diagnoses a possibility for realignment; this is where intersubjective convergence of entrepreneurial beliefs and consumer preferences results in a valid opportunity for action. Although this does not guarantee a successful venture—entrepreneurial judgment may still fail to implement the appropriate strategies for successful exploitation—it is nonetheless a precondition for successful judgment. No amount of expert judgment can overcome a lack of intersubjective convergence between consumer preferences and entrepreneurial beliefs.Put differently, if judgment is the ability to “accurately assess, estimate, or infer others’ preferences” (McMullen 2015, 654), then discovery of intersubjective convergence (i.e., opportunity) is a necessary prerequisite for a correct judgment that results in a profitable investment; otherwise, correct judgment will result in no investment action at all.
In this view, there is no reason to assume that either (a) opportunity (convergence) always results from the discovery process or (b) entrepreneurs engaging in discovery always recognize and/or exploit the opportunities that emerge. Opportunities are uncertain; they can fail to emerge, they can emerge and be missed, or they can emerge, be recognized, and still fail to be taken advantage of with the correct entrepreneurial judgments and investments. Thus, Foss and Klein’s (2012) judgment-based approach is not entirely at odds with the view expressed here. Rather, it is more correct to say that the process by which an opportunity is discovered is operationally distinct from the process by which judgments are made. Correct (successful) judgment requires correct (successful) discovery, but discovery itself does not ensure correct judgment. Foss and Klein are correct to emphasize a previously underexplored aspect of the entrepreneurial process but are incorrect in suggesting that discovery is unimportant. The framework presented here incorporates elements of both and may thus be expressed as a discovery-judgment view (DJV). This view of opportunity discovery fits well within the parameters of evolutionary reasoning as well as with notions of pattern recognition emphasized by Baron (2004, 2006). Most importantly, it makes a useful distinction between the information-gathering (discovery) and decision-making (judgment) elements of the entrepreneurial process.
APPLICATIONS OF THE DISCOVERY-JUDGMENT VIEW TO ENTREPRENEURIAL STRATEGY AND POLICY Our view suggests that the motivation for entrepreneurial actions is the possibility of intersubjective convergence between beliefs and preferences in a future goods space. Thus, it indicates a distinction between the conditions of opportunity and the strategies for recognizing and exploiting them. This is at the heart of Mises’s ([1949] 1996, 214) distinction between the capitalist-entrepreneur—the uncertainty-bearing aspect of entrepreneurship emphasized in Knight (1921) and in the JBA framework—and the entrepreneur promoter, who speculates on behalf of the capitalists. This entrepreneur not only speculates about future conditions that may bring about profits, as a pure capitalist might, but also formulates specific plans (strategies) to adjust production to the expected future conditions. Entrepreneurs are more than just risk takers; they are the actors who imagine, explore, and validate decision alternatives regarding future resource allocations.
Strictly speaking, economics does not suggest that consumers want goods and services, per se; what they desire—and are willing to sacrifice for—are the “features” of goods and services. Features are what make up consumer preferences, not goods and services, because it is the advancement of subjective ends like happiness, health, comfort, prestige, contentment, joy, status, power, etc. that individuals are trying to satisfy when they sacrifice resources to obtain goods and services (see, e.g., Gorman 1959, 1980; Lancaster 1966, 1971; and Becker 1965, 1981, 2007). Therefore, the “discovery” aspects of entrepreneurship does not mean discovery of individuals’ demand for iPhones or ride sharing services, but the discovery of preferences that suggest something like an iPhone or a ride sharing service might be demanded at a price above opportunity cost. In other words, discovery does not require that a fully formed idea of a product or service be in the mind of either the entrepreneur or the consumer, only that the entrepreneur be able to gather and process information about consumer preferences and relate it to their own ideas about the use of resources and their opportunity costs. It does not require a demand for any particular thing.In fact, this must be precisely what Ramoglou and Tsang mean by “propensities,” because they are the “seeds” from which a fully formed demand must eventually emerge. Before introducing products like iPhones or ride sharing services into the marketplace, entrepreneurs examine evidence of consumer preference for features of these goods (like the convenience of ride sharing, internet connectivity, or any of the other characteristics that make them desirable), what consumers might be willing to sacrifice for them, and the opportunity costs of including them in the bundle of features that define the good or service. This is what we mean by discovery.
A useful analogy is that of entrepreneurial strategy as an options-producing (or options-writing) process. In finance theory, option writers obligate themselves to future courses of action without the certainty of knowing that those courses of action will turn out to be profitable; they provide options for others to submit as tests of those expectations. The writer obligates himself or herself to a course of action that depends on the subsequent decision of the purchaser of the option to exercise it or not. If conditions turn out to be favorable for exercise, the option writer stands as the counterparty (buyer for the option to sell, seller for the option to buy) to the option holder; if not, the option expires unexercised along with the obligation of the writer. Option writers seek to benefit from future market conditions by receiving more in profit from the sale of options than they incur in costs of obligations.One of the most well-known models of options pricing, the Black-Scholes option pricing model, estimates this value (premium) as a function of five simple features: the price of exercise, the spot price of the underlying asset(s), the expected volatility of the underlying asset price(s), time until exercise, and the risk-free rate of return. One can define entrepreneurial strategy as the options-writing process applied to the creation of new paths of future resource allocation, i.e., the writing of real, as opposed to financial, options. It is, to paraphrase Jean-Baptiste Say, the application of knowledge to a potentially useful purpose (Hebert and Link 1982, 31), and the process that produces this knowledge and its application is the work of entrepreneurial discovery, both within and without existing firms.
The options-writing perspective has implications for our understanding of entrepreneurial strategy. First, the entrepreneurial function can be thought of as encompassing two very different roles, often fulfilled by different actors. The writers of real options comprise the actors who engage in a systematic process designed to explore third-person potential opportunities and examine the first-person characteristics of those opportunities by submitting them to market tests. These are Mises’s ([1949] 1996) entrepreneur promoters; they are what we traditionally think of as the Schumpeterian entrepreneur who searches for new means-ends frameworks, or a new “production function” (Schumpeter 1934). The entrepreneur promoter must also be able to “engineer agreement among all interested parties, such as the inventor of the process, the partner, the capitalist, the supplier of parts and services, the distributor, etc.” (Hirschman 1958, 17).This description suggests a strong affinity with the stakeholder approach of Parmar et al. (2010) and others.
Mises ([1949] 1996) also refers, however, to the risk-taking and judgmental aspects of entrepreneurship fulfilled by those who choose from among various options to bring first-person ventures into existence via funding and expertise. These capitalist-entrepreneurs are the ones who are responsible for making the crucial decisions that direct resources toward specific ventures—and, by extension, not toward others. This aspect of the entrepreneurial process refers to the outcome of trial-and-error market tests intended to evaluate third-person opportunities for first-person significance, as well as the associated asset-specific investments necessary to materialize the chosen options. David A. Harper (1996, 34) refers to this part of the process as the “internal architecture of a business enterprise [that] affects the acceptance and rejection of entrepreneurial hypotheses and enterprising activity.” Just as financial options purchasers give actual existence to an options contract by agreeing to include it their portfolios, capitalist-entrepreneurs attempt to actualize opportunities by expending resources (financial, intellectual, and social capital) to bring them to fruition.This underscores the importance of a well-functioning financial system directing resources and expertise to the most valuable ventures (Dempster 2015).
Notice that in the analogy of the options process to the entrepreneurial process, the entrepreneur promoter takes the role of the options writer, while the capitalist-entrepreneur takes the role of the option purchaser. Mises ([1949] 1996, 215) realized that these two roles are often entangled because we use one term, entrepreneur, to express both aspects of the entrepreneurial process. Therefore, the tension between Schumpeterian innovation and Kirznerian price discovery is the result of linguistic confusion over what aspect of the entrepreneurial process is being emphasized. This paper has argued that the tension between creation and discovery is, in part, the result of this same confusion. The very term entrepreneur is an umbrella concept that describes several functions of innovation, promotion, and risk taking (Hebert and Link 1982) that evolve within the same process.
Further, it is not necessary that the entrepreneurial roles implied by the options analogy refer to distinct parties. Entrepreneur promoters, unlike financial option writers, typically devise and arrange contracts that allow them to direct resources contingently toward the developing ends and to share in the upside potential of the future resource allocation paths they identify.An exception would be those who search for opportunities with the intent of selling them to others. Likewise, unlike financial option holders, capitalist-entrepreneurs often take an active role in the development of the market tests that identify potential opportunities. This view of the dual nature of entrepreneurial strategy—the direction of attention and decision alternative generation by entrepreneur promoters, and the direction of resources and risk taking by capitalist-entrepreneurs—allows us to build a conceptual bridge between the subjective, speculative nature of entrepreneurial search and the objective, concrete nature of entrepreneurial action. It is, thus, a description of Sarasvathy and Venkataraman’s (2011, 125–27) notion of intersubjectivity as the concept that links the identification of market problems with their solutions via a coherent, directed process of knowledge integration and informational synthesis.
The view presented in this article also provides a more stable framework for exploring and understanding the public policy implications of variability in the institutional contexts of entrepreneurial action. Baumol (1990) and subsequent work (see, e.g., Acemoglu, Johnson, and Robinson 2001; Boettke and Coyne 2009; Sobel, Clark, and Lee 2007; Sobel 2008; and Dempster and Isaacs 2017) emphasize the importance of institutions for determining the social welfare consequences of entrepreneurial action. In short, institutions incentivize differences in entrepreneurial strategies that may be either welfare enhancing or welfare reducing from a societal standpoint. Entrepreneurs choose strategies for exploiting perceived opportunities based on their estimates of private benefit and cost, which may or may not reflect social benefit-cost ratios. Thus, it is possible that entrepreneurial discovery could result in decision alternatives that anticipate private net benefits while also resulting in net social welfare losses. Simple examples include perceived opportunities exploited via corruption, political reallocation of resources, or the establishment of monopolistic barriers to entry. In maintaining the central position of opportunity in the analysis of entrepreneurial action, the view presented here provides a framework for examining variability in the social welfare impacts of alternative decision strategies that other approaches which have jettisoned the theory of opportunity discovery will tend to obscure.
CONCLUSIONS The concept of entrepreneurial opportunity has undergone a period of useful critique and refinement since Venkataraman (1997) and Shane and Venkataraman (2000) first employed the term as one of the defining features of entrepreneurship studies. This article has incorporated much of the research in this area over the past two decades to formulate a novel Austrian reinterpretation of this concept as an intersubjective phenomenon that emerges from the entrepreneurial process of discovery and judgment. This view recognizes the inherent problems with the traditional Kirznerian portrayal of discovery as a matter of alertness or attentiveness to preexisting conditions and instead conceives of entrepreneurship as a price discovery procedure for the emergence of future goods, services, and resources within an evolutionary realist framework. In this framework, entrepreneurial motivations and actions are reflections of the expectation of actual, but yet-to-be-revealed, conditions here described as opportunities, and the process by which these expectations are formed and validated is described as discovery. Discovery is, thus, distinct from judgment, as it describes the process that allows judgment to be exercised, i.e., it is an antecedent to judgment. This view retains the importance of the anticipation of intersubjective agreement between entrepreneurial beliefs and consumer preferences as the sine qua non of the Austrian view of entrepreneurship while jettisoning problematic descriptions of opportunity discovery as the result of superior attentiveness to the preexisting conditions of supply and demand.
Abstract: As employees are increasingly recognized as an important source of ideas and inspiration, contemporary leadership research finds that the central task of leaders is to empower employees to realize their skills and talents to achieve an organizations’ visions and goals. Drawing on this leadership premise, this study develops the concept of entrepreneurial empowerment (EE). EE has structural and psychological dimensions that empower employees to utilize their knowledge to solve the internal Hayekian knowledge problem. EE introduces an endogenous discovery process in which entrepreneurial leaders play a central role in empowering employees to use their localized knowledge. This entrepreneurial discovery process offers opportunities to adapt and innovate using the knowledge experiences of employees. This study underscores that a venture’s success is not tied to an entrepreneur’s inspirational ideas (or, more broadly, their asymmetric knowledge experiences), but to their ability to inspire ideas from all levels of their business hierarchy.
JEL Classification: B53, M12, M54 Desmond Ng (dng@tamu.edu) is associate professor of agribusiness and strategy management at Texas A&M University. The author would like to thank the special guest editor, Professor Bylund, and the two anonymous reviewers for their constructive comments and suggestions.
“No company, small or large, can win over the long run without energized employees who believe in the mission and understand how to achieve it.” – Jack Welch, General Electric
To succeed in an increasingly complex and changing market environment, ventures can no longer compete on the basis of their leader’s capabilities, knowledge, talents, and vision alone (e.g., Cowen and Parker 1997; Foss, Foss, and Klein 2007; Rigtering, Weitzel, and Muehlfeld 2019). Ideas to develop new products and services can come from anywhere, from loyal customers, blog spheres, supply chain partners, social media, and above all employees (Rigtering, Weitzel, and Muehlfeld 2019). For instance, 3M established a culture in which employees are encouraged to develop “home-grown” solutions to addressing their customers’ needs. These homegrown solutions transformed a small-scale mining venture into a leading material sciences company and have earned the company a spot on Fast Company’s Best Workplace for Innovators list (Rubinson 2009; FastCo Works 2019). Companies such as 3M underscore that in order to succeed entrepreneurs must be able to adapt to ideas that extend beyond their own (e.g., Lee, Lee, and Pennings 2001; Rigtering, Weitzel, and Muehlfeld, 2019; Sarasvathy 2001). Adaptation promotes an integration of different knowledge experiences that enables the venture to respond to changing market conditions and opportunities not previously considered (e.g., Hargadon and Sutton 1997; Sarasvathy 2001; Sullivan and Marvel 2011). Hence, although successful ventures are commonly attributed to an entrepreneur’s ideas, talents, and vision (e.g., Witt 1998, 1999), entrepreneurs today face increasing demands to adapt their ideas to the knowledge experiences of others (see Cowen and Parker 1997; Rigtering, Weitzel, and Muehlfeld 2019; Sarasvathy 2001).
Although the role of Austrian economics in contemporary entrepreneurship research remains a subject of much discussion and debate (Klein and Bylund 2014), Austrian economics is particularly suited to addressing the challenges faced by today’s entrepreneurs. According to the subjective tenets of Austrian economics, entrepreneurs operate in a sea of subjective experiences in which they adapt by mobilizing these knowledge experiences to address opportunities not currently met by the market. This adaption has been widely understood as the Hayekian knowledge problem: the problem of how to utilize knowledge experiences that are broadly distributed among the productive members of society. F. A. Hayek (1945) argued that the productive members of society, such as employees, have a knowledge of the “particular circumstances of time and place” (521). This knowledge involves an employee’s particular understandings of the special circumstances, challenges, and local conditions of their job. Hayek (1945) argued that a single mind, such as that of a centrally planner, cannot offer an adaptation that can utilize this “knowledge of particular circumstance of time and place,” because this knowledge is highly localized to an employees’ experiences. He instead argued that employees are in the best position to utilize this knowledge because their understandings of the special circumstances of their job offered employees or “arbitrageurs” (522) opportunities to exploit local price differentials not known by others. This arbitrage function was later formalized by Israel M. Kirzner’s (1979, 2009, 2019) concept of the alert entrepreneur. Alertness involves discovering price arbitrage opportunities by bringing into use factors of productions at a price less than their valued uses. Specifically, as employees are key factors of a firm’s production, alertness solves the Hayekian knowledge problem, because the alert entrepreneur is incentivized to bring into use their employee’s knowledge to discover the price arbitrage opportunities of the market.
Although Kirzner (1979) has been credited with solving the Hayekian knowledge problem (Elert and Henrekson 2019; Foss and Klein 2016), the concept of alertness implicitly assumes that an employee’s knowledge can be centralized under an entrepreneur’s leadership. This leadership involves a position of authority in which the entrepreneur has the power to institute their vision over their employees (Shamir, House, and Arthur, 1993; Witt, 1998). In this position, however, an entrepreneur cannot readily identify their employees’ knowledge, because the entrepreneur’s authority is removed from their employees’ day-to-day experiences. This is consistent with Hayek (1945), who argued that employees are best suited to making decisions on how to allocate their time, resources, and efforts in dealing with their daily operational challenges because employees are most familiar with the circumstances facing them in carrying out their tasks. Hence, the challenge facing the entrepreneur is that their inability to centralize their employees’ knowledge introduces an internal Hayekian knowledge problem (see also Elert and Henrekson 2019; Foss 1997; Foss, Foss, and Klein 2007) of: how an entrepreneur in a position of authority can utilize the different knowledge experiences of their employees when employees are in the best position to know their valued contributions?
This study’s objective is to develop a concept of “Entrepreneurial Empowerment” (EE) to address this internal Hayekian knowledge problem. Leadership research has widely recognized that employees are an important source of ideas and inspirations (Argyris 1998, Foss, Foss, and Klein 2007; Gagne and Edward 2005; Govindarajan and Srikanth 2013; Lee and Koh 2001; Lee, Willis, and Tian 2018; Rigtering, Weitzel, and Muehlfeld 2019). The task of the leader, then, is to empower employees to realize their skills and talents to achieve the organization’s mission and goals (Argyris 1998; Cowen and Parker 1997; Foss, Foss, and Klein 2007; Lee and Koh 2001; Lee, Willis, and Tian 2018). Drawing on this leadership premise, this article develops the concept of entrepreneurial empowerment (EE). EE involves a leadership task of organizing a firm’s internal decision-making process in which employees are delegated a decision-making authority that advances the entrepreneur’s mission. Specifically, EE has structural and psychological dimensions that empower employees to utilize their knowledge of particular circumstances of time and place to solve the internal Hayekian knowledge problem. By solving this problem, EE offers opportunities for the entrepreneurial leader to adapt to and innovate using the knowledge experiences of their employees in ways that cannot be achieved through centralized direction. Propositions surrounding this EE concept are offered. One major contribution of the concept of EE is that the entrepreneurial leader offers an internal organization that empowers employees to solve an internal Hayekian knowledge problem and thus advances an entrepreneur’s mission or goals. As result, this study offers a theory of internal organization that opens up the “black box” of Austrian economics (Foss and Klein, 2012 70).
I. UNITS OF ANALYSIS, DEFINITIONS AND ASSUMPTIONS Before developing this study’s conceptual model, it is important to outline its definitions, assumptions, and units of analysis. According to leadership research, empowerment is defined by an “increased individual motivation at work through the delegation of authority to the lowest level in an organization where a competent decision can be made” (Seibert, Silver, and Randolph 2004, 332). As entrepreneurs often hold positions of leadership, an entrepreneur’s leadership involves the power to delegate authority to the lower levels of their decision hierarchy (e.g., Cowen and Parker 1996; Foss, Foss, and Klein 2007; Shamir, House, and Arthur 1993; Witt 1998). In addition, this leadership also involves an ability to motivate and shape employees’ behavior and attitudes (Ashford and Sitkin 2019; Shamir, House, and Arthur 1993; Witt 1998), as well as empowering the psychological states or intrinsic motivations of their employees (Lee and Koh 2001; Lee, Willis, and Tian 2018). With these distinctions, entrepreneurial leadership is defined by structural and psychological dimensions that involve empowering employees through a delegation of authority to all levels of the decision hierarchy and an ability to appeal to employees’ intrinsic motivations. This definition assumes that employees’ empowerment is “influenced or caused” by an entrepreneur’s leadership. This assumption is consistent with Lee and Koh (2001), in which empowerment is understood as the “behavior of a supervisor who empowers his/her subordinates” (685). With this assumption, the unit of analysis is focused on the structural and psychological relationships that exist between the entrepreneurial leader and their employees (Lee and Koh 2001). Specifically, this study focuses on the leadership of senior members and not supervisory managers, because leadership studies find that hierarchically organized businesses are subject to social learning processes in which a leader’s actions can have a “cascading effect” that impacts the lowest-level employees of their decision hierarchy (Liu, Liao, and Loi 2012; Shamir, House and Arthur 1993; Witt 1998).
Empowerment and Hayek’s Libertarian View of Markets
Although the concept of empowerment is commonly explained in terms of a leadership function (e.g., Lee and Koh 2001, Spreitzer 2008), empowerment also shares a similar political economic orientation to the libertarian tenets of F. A. Hayek (1945, 1952). As in Hayek (1945), empowerment is a political exercise that rejects the “politics in command” of centrally planned/socialist economies (Mohanty 1995, 1434). Empowerment involves granting freedom and equality by transferring power from an upper level agency, such as a central planner or authority, to people below (Mohanty 1995). This empowerment involves affirming an individual’s freedoms by strengthening their capacity for self-governance, autonomy and self-determination and is an important economic and political goal of Western societies (Mohanty 1995). Similarly, Hayek’s notion of “true libertarianism” is founded on a political economic philosophy that celebrates the benefits of individual choice and freedom. This libertarianism appeals to the collective powers of a decentralized decision-making process, as Hayek (1952) shows:
many of the greatest things man has achieved are not the result of consciously directed thought, and still less the product of deliberately coordinated effort of many individuals, but of a process in which the individual plays a part which he can never fully understand. They are greater than any individual precisely because they result from the combination of knowledge more extensive than single mind can master. (84)
Although empowerment shares a similar political-economic orientation to Hayek’s true libertarianism, their motivations for rejecting the powers of a central authority differ. Empowerment rejects the “politics in command,” because of the corruptive tendencies of government (Mohanty 1995). Hayek’s true libertarianism (1945) rejects central planning on grounds of its limited ability to process decentralized information (see also Klein 1996). Hayek (1945) argued that the allocation of societal resources requires centralizing dispersed knowledge experiences that cannot be fully known by a central authority. This dispersed knowledge is held by the “man on the spot,” consisting of workers or employees. Each employee has a knowledge of the particular “circumstances of time and place,” or more simply put, knowledge of the particulars. This knowledge consists of the particular work challenges and local work conditions faced by an employee. For instance, a real estate employee’s ability to develop their clientele is dependent on their unique understandings of the amenities in a neighborhood (i.e., quality of schools, relative affluence of homeowners, crime rates, general history of the neighborhood, etc.). The man on the spot/employee is better suited to utilizing this knowledge of the particulars than a centrally planned actor, because the man on the spot is most familiar with the unique circumstances of their job (Hayek 1945). As a result, Hayek (1945) argued that the chief economic problem is not concerned with how a central planner can allocate the scarce resources of society, but rather a knowledge problem “of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know” (520).
II. ALERT ENTREPRENEURSHIP AND A SOLUTION TO HAYEK’S KNOWLEDGE PROBLEM In sharing Hayek’s (1945) commitments to freedom and liberty, Kirzner’s (1979) concept of alertness offered a mechanism key to solving the Hayekian knowledge problem (Foss and Klein 2016). Alertness is defined as “an attitude of receptiveness to available, but hitherto overlooked, opportunities” (Yu 2001, 51). This receptiveness involves a psychological predisposition for discovering price arbitrage opportunities not seen by others (Kirzner 1979). Alertness involves discovering price arbitrage opportunities where the entrepreneur assembles their factors of production at a price that is less than the prices received from the sale of their products / services; however, it does not entail a deliberate search (Kirzner 1979, 2019; Yu 2001). Deliberate search involves a commitment of resources (Kirzner 2019) in which the “agents already know enough of the territory that they know what kind of information they want and where to acquire such information” (Yu 2001 51). Yet Tony Fu-Lai Yu (2001) argued that agents search because they are dissatisfied with their current information. This dissatisfaction motivates a search for better knowledge involving the asymmetric knowledge experiences of the entrepreneur (Shane and Venkataraman 2001, Yu 2001). As employees’ knowledge of the particulars are distributed across an organization’s factors of production, an entrepreneur has an asymmetric knowledge that enables the entrepreneur to assemble these distributed experiences at a total price or cost that is less than their value uses (i.e., prices of the products or services received). Specifically, the task facing the alert entrepreneur is to draw on their asymmetric knowledge experiences in discovering those wage rates that will not only incentivize employees to utilize their knowledge of the particulars, but to also discover a wage rate that is less than the prices of their sold products or services. Hence, through this alert discovery of arbitrage opportunities, the entrepreneur engages in a nondeliberate search in which employees’ knowledge of the particulars is brought into use by the price system to solve the Hayekian knowledge problem.
Internal Hayekian Knowledge Problem
Yet in spite of Kirzner’s (1979) contributions to solving the Hayekian knowledge problem, the entrepreneur faces a distinct “internal Hayekian knowledge problem” (Elert and Henrekson 2019; Foss 1997). This internal Hayekian knowledge problem involves a use of knowledge in which employees’ knowledge of the particulars cannot be centralized under the direction of an entrepreneur’s authority (see also Cowen and Parker 1997; Elert and Henrekson 2019; Shane 2000). According to Hayek (1945), employees’ knowledge of the particulars cannot be centralized because this centralization requires aggregating an employee’s knowledge of the particulars in which differences in their local work conditions and special circumstances would be abstracted away. Due to the distributed nature of an employee’s knowledge of the particulars, this knowledge thereby cannot be conveyed to a central authority (Hayek 1945, 524). Since entrepreneurs are also tasked with allocating their firm’s factors of production (e.g., Klein 1996; Bylund 2016), this inability to centralize their employee’s knowledge of the particulars renders the entrepreneur unable to allocate their factors of production—employees—to their most valued uses. As result, unlike the traditional Hayekian knowledge problem, the internal Hayekian knowledge problem raises a distinct firm-level problem, because the challenges surrounding the centralization of a firm’s distributed knowledge impact a firm’s internal allocation of resources.
The internal Hayekian knowledge problem is closely tied to Ludwig von Mises’s economic calculation problem, and both can be used to elaborate on this firm-level distinction. According to Mises, a firm is tasked with an economic calculation problem of allocating a firm’s resources or factors of production that would satisfy the needs of its consumers (Foss and Klein 2010; Klein 1996). This allocation requires that the entrepreneur understand current factor prices as well as the anticipated prices of consumer goods sold (Foss and Klein 2010). An understanding of these current factor prices is critical, because in the absence of these factor prices, the entrepreneur cannot allocate their factor inputs into meeting the firm’s consumer needs (Klein 1996). Mises has used this economic calculation problem to challenge centrally planned governments, because the absence of property rights over factors of production limits a firm’s ability to discover the prices of their factor inputs (Klein 1996). In the absence of these factor prices, socialistic and, more generally speaking, centralized planned organizations, cannot offer an allocation of capital that solves the economic calculation problem (Bylund 2016; Klein 1996; Foss and Klein 2010). The internal Hayekian knowledge problem parallels the criticisms raised by Mises’s economic calculation problem. According to Hayek (1945), the distributed nature of an employee’s knowledge renders such knowledge unable to be aggregated into a price statistic (Hayek 1945). In the absence of these internal prices, an employee’s knowledge of particulars cannot be coordinated into discovering an allocation of resources that will meet the needs of the firm’s customers. As a result, like Mises, the internal Hayekian problem underscores that centrally planned organizations face limits in their ability to solve the economic calculation problem.
III. ENTREPRENEURIAL JUDGMENT To address limits in a firm’s central authority, an entrepreneur’s judgment has been offered as a response to Mises’s economic calculation problem (Bylund 2016; Klein 1996). Judgment refers “to the process of businesspeople forming estimates of future events in situations in which the relevant probability distributions are themselves unknown” (Foss, Foss, and Klein 2007, 1896). For instance, judgment can involve the formation of a business plan in which factor inputs are identified and coordinated with the purpose of earning future rents or profits (Foss, Foss, and Klein 2007). This judgment occurs by giving the entrepreneur ownership over the use of a firm’s factor inputs (Foss, Foss, and Klein 2007; Foss and Klein, 2010). According to Mises’s economic calculation problem, ownership over factor inputs creates an entrepreneurial incentive to reveal their prices such that factors of production can be allocated in ways that satisfy future needs or demand expectations (Klein 1996). This is because factor prices are influenced by the varied uses of an input, which gives owners of capital a strong incentive to reveal their factor input’s valued uses (see also Bylund 2016; Klein 1996). The challenge, however, is that these valued uses are known only by members who have an intimate or particular understanding of a factor’s varied uses (Hayek 1945). Hence, judgment suggests that owners of capital have a strong incentive to encourage their employees to utilize their knowledge of particulars to addressing their firm’s economic calculation problem (see also Klein and Foss 2010; Klein 1996). This is consistent with Per Bylund (2016), who noted, “the only basis for making decisions and attempting to identify room for improvement is entrepreneurial judgment: there are no market prices to guide the entrepreneur” (110). This judgment suggests that through ownership the entrepreneur exerts control over the firm’s internal allocation of resources that is distinct from those resource allocations determined by market prices (e.g., Foss, Foss, and Klein 2007).
Theory of the Firm: An Austrian Judgment Perspective
To understand this internal allocation, R. H. Coase’s theory of the firm is instructive to Austrian explanations of judgment (see also Bylund 2020; Klein and Foss 2010).In that, while Kirznerian (1979) and Hayekian (1945) explanations would argue that market prices would incentivize employees to utilize their knowledge of the particulars, Coase (1937) had long recognized that there is a transaction cost in determining these relevant prices. Coase (1937) argued that if there are no transaction costs, an employee’s knowledge can be readily coordinated through a series of market-based exchanges. These contractual exchanges would do away with the need to transmit any knowledge to a central authority, and thus an organization—as defined by Coase (1937) an authority would cease to exist. The fact, however, remains that authority exchanges exist in all types of organizations, including entrepreneurial ones. The existence of these exchanges suggests that the price system is not a sufficient mechanism to incentivize the use of knowledge within an organization (see also Elert and Henrekson 2019; Shane 2000). This is particularly the case when considering an employee’s knowledge of the particulars, because such knowledge is tacitly known to the employee. With this tacitness, external prices cannot readily reveal the valued uses of an employee’s knowledge of particulars (see also Bylund 2016; Foss and Klein 2010), because there is a transaction cost in organizing this tacit knowledge through a market-based exchange. Thus, according to a Coasian explanation, a firm’s existence can be attributed to an entrepreneur’s judgment because judgment offers an alternative to market prices in allocating a firm’s internal resources (Bylund 2016, 2020).
For instance, Bylund (2020) draws on a Coasian argument to explain a firm’s existence. Bylund (2020) attributes a firm’s existence to the entrepreneur/manager’s ability to “actively directs factors of production instead of the price mechanism” (10). Through an entrepreneur/manager’s authority, external market exchanges are internalized in the firm, avoiding the transaction costs of the market (Bylund 2020). These transaction or marketing costs involve costs in determining factor prices and organizing factor inputs. Bylund (2020) argues that a firm exists when the entrepreneur/ manager directs an internal allocation of resources that avoids these marketing costs. Yet, due to limits in bounded rationality, an entrepreneur/manager’s internal allocation of resources is subject to diminishing returns. These diminishing returns limit an entrepreneur/manager’s ability to replicate the resource allocations of the market. Hence, Bylund (2020) argues that a firm’s existence depends on developing an internal allocation that not only avoids marketing costs (MktgCost) but also avoids the relative inefficiency of an entrepreneur/manager’s internal allocation (As) to a market efficient allocation (Ae).According to Bylund (2020), a firm’s existence is explained by a simple rearrangement of his terms where Mktg Cost > Ae−As. By drawing on this marginal analysis, Bylund (2020)It should also be noted that Bylund’s (2020) work is based on an interpretation of Coase’s original insights. This work involves formulizing Coase’s theory and this formulization should not be conflated with Coase’s original or seminal contributions. An alternative to Coase’s theory is offered by Bylund (2016) also argues that the entrepreneur/manager can increase the size of their firm’s operation when their internal allocation of resources (As) exceeds the difference between the market efficient allocation (Ae) of resources and the market costs associated with this allocation (MktgCost).
Although Bylund (2020) does not directly examine the role of entrepreneurial judgements, an entrepreneur’s judgement is implicit in its explanations (see Bylund 2016). Since the entrepreneur/manager plays a “directive” role in the firm’s internal allocation of resources (Bylund 2020), an entrepreneur’s judgments surrounding the prices of factor inputs can offer an internal allocation of resources (As) that avoids Bylund’s (2020) marketing costs. For instance, since an entrepreneur’s judgment encourages employees to utilize their knowledge of the particulars (see also Foss, Foss, and Klein 2007), such knowledge offers an internal allocation of resources that is not readily known through external market prices. This judgment thereby offers an internal allocation (As) that avoids marketing costs and thus impacts a firm’s reason to exist. Furthermore, since an entrepreneur’s judgment is also subject to limits in bounded rationality, there are diminishing returns to an entrepreneur’s judgments. Such diminishing returns can reduce the efficiency of an entrepreneur’s internal allocation of resources (As) and thus impact the boundary conditions described in Bylund’s (2020) marginal analysis.
Entrepreneurial Judgment and a Firm’s Internal Organization
Although the concept of judgment offers important insights for explaining a firm’s existence and boundaries (e.g., Bylund 2016, 2020), Foss, Foss, and Klein’s (2007) theory of economic organization argues that an entrepreneur’s judgment can also impact a firm’s internal organization. According to Foss, Foss, and Klein. (2007), judgment involves a leadership role in which a firm’s human and capital assets are organized under the direction and control of the entrepreneur. This internal organization involves judgments surrounding the design of a firm’s formal and informal communication structures and system of rewards that would secure the control and support of a firm’s employees (Cowen and Parker 1997; Foss, Foss, and Klein 2007; Rigtering, Weitzel, and Muehlfeld 2019). This internal organization has been historically described by an authoritarian decision-making structure in which the entrepreneurial leader has direct control and influence over their employees’ behaviors (Bylund 2020; Coase 1937; Cowen and Parker 1997). Yet, due to the increasing complexity of markets, modern organizations face increasing pressures to organize this internal decision-making structure in ways that best respond to these external changes (Cowen and Parker 1997; Foss, Foss, and Klein 2007; Rigtering, Weitzel, and Muehlfeld 2019). This internal organization involves delegating a leader’s decision-making authority to all levels of the firm’s decision-making hierarchy (see also Cowen and Parker 1997; Foss, Foss, and Klein 2007; Rigtering et al 2019).
In response to this decentralization of decision tasks, Foss, Foss, and Klein (2007) argue that an entrepreneur’s leadership role involves organizing the firm’s decision-making authority such that employees are engaged in a “derived judgment” that acts on behalf of the entrepreneur’s original judgments (see also Cowen and Parker 1997; Rigtering, Weitzel, and Muehlfeld 2019; Witt, 1998, 1999). An entrepreneur’s original judgment, or simply judgment, refers to the “formation and execution of a business idea” (Foss, Foss, and Klein 2007, 1896), such as a firm’s mission or goals. A derived judgment involves “utiliz[ing] the knowledge best known to” the employee (Foss, Foss, and Klein 2007, 1894) in responding “to new circumstances or situations that may be unknown to the employer.” (Foss, Foss, and Klein 2007, 1894). These derived judgments draw on the employee’s knowledge to develop “productive” activities that advance an entrepreneur’s mission or judgment (Foss, Foss, and Klein 2007; see also Rigtering, Weitzel, and Muehlfeld 2019). Yet since this derived judgment is predicated on giving employees greater discretionary powers, employees can also draw on their knowledge to advance their personal goals (Foss, Foss, and Klein 2007). An employee’s derived judgment can thereby result in “unproductive” activities that undermine the entrepreneur’s mission or judgment (Foss, Foss, and Klein 2007). Hence, the challenge surrounding an entrepreneur’s judgment is in organizing a decision-making structure in which employees utilize their knowledge to serve the entrepreneur’s judgment and not their own (see also Cowen and Parker 1997; Witt, 1998).
For instance, Ulrich Witt’s (1998, 1999) concept of entrepreneurial leadership reflects this type of judgment. According to Witt (1998), entrepreneurial leadership involves a judgment surrounding an entrepreneur’s “imaginations” about the future prospects of a firm’s business concept or mission. Such imaginations or judgments are realized by inducing the support of the firm’s employees (Witt 1998). As in Foss, Foss, and Klein (2007), this support operates within a decentralized organizational setting. With this decentralization, there are limits on a leader’s bounded rationality that preclude the leader from directly controlling and influencing their employees’ behavior. Witt (1998) argues that this decentralization requires a leadership that appeals to the social and psychological aspects of a firm’s internal organization (Witt 1998). The social aspects of a firm’s internal organization involve instituting a social consensus among employees in order to realize an entrepreneur’s imaginations. In addition, while financial renumeration is important to inducing the support of employees, Witt (1998) argues that leadership must also appeal to an employee’s psychological motivations. This may involve relating an entrepreneur’s imaginations to an employee’s personal values. Hence, according to Witt (1998), judgments involve a leadership role of instituting a social and psychological decision-making process that seeks the support of employees. Such judgments are central to an entrepreneur’s leadership, because they allow the entrepreneurial leader to utilize their employees’ decentralized knowledge experiences in fulfilling the entrepreneur’s imaginations or judgments (see also Cowen and Parker, 1997).
IV. ENTREPRENEURIAL EMPOWERMENT Yet although the organization of a firm’s decentralized experiences is implicit to the internal Hayekian knowledge problem, an entrepreneur’s leadership role in empowering employees to address this knowledge problem remains largely undeveloped in theories of economic organization (Cowen and Parker 1997; Foss, Foss, and Klein 2007; Witt 1998). A concept of entrepreneurial empowerment (EE) is proposed. EE appeals to a judgment in which the decision task of the entrepreneurial leader is to institute “structural and psychological” forms of empowerment that encourage employees to draw on their knowledge of the particulars to realize an entrepreneur’s mission or judgment. Specifically, since judgment involves an ownership stake, the entrepreneurial leader is defined as an individual who has an ownership stake in their business and/or holds a senior leadership position in the organization (i.e., CEO). With this ownership stake, the entrepreneurial leader has the incentive and decision-making power to institute structural and psychological forms of empowerment practices on their employees (see also Cowen and Parker 1997; Witt 1998).
With this characterization of the entrepreneurial leader, EE approaches the internal Hayek knowledge problem not by viewing the entrepreneur as a central planner, but as a collaborator who cultivates a greater sense of autonomy in their employees. In particular, although giving employees greater decision-making autonomy can offer a means to utilize their knowledge of the particulars (e.g., Foss, Foss, and Klein 2007), this decentralization is only a partial solution. As Hayek (1945) described,
We must solve it by some form of decentralization. But this answers only part of our problem. We need decentralization because only thus can we ensure that the knowledge of the particular circumstances of time and place will be promptly used. But the “man on the spot” cannot decide solely on the basis of his limited but intimate knowledge of the facts of his immediate surroundings. There still remains the problem of communicating to him such further information as he needs to fit his decisions into the whole pattern of changes of the larger economic system. (524–25; author’s emphasis)
In response to this form of decentralization (see also Cowen and Parker 1997; Foss, Foss, and Klein 2007; Rigtering, Weitzel, and Muehlfeld 2019), EE offers a structural and psychological source of empowerment that addresses the “communicative” and “man on the spot” requirements of Hayek’s decentralization. Structural empowerment consists of the communicative systems of a firm’s internal organization. This communication involves the provision of “opportunities, information and support” that empower employees to realize their latent skills and experiences (Spreitzer 2008, 55). Psychological empowerment involves an appeal to the “man on the spot’s” intrinsic motivations. These intrinsic motivations involve cultivating a psychological state “in which an individual wishes and feels able to shape his or her work role and context” (Spreitzer 1995, 1444).
The structural and psychological components of EE, it is argued, solve the internal Hayekian knowledge problem by empowering employees to utilize their knowledge of the particulars in addressing the unique or circumstantial challenges of their job tasks. Yet, as employee can utilize their knowledge for their own benefit (Foss, Foss, and Klein 2007), the solution to the internal Hayekian knowledge problem also requires that the entrepreneurial leader empower employees to utilize their knowledge of particulars in ways that realize an entrepreneur’s mission or judgment. In addition to examining the individual components of the EE concepts—structural empowerment and psychological empowerment—this study argues that an examination of their joint impact can empower employees to utilize their knowledge of the particulars to advance an entrepreneur’s mission or judgment. In this fashion, the concept of EE offers a distinct firm-level solution to the internal Hayekian problem. To develop this argument, each of the structural and psychological components of the EE concept are first examined.
Structural Empowerment (SE)
Based on a social structural perspective, structural empowerment (SE) is defined by a “sharing power (i.e., formal authority or control over organizational resources (Conger and Kanungo 1988)) through the delegation of responsibility throughout the organizational chain of command” (Spreitzer 2008, 55). To institute this redistribution of authority, structural empowerment (SE) consists of practices that make efforts to develop in employees a greater: 1) autonomy to develop goals, a system of rewards, work procedures, and responsibilities in regard to employees’ assigned job tasks, 2) transparency of information where strategic goals and direction are communicated in ways relevant to their job performance, and 3) training practices that build their knowledge, skill, and ability to perform their assigned job tasks well (Spreitzer 2008).
The goal of the empowered entrepreneur is to develop SE practices that provide employees with the “opportunity, information, support, and resources” (Spreitzer 2008 55) to fully realize their latent skills and experiences in addressing the changing circumstances of their job (Spreitzer 2008). An entrepreneur can provide opportunities by developing resource forums and centers that promote the sharing of ideas among employees (Hargadon and Sutton 1997). For instance, in their study of the product design firm IDEO, Hargadon and Suttons (1997) pointed out that IDEO created a resource forum that pooled the design solutions used in previous projects. Engineers could draw on this pool to solve the current problems they faced in their job tasks. Entrepreneurs can also provide financial support to promote the development of new product ideas. Companies such as Google have provided millions in seed capital to help commercialize products developed by their project teams (Gagne and Deci 2013). Lastly, the entrepreneur can promote a sharing of information, for example through their organization’s policies on risk taking. Jeff Bezos and Elon Musk recognize that their organizations’ success rests on a policy that failure is a necessary part of the innovation process. This policy of failure can promote greater risk taking in employees and thus promote a greater willingness to experiment with new ideas (Henao-Zapata and Peirὀ 2018).
By providing employees with such opportunities, information, and support, SE practices offer an important communicative structure that demonstrates an entrepreneur’s commitment to an employee’s autonomy (see also Argyris 1998). Leaders need to communicate to their employees that they have made a personal commitment to empowering them (see also Argyris 1998; Bendahan et al. 2015). Developing this commitment is important, because leaders can engage in empowerment practices with politically correct motivations and not with a genuine commitment in promoting the autonomy of their employees (Argyris 1998). A communicative structure involving the provision of opportunities, information, and support signals a leader’s commitment to empowering their employees and thus assures employees that their leader’s empowerment efforts are genuine.
Exhibiting this genuine commitment, this communicative structure increases an employee’s willingness to exploit their knowledge of the particulars in that it reduces an employee’s fear that the use of their knowledge of the particulars will threaten the power and authority of the entrepreneur. For instance, studies find that leaders face difficulties giving up their positions of authority (Argyris 1998; Bendahan et al. 2015). This difficulty arises, because authority offers leaders the power to influence their subordinates in ways that advance a leader’s self-interest (Bendahan et al. 2015; Lubit 2002; Schyns and Schilling 2013). Hence, by providing employees the opportunities, information, and support to more fully utilize their knowledge, an entrepreneur not only demonstrates a clear commitment to relinquishing their control over their employees but also places trust in employees to utilize their knowledge of the particulars to advance their job task. This commitment as a result reduces the entrepreneur’s potential for retaliatory action and reduces an employee’s fear that utilizing their knowledge of particulars will threaten the entrepreneur’s authority (e.g. Bendahan et al. 2015; Lubit 2002; Schyns and Schilling 2013). This is consistent with empowerment studies that find that employees are hesitant to engage in greater decision-making autonomy because they fear the repercussions this may have for a leader’s authority (Spreitzer 1996). Therefore, in order to empower employees, their leaders must give their commitment to this, because in its absence employees do not want to be held accountable for decisions that are not supported by their leaders. SE offers a communicative structure that alleviates such concerns, because the provision of opportunities, information and support signals an entrepreneur’s commitment to empowering employees to make decisions.
Proposition 1: SE involving the provision of opportunities, information, and support positively influences an employee to utilize their knowledge of the particulars in their job tasks.
Psychological Empowerment (PE)
Unlike the communicative aspects of SE, PE appeals to an empowerment that is experienced by the employees themselves (see also Spreitzer 2008). Psychological empowerment (PE) is defined as a “psychological state of a subordinate [i.e., employee] perceiving four dimensions of meaningfulness, competence self-determination and impact, which is affected by empowering behaviours of the supervisor [i.e., entrepreneur]” (Lee and Koh 2001, 686). Each of these psychological states is described as follows:
Meaning involves a fit between the needs of one’s work role and one’s beliefs, values and behaviours….Competence refers to self-efficacy specific to one’s work, or a belief in one’s capability to perform work activities with skill….Self-determination is a sense of choice in initiating and regulating one’s actions….It reflects a sense of autonomy or choice over the initiation and continuation of work behaviour and processes (e.g., making decisions about work methods, pace, and effort). Impact is the degree to which one can influence strategic, administrative, or operating outcomes at work. (Spreitzer 2008, 57)
Studies have found that meaning, competence, self-determination, and impact increase an employer’s ability to achieve the objectives and challenges of their job (Lee and Koh 2001; Spreitzer 2008). For instance, an employee who finds meaning in their job develops greater motivation in fulfilling the requirements of their job (Henao-Zapata and Peirὀ 2018). Furthermore, competence or self-efficacy has been associated with improvements in an employee’s productivity (Henao-Zapata and Peirὀ 2018; Spreitzer 1996, 2008). Self-determination in which the employee takes on greater personal responsibilities in defining their job goals has been found to improve an employee’s goal achievement (Eva et al. 2019, Henao-Zapata and Peirὀ 2018; Spreitzer 1996, 2008). Lastly, impact has been found to increase an employee’s feelings of control over the workplace and promotes a greater commitment to pursuing organizational goals (Spreitzer 2008).
Since leadership is central to the empowerment of employees (Argyris 1998; Lee and 2001; Spreitzer 2008), the goal of the entrepreneur is to PE an employees’ sense of meaning, competence, self-determination, and impact in their jobs. This PE involves developing a vision that provides a sense of meaning and purpose to employees. For instance, Truett Cathy, the founder of the immensely successful Chick-fil-A restaurants, developed a vision based on Christian principles in which the glorification of God involved the provision of “second to none” service to his customers. This vision deeply resonated with the personal beliefs of his employees, and this greater sense of meaning and purpose has resulted in a commitment to service that is unrivalled in the food industry (Kruse 2015; Petrone 2014). An entrepreneur can promote self-determination by offering their employees the freedom to explore their personal talents and skills. Companies such as 3M and Google allow their employees to use up to 15 percent of their time to pursue projects of their own choice (Govindarajan and Srinivas 2013). Empowerment studies find that this self-determination can increase an employee’s sense of competence that they have the skills and experiences necessary to complete their jobs (Spreitzer 2008). Lastly, entrepreneurs who believe that their products and services have an impact on society can encourage their employees to develop job tasks in realizing such impacts. For instance, Toyota has made a commitment to producing cars that meet its environmental sustainability goals. To realize such goals, Toyota’s engineering specialists developed a solvent to clean the robots used in painting vehicle bumpers. The use of hazardous chemicals and water was significantly reduced as well as the number of defective bumpers.See https://www.toyota.com/usa/environment/.
By engaging in such forms of PE, entrepreneurs will not only develop a greater sense of meaning, competence, self-determination, and impact in their employees, but employees will also be more likely to utilize their knowledge of the particulars in ways not recognized by Hayek (1945). Hayek (1945) writes that “every individual has some advantage over all others in that he possesses unique information of which beneficial use might be made, but of which use can be made only if the decisions depending on it are left to him or are made with his active cooperation” (521–22). Austrians (Cowen and Parker 1997; Hayek 1945; Kirzner 1979, Foss, Foss, and Klein 2007) would argue that an extrinsic reward system would incentivize employees to engage in this active cooperation, to utilize their knowledge of the particulars. Yet various studies find that financial or extrinsic rewards (i.e., wage rates) can undermine an individual’s intrinsic motivation (Argyris 1998; Judge et al. 2010; Kuvaas et al. 2017; Ryan and Deci 2000). Judge et al. (2010, 158) explains
that extrinsic rewards are ultimately demotivating and dissatisfying to individuals. Because they have a negative effect on intrinsic interest in a task or job, extrinsic motivations tend to undermine perceived autonomy…. Moreover, goals for financial success have been argued to undermine well-being, because these goals represent a controlled orientation that interferes with the fulfillment of more enduring needs such as self-acceptance or affiliation.
Since PE involves an appeal to an employee’s intrinsic motivations, the use of financial, or extrinsic, rewards cannot psychologically motivate an employee to utilize their knowledge of the particulars. The reason is that financial rewards incentivize employees on the basis of achieving performance goals set by their supervisors and not on the basis of goals that advance their personal long-term growth (Judge et al. 2010). Stated differently, extrinsic, financial rewards only incentivize employees to take on initiatives when financial rewards are increased (Argyris 1998; Judge et al. 2010) and thus tend to undermine an individual’s autonomy to fulfill their high-order needs. In contrast to financial rewards, studies have shown that intrinsic motivations are positively related to greater levels of employee persistence and proactiveness (Judge et al. 2010; Kuvaas et al. 2017) and a greater ability to internalize the specific conditions of their work climate (Gagne and Deci 2005). These findings suggest that a PE employee will utilize their knowledge of the particulars in their job task because this knowledge offers them a greater sense of control in their work and the ability to proactively shape their tasks. This increased autonomy allows them to perform their jobs in ways that advance their personal goals and identities. Hence, PE increases an employee’s use of their knowledge of the particulars by empowering them to realize their higher-order or self-actualizing needs in ways that cannot be realized by the extrinsic financial rewards of Hayek (1945; see also Spreitzer 2008).
Proposition 2: a PE involving the development of a sense of meaning, competence, self-determination, and impact increases employees’ intrinsic motivation to utilize their knowledge of the particulars in their job tasks.
V. DECENTRALIZATION BENEFITS OF ENTREPRENEURIAL EMPOWERMENT By utilizing an employee’s knowledge of the particulars, SE and PE not only offer a means to solve the internal Hayekian knowledge problem, but also offer opportunities to exploit the benefits of decentralization. Austrian economists recognize that decentralization introduces intrafirm learning opportunities that increase an organization’s ability to adapt to and innovate in changing market conditions (Elert and Henrekson 2019; Foss, Foss, and Klein 2007; Henao-Zapata and Peirὀ 2018; Rigtering, Weitzel, and Muehlfeld 2019). These benefits of decentralization stem from the greater autonomy given to an organization’s subunits to engage in local problem-solving behaviors (Cowen and Parker 1997; Kollman, Miller, and Page 2000; Richardson et al. 2002; Rigtering, Weitzel, and Muehlfeld 2019). For instance, by offering employees greater autonomy in their decision-making, employees can draw on their day to day operational experiences to adapt to the problems faced in their job tasks. Furthermore, this greater autonomy comes with a lower resistance to change and thus increases employees’ freedom to pursue new ideas and innovations (Henao-Zapata and Peirὀ 2018; Rigtering, Weitzel, and Muehlfeld 2019). Hence, as structural and psychological empowerment offer employees a greater decision autonomy, these different forms of empowerment enable employees to exploit the adaptive and innovative benefits of decentralization.
Yet since the task of the entrepreneurial leader is to empower employees in ways that realize the entrepreneur’s mission or judgment, the structural and psychological components of EE cannot individually accomplish this leadership task. This is because the structural and psychological components operate at different levels of analysis in which neither considers the influences of the other (Siebert, Silver, and Randolph 2004). Empowerment studies have argued that a joint consideration of these components is needed because a firm’s internal communication structure has been shown to influence an employee psychological motivations (Siebert, Silver, and Randolph 2004). In the context of entrepreneurial leadership, a leader who jointly leverages the structural and psychological components of the EE concept not only empowers their employees to exploit the adaptive and innovative benefits of decentralization but can also empower employees to utilize their knowledge of particulars to advance an entrepreneur’s judgment or mission.
Bounded Autonomy
To explain this aspect of entrepreneurial leadership, EE exploits the adaptive benefits of decentralization by leveraging the relationship between a firm’s “bounded autonomy” and an employee’s “self-determination” (Siebert, Silver, and Randolph 2004; Spreitzer 2008). Bounded autonomy refers to the structural empowerment aspects of EE and is defined by “organizational structures and practices that encourage autonomous action, including the development of a clear vision, and clarity regarding goals, work procedures, and areas of responsibility” (Seibert, Silver, and Randolph 2004, 333; see also Spreitzer 1996). In the Austrian economics literature, this bounded autonomy has been described as a “nested hierarchy” (Foss, Foss, and Klein 2007, 1897) or “polyarchy” (Cowen and Parker 1997, 59). Common to these descriptions is that the firm is organized around a number of decentralized/partly autonomous units, each of which is delegated a decision authority that operates within the context and constraints of a greater decision-making authority (Cowen and Parker 1997; Foss, Foss, and Klein 2007; Witt 1998).
Although a firm’s bounded autonomy is organized in a fashion similar to other studies or economic organization (Cowen and Parker 1997; Foss, Foss, and Klein 2007; Rigtering, Weitzel, and Muehlfeld 2019; Witt, 1998), this study adds that the depth / width of this bounded autonomy is influenced by limits in entrepreneurs’ judgment. Due to limits on bounded rationality, transaction cost explanations would argue that an entrepreneur’s judgment faces increasing costs in coordinating an increasing specialization of tasks within its decision hierarchy. The depth of an organization’s bounded autonomy is influenced by the extent to which these specialized tasks can be vertically integrated within the bounded autonomy (see also Bylund, 2016). With limits on an entrepreneur’s judgement, entrepreneurial leaders face increasing difficulties in understanding the specialized decisions made by lower or deeper members of its decision hierarchy because these employees’ tasks are highly specialized to the unique circumstances and challenges of their local work environment. As result, an entrepreneur’s efforts to institute a bounded autonomy are subject to diminishing returns that limit the depth of specialized activities that can be integrated into this bounded autonomy. Furthermore, limits in an entrepreneur’s judgment also impact the width or scope of activities in a firm’s bounded autonomy. The width or scope of a bounded autonomy consists of the diversity of specialized activities in a firm’s decision hierarchy. Bylund (2016) argues that this diversity of specialized activities can exhibit interdependencies or synergies that are difficult for the entrepreneur to know. The width of scope of these experimented activities is thus limited by an entrepreneur’s ability to discover the interdependencies or synergies among them. Hence, as an entrepreneur’s EE is impacted by their judgment, an entrepreneur’s efforts to institute a bounded autonomy are subject to cognitive limitations that restrict the depth / width of this bounded autonomy.
By recognizing such limits in an entrepreneur’s structural empowerment efforts, a bounded autonomy is distinct from other decentralized forms of organization, such as Oliver E. Williamson’s (1975) M-form organizational structure. Williamson’s (1975) M-form organization emphasizes a highly diversified knowledge structure in which units are unrelated to the activities of others. With this autonomy, employees in each unit compete against others for corporate funds. While such competition offers a means to replicate the external market process, unit goals are prioritized over corporate goals (Cowen and Parker 1997). In contrast, the units in a bounded autonomy are guided and directed by the limits of an entrepreneur’s judgment. In order to conserve an entrepreneur’s bounded rationality, the entrepreneurial leader institutes a bounded autonomy in which the depth and width of unit activities are limited to those activities that are related to an entrepreneur’s mission or judgment. Hence, consistent with Cowen and Parker (1997), limits in an entrepreneur’s judgment result in a bounded autonomy in which the depth /width of a unit’s activities exhibit a coherence or relatedness that is absent from Williamson’s M-form structure.
Bounded Autonomy and Self-Determination
Under a bounded autonomy, employees engage in a self-determination that exploits the adaptive benefits of decentralization in ways consistent with an entrepreneur’s mission or judgment. Specifically, bounded autonomy reduces the ambiguities surrounding the expectations and scope of an employee’s decision-making authority (Spreitzer 1996). This reduction of ambiguity is important, because “if people do not know the extent of their authority and what is expected of them, they will hesitate to act (i.e. lack of self-determination) and thus feel unable to make a difference (i.e. lack impact)” (Spreitzer 1996, 487). This reduction of ambiguity offers employees a clear delineation of their decision-making authority, promoting a greater sense of self-determination that avoids the resistance to change typically found in organizational bureaucracies (Spreitzer 1996) by giving employees greater authority to draw on their knowledge of the particulars to address the challenges and expectations of their jobs. Studies find that such self-determination can increase an employee’s resiliency in their decision-making and promote a greater resourcefulness to seek local resources and experiences (Henao-Zapata and Peirὀ 2018; Spreitzer 1996). This resiliency and resourcefulness suggest that employees will draw on their knowledge of the particulars to gain an intimate understanding of their local work conditions. This localized understanding in turn increases an employee’s ability to adapt to the changing circumstances of their job. Unlike the unproductive behaviours described by Foss et al. (2007), an employee’s self-determination is constrained by a firm’s bounded autonomy. That is, a bounded autonomy offers a clear delineation of an employee’s delegated decision-making authority in which their self-determination is limited to their local conditions.
For instance, the joint influences of bounded autonomy and self-determination can be explained in terms of Koch Industries’ “market-based management” strategy (Cowen and Parker 1996; see also Klein 1996). This management strategy involves communicating the corporate mission to each business unit and delegating a decision-making authority to each unit in support of this corporate mission. This delegated decision-making offers a type of “bounded autonomy” in which units are given discretion to determine unit-level missions that guide their employees to make daily decisions that support the corporate mission (Cowen and Parker 1997). With respect to the self-determinative aspects of psychological empowerment, Koch’s market-based management also involves adopting a matrix management structure in which employees report to the senior managers of different units. With this matrix management, employees are “ultimately accountable to the consumer of the firm’s products and to the firm’s mission rather than to some specific individual known as a “boss” (Cowen and Parker 1997, 50–51). While we cannot directly assess the psychological aspects of an employee’s self-determination, Koch’s matrix structure offers a means for employees to assert their self-determination in responding to the needs of the firm’s customers. Furthermore, Koch Industries also offers compensation that rewards employees for developing products and services that advance the firm’s mission. These resources provide opportunities that affirm an employee’s self-determination. As a result, by jointly leveraging the bounded autonomous and self-determinative aspects of EE, these empowerment practices enable employees to exploit the adaptive benefits of decentralization in ways that also advance the entrepreneur’s mission or judgment (see also Cowen and Parker 1997).
Proposition 3: entrepreneurial empowerment involving a SE practice of bounded autonomy positively influences an employee’s PE by developing a self-determination that adapts to an entrepreneur’s mission or judgments.
Broad Sharing of Information and Competence
In addition, EE offers a structural and psychological empowerment that exploits the decentralized benefits of innovation. Specifically, a SE policy involving a broad sharing of information can psychologically empower employees to institute new ideas in their job tasks by promoting a sense of competence. This broad sharing of information involves sharing an organization’s strategy to all members of its decision hierarchy (Spreitzer 1996). For instance, Kellogg’s CEO, Carlos Gutierrez, instituted a value-added strategy that differentiated Kellogg’s products from an increasingly competitive cereal market. Mr. Gutierrez was successful in implementing this value-added strategy, because he was able to relate this differentiation strategy to the specific job demands and goals of every employee in his organization (Boyle 2004). Empowerment studies find that this broad sharing of information increases an employee’s sense of meaning and purpose, because employees can see the “big picture” and gain a better understanding of how their job fits within their organization’s broader vision or mission (Siebert, Silver, and Randolph 2004; Spreitzer 1996). Furthermore, studies find that this greater sense of meaning and purpose can increase an employee’s feelings of competence (Gagne and Deci 2005; Siebert, Silver, and Randolph 2004; Spreitzer 1996). This competence is important to instituting new ideas and innovations, because it increases employees’ perception that their implemented ideas will succeed and will have a meaningful impact on their organization’s future goals (Gagne and Deci 2005; Henao-Zapata and Peirὀ 2018; Seibert et al. 2004).
As entrepreneurs are often admired for their vision, an EE involving a broad sharing of information psychologically empowers an employee’s competence to engage in innovations that realize this vision. Specifically, a broad sharing of an entrepreneur’s vision offers employees a greater context in which to understand how their knowledge of the particulars can help realize an entrepreneur’s vision. This communication is important, because an employee who fails to understand how their knowledge of the particulars fits within the entrepreneur’s vision can create coordination problems (Witt 1998). Each employee will seek to utilize their knowledge of the particulars without considering their impact on others. As a result, such autonomous decision-making introduces conflicts in implementing innovations that would realize an entrepreneur’s vision (see also Foss, Foss, and Klein 2007). In order to avoid such conflicts, employees must develop a shared understanding of the entrepreneur’s vision (Spreitzer 1996; Witt 1998). This shared understanding is consistent with the communicative aspects of Hayek’s (1945) decentralization which posits that an employee’s knowledge of the particulars need to be understood within the context of a larger information system (see also Witt 1998). However, since Hayek (1945) relies on the price system to communicate the goals of this larger system, he does not consider those communication systems that appeal to an employee’s intrinsic motivations. EE addresses this shortcoming. An EE involving the broad sharing of an entrepreneur’s vision with all members of their organization (such as Gutierrez’s strategy at Kellogg’s), psychologically empowers an employee’s feeling of competence. This empowerment occurs, because a shared understanding aligns an employee’s knowledge of the particulars with their entrepreneur’s vision (Witt 1998) and thus increases an employee’s feelings of competence—that their knowledge of the particulars can have an impact in realizing the entrepreneur’s vision. This competence energizes an employee’s creativity to utilize their knowledge of particulars to develop new ideas in their jobs.
For instance, 3M started a new product that started with a complaint in their customer care division. The employee sought a solution by conducting his own research and then recontacted the customer to see if the solution was a suitable remedy (Rubinson 2009). This is consistent with studies’ finding that empowered employees tend to engage in greater creativity and innovation (Gagne and Deci 2005; Henao-Zapata and Peirὀ 2018; Kuvaas et al. 2017; Zhang and Bartol 2010). However, unlike these studies, which focus on the psychological aspects of empowerment, this study argues that a broad sharing of entrepreneur’s visions empowers employees competence to utilize their knowledge of the particulars to discover novel solutions that would realize an entrepreneur’s vision. This is consistent with J. P. C. Rigtering, G. U. Weitzel, and K. Muehlfeld (2019), who argue that lower-level managers and employees draw on their domain-specific knowledge to implement new business ideas. Hence, they argue, the task of corporate leaders is to “contextually frame” these lower-level innovative efforts to align with the corporate vision. This study argues that a SE practice of broad information sharing and its influence on an employee’s competence can contribute to a contextual framing in which the entrepreneur is able to exploit the decentralized benefits of innovation.
Proposition 4: entrepreneurial empowerment involving a SE practice of broad information sharing positively influences an employee’s PE by developing their competence to innovate in activities that advance an entrepreneur’s mission or judgment.
DISCUSSIONS AND CONCLUSIONS As entrepreneurs’ success is often attributed to their ability to identify unnoticed market opportunities, the discovery of opportunities within a firm’s internal organization remains largely underexamined in Austrian economics and mainstream entrepreneurship research (see Alvarez, Barney, and Anderson 2013). Yet leadership research has widely recognized that employees are central to an organization’s success and thus the task of a leader is to empower their employees to realize this success. This distinction was recognized earlier by Chester I. Barnard’s (1938) seminal work on leadership. He argued that the quintessential task of a leader is to communicate and empower a common purpose to their employees. A concept of entrepreneurial empowerment has been developed in which opportunities for employee empowerment are used to solve an internal Hayekian knowledge problem. In this solution to the internal Hayekian problem, the entrepreneur’s task as a leader is to structurally and psychological empower their employees in order to unleash their latent potential. EE’s structural and psychological dimensions motivate employees to use their knowledge of the particulars to discover the adaptive and innovative benefits of decentralization. EE has three implications for Austrian economics and entrepreneurship research.
First, according to Austrian economic explanations, adaptation and innovation are largely explained in terms of market-level processes. As result, an organization’s adaptive and innovative processes remain generally understood as a “black box” (Kirzner 2019). EE offers a direction for Austrian economists to “open” up this black box in which a venture’s ability to adapt and innovate is attributed to the structural and psychological aspects of the EE concept. EE introduces an adaptive and innovative process that is endogenous to an employee’s knowledge of the particulars. This endogenous process underscores that although the success of a venture is widely attributed to its entrepreneur’s inspirational ideas, a venture’s success can also come from those involved in executing these ideas. This is because employees have the most familiar understandings of the challenges surrounding the implementation of their leader’s ideas. More broadly speaking, this knowledge of the particulars offers employees a unique position to adapt and innovate activities that reconcile the challenges of their job tasks with the ideas and goals of the entrepreneur. The utilization of this knowledge opens up the black box of Austrian entrepreneurship, in which an organization’s adaptation and innovation is explained by a decentralized process that cannot be centralized by an entrepreneur’s leadership (see also Shane 2000).
More fundamentally, EE’s utilization of an employee’s knowledge of the particulars offers a decentralization that appeals to Mises’s open-ended view of entrepreneurship (Salerno 1993). By solving the internal Hayekian problem, EE offers an economic calculation in which the employee’s knowledge of the particulars is used in determining an allocation of internal resources that meets the needs of a firm’s consumers. Since consumer needs will continually evolve, EE’s solution to the internal Hayekian problem offers an economic calculation that evolves with the changing needs of the consumer. Consistent with Mises, EE will result in an economic calculation in which this changing allocation of internal resources may not converge toward an equilibrium outcome (see also Salerno 1993). EE thereby offers an alternative to alert explanations of the market process.
Second and relatedly, since the concept of EE has a distinctly proactive orientation, EE introduces a “deliberateness” not found in alert entrepreneurial explanations (Kirzner 2019). Unlike with Kirzner (2019), the structural and psychological dimensions of EE involve a search that requires a deliberate commitment of an entrepreneur’s time and efforts. Structural empowerment requires that the entrepreneur institute practices that provide employees the opportunity, information and support to realize their latent potential. As these policies involve redistributing the power in an organization’s hierarchy, supervisory members of this hierarchy are likely to resist such policies, because they undermine their position of power and influence (Argyris 1998; Bendahan et al. 2015). Hence, an entrepreneur who institutes such SE policies is likely to expend considerable time and effort in overcoming this resistance.A reviewer has noted that once an entrepreneur has instituted such structural and psychological forms of empowerment this resistance to change will not likely persist. That is, the ultimate goal of EE is to empower employees to act in accordance to an entrepreneur’s mission or judgment. Hence little resistance by employees will be expected once the individual and joint efforts of EE are instituted by the entrepreneur. With this commitment of effort, EE introduces a deliberateness that is particularly relevant to addressing recent debates surrounding an entrepreneur’s claims to the wealth creation process. For instance, a NY representative, Alexandria Ocasio-Cortez, argued that wealthy business owners did not deserve their wealth because they “sat on couches, while thousands were paid modern day slave wages.” EE argues that due to the commitment of resources required by the structural and psychological empowerment process, entrepreneurs have a direct claim to such wealth. Stated differently, EE argues for a Friedman system of ethics (see also Bylund 2019, Kirzner 2019) that justifies an entrepreneur’s wealth on the basis that they have contributed resources in empowering their factors of production (i.e., employees). Hence unlike Kirzner’s (2019) rejection of Friedman’s system of ethics, EE argues that entrepreneurs have a legitimate moral claim to the wealth creation process, because this wealth creation is based on an entrepreneur developing a deliberate relationship to their factors of productions (see also Bylund 2016).
Third and lastly, the concept of EE offers a type of judgment that is important to explaining a firm’s internal organization. EE appeals to a judgment that is not principally concerned with developing an internal allocation of resources that reduces the transactions cost of the market. Instead, EE appeals to a judgment in which the task of the entrepreneurial leader is to organize a firm’s internal decision-making structure in which employees utilize their knowledge of particulars to advance their entrepreneur’s judgment. In addition, entrepreneurs are often viewed as visionary leaders. But entrepreneurs have a leadership responsibility to not only articulate a compelling vision to their employees, but also to empower their employees to realize this vision. The concept of EE offers a type of judgement in realizing entrepreneurial visions. This judgment involves efforts to organize a firm’s internal communication structure and to provide appropriate psychological motivations that empower employees to realize their entrepreneur’s vision. The implication of this wealth creation process is that EE favors a more creative explanation of entrepreneurial opportunities (Alvarez and Busenitz 2001) in which opportunities are brought into existence by the empowerment efforts of the entrepreneur. EE, however, does not imply a rejection of the price arbitrage opportunities of alert entrepreneurship, because alert entrepreneurship and EE are concerned with solving different knowledge problems. EE emphasizes a distinctly firm-level approach to solving the internal Hayekian problem. This firm-level approach argues that an employee’s inherent potential cannot be fully realized by the external price system. In contrast, alertness emphasizes the discovery of price arbitrage opportunities at the market level and therefore relies on prices that cannot reveal an employee’s latent potential. An important direction for Austrian economics research is to examine both forms of entrepreneurship, because they address different aspects of the entrepreneurial discovery process.
Abstract: We highlight the important role that time plays in conceptualizations of opportunity in entrepreneurship research. Through two longitudinal case studies, we introduce a more dynamic understanding of opportunities than portrayed by current theorizing, which tends to emphasize “opportunity discovery.” By adopting a dynamic temporal perspective, we integrate Kirzner’s and Mises’s approaches to entrepreneurial action to generate novel insights about how entrepreneurs view opportunities as initial opportunity beliefs, how these beliefs change over time, and how these changes help inform scholarly research of opportunities. We argue that taking the role of time into consideration opens up new questions related to opportunity and the dynamics of its development.
JEL Classification: B53, D80, L26 Alexander McKelvie (mckelvie@syr.edu) is professor of entrepreneurship in the Department of Entrepreneurship ∧ Emerging Enterprises and associate dean at the Whitman School of Management at Syracuse University.
Johan Wiklund (jwiklund@syr.edu) is the Al Berg Chair in Entrepreneurship at the Department of Entrepreneurship and Emerging Enterprises at the Whitman School of Management at Syracuse University. He is the current editor-in-chief at Entrepreneurship Theory and Practice.
Jeffery S. McMullen (mcmullej@indiana.edu) is the David H. Jacobs Chair in Strategic Entrepreneurship at the Kelley School of Business, Indiana University. He is the current editor-in-chief of the Journal of Business Venturing and researches entrepreneurship as a process of self-discovery and socioeconomic change.
Almantas P. Palubinskas (apalubin@syr.edu) is a PhD candidate and an Institute for an Entrepreneurial Society fellow at the Whitman School of Management at Syracuse University.
INTRODUCTION The pursuit of opportunities continues to be a central component of entrepreneurship research (Shane and Venkataraman 2000; McMullen and Kier 2016; McMullen and Shepherd 2006; Scheaf et al. 2019) despite its increasingly controversial role (Davidsson 2015; Foss and Klein 2018; Wood 2017). Entrepreneurial opportunities are “those situations in which new goods, services, raw materials or organizing methods can be offered and sold at more than their costs of production” (Shane and Venkataraman 2000, 220). Important in this definition is the notion that there is some correspondence between the willingness of the market to pay a certain price and the ability of the entrepreneur to provide a good or service at a certain cost. Such correspondence can be challenging if a considerable amount of time passes between the entrepreneur’s inspiration, ideation, and implementation such that the situation inspiring the entrepreneur to generate an idea and convince various stakeholders to support its implementation no longer characterizes the entrepreneur’s environment by the time implementation is complete.
The simple fact that it takes time to introduce a new good or service and that conditions may change in the meantime is often overlooked by opportunity-based entrepreneurship research. Instead, research into opportunities has historically adopted a static view of opportunities (Dimov 2011; McMullen and Dimov 2013; Scheaf et al. 2019), possibly because research on the topic has been primarily conceptual and focused on opportunity discovery as the stimulus for entrepreneurial action, while the relatively little empirical work has emphasized the discovery and evaluation of opportunities as opposed to their development. As a result, opportunities have been called “theoretically exciting but empirically elusive” (Dimov 2011, 57). Yet there have been scholars who have called for greater examination of the relationship between time and opportunity. For instance, Jeremy C. Short and colleagues (2010) suggested that researchers “must understand the temporal dynamics of opportunities” to comprehend the opportunity process. Cameron M. Ford (2002) argued that including greater considerations of time could help researchers reflect the experiences of entrepreneurs, and Dimo Dimov (2007) noted that acknowledging time could help researchers to understand the continuous development and evolution of opportunities.
Despite such exhortations, the field has remained reluctant to address the theoretical development and empirical consideration of these temporal issues in the study of opportunity. Although there has been increased attention to timing effects (Choi, Lévesque, and Shepherd 2008; Wood, Bakker, and Fisher, in press), the relationship between the passage of (clock) time and entrepreneurship is limited (Lévesque and Stephan 2020). As a result, we have limited knowledge about how time affects opportunity development despite remarkable achievements concerning other aspects of the entrepreneurial process made possible by Austrian economics, most notably the work of Israel M. Kirzner, Ludwig von Mises, and Ludwig M. Lachmann. However, the field is a long way from fully integrating these approaches into the more recent discussions of the important dynamic and temporal aspects that stem from the pursuit of opportunities over time.
The purpose of this article is to explore the opportunity development process inductively using two longitudinal case studies. In doing so, the role of time in the notion of entrepreneurial opportunity is explored and emphasized. As “clock time” (Crossan et al. 2005) passes, the potential for the underlying conditions that comprise the opportunity also change. These conditions involve the willingness and ability of the entrepreneur and other potential producers to supply a product solution at a given price as well as the willingness and ability for enough customers to pay an offering price high enough to justify the entrepreneur’s effort. Passage of clock time introduces the potential for changes in the willingness and the ability of both producers and consumers as a function of changes in data and expectations about the external world (i.e., expectancies about resource availability and prices of inputs, substitutes, and competing solutions as well as current institutional conditions such as social, technological, economic, environmental and political) and the internal world (i.e., values of various states, such as preferences, desires, motives, needs, wants, beliefs, norms, and attitudes). However, as the passage of clock time does not necessarily imply a change to the underlying conditions, our focus is on a subjective perspective of time, as this is likely to impact the opportunity beliefs of the entrepreneur. We do acknowledge that clock and subjective time may intersect, as the more clock time passes, the more the potential for conditions to change grows, regardless of whether or not conditions actually change. Subjectively, this means that expectations of changing conditions for an opportunity may also change such that opportunities’ attractiveness can wax or wane over time based on the entrepreneur’s expectations.
This affects how research questions are framed and the theoretical perspectives used to answer these questions. Indeed, only longitudinal methods can effectively capture temporal dynamics of opportunities. Case studies offer the ability to shed light on the context and process of opportunity development, thereby allowing for theory development (Siggelkow 2007). Thus, new ventures that focus on the entrepreneurs’ initial opportunity beliefs and subsequent metamorphosis of those beliefs to reflect the role of time throughout the opportunity process have been selected. In doing so, we capture how initial opportunity beliefs may be revised and reshaped (as a function of changes in data and their effect on expectancy-value considerations), thereby contributing to scholarly understanding of the process aspects of opportunity development. The influence of Austrian economics on these discussions is also highlighted with the hope of further clarifying these roots of mainstream entrepreneurship scholarship.
The results of the case studies suggest that an entrepreneurial opportunity in dynamic environments is conceptualized as an initial belief about the viability of a potential product solution idea for a market problem. Yet as time transpires between formation of the initial opportunity belief and the development of the capability to exploit the opportunity, the environmental conditions that originally presented the situation to advance one’s desires change. Resources must be acquired, investors must be identified and persuaded to invest, relationships with suppliers and distributors must be established and nurtured, and customers must be made aware of the product offering (Zott and Huy 2007). Each of these the opportunity (McMullen 2015). Despite its conspicuous absence in the academic literature, this dynamic notion of opportunity is regularly communicated in practice and captured by the expression “The window of opportunity is closing.”
This study’s findings and analysis make three main contributions to the literature possible. The first is the elucidation of the implications of the role of time in opportunity research. This helps to move the current ideas in opportunity research toward a more dynamic view, serves to identify the appropriate boundary conditions for a static versus dynamic temporal view of opportunities, and reveals important questions that researchers have yet to consider. For instance, we illustrate that some views, such as Kirzner’s widely adopted view of entrepreneurial alertness and opportunity discovery, may be better suited for explaining the development of initial opportunity beliefs that can be identified and exploited instantaneously (such as arbitrage situations) than for explaining instances that are characterized by a large temporal gap between belief and action. When timing and process are more central to theorizing, we propose that Mises’s understanding of the entrepreneur as a coordinator of resources and bearer of uncertainty may offer a more promising lens through which to examine entrepreneurial action.
Second, by examining the fluid nature of opportunities, this study identifies factors that affect the temporal understanding of opportunities. For instance, understanding initial opportunity beliefs and how they change over time helps illuminate central but poorly understood concepts and dynamics in entrepreneurship research, such as how entrepreneurs navigate uncertainty about demand and supply caused by changes in data over time and how they form new local knowledge of time and place. By explicating the role of these key concepts, this article provides a more robust framework for understanding entrepreneurial action, one that recognizes the value of learning and iterative processes as part of the pursuit of opportunity.
Third, microlevel areas of Austrian economics that may be viewed as contrasting begin to be reconciled. Of particular relevance are the two distinct conceptualizations of the entrepreneur as either an alert arbitrageur (Kirznerian entrepreneur) or an uncertainty-bearing producer (Misesian entrepreneur). The Misesian view may be reconcilable with the Kirznerian view at the macro level (Kirzner 1982) based on the fundamental assumptions about the functioning of economic systems, but at the micro level significant differences exist between the two approaches. Once the subject of the theory shifts from the economy in which the entrepreneur serves as an agent of the system to a particular entrepreneur who is the system of interest, these differences present serious consequences for theorizing about the entrepreneurial process and the role of uncertainty, ignorance, and knowledge within this process. Because most entrepreneurial action scenarios are unlikely to involve instances in which entrepreneurial opportunities are both recognized and exploited instantaneously, as Kirzner’s (1973) theory of entrepreneurial alertness would suggest, we propose that the Misesian entrepreneur, as the coordinator of resources and bearer of uncertainty, may provide a more robust description of the entrepreneurial exploitation process as it occurs behaviorally. At the same time, Kirzner’s theory about ignorance and alertness provides valuable insights into how and why certain individuals discover opportunities while others do not. These microlevel implications and their appropriate boundary conditions are highlighted, and a model where both lines of thought are integrated is proposed. Consequently, a more robust model of entrepreneurial action is presented, one that can capitalize on both entrepreneurial alertness as well as the temporal aspects associated with marshalling resources.
RESEARCH METHOD Research Setting
Two longitudinal case studies were conducted to inductively describe and analyze the role of time in the opportunity pursuit process. To track these changes, especially as they relate to the underlying “how” and “why” questions, a qualitative approach was adopted. Qualitative methods allowed for the capture of the rich array of experiences that firms go through during start-up and subsequent development (Van de Ven and Engleman 2004). This method is especially useful for sharpening existing theory (Siggelkow 2007), because it enables investigation of the associated temporal processes (Gehman et al. 2018; Lévesque and Stephan 2020; Pettigrew, Woodman, and Cameron 2001) through which the opportunity, beliefs, and context influencing them change over time (Van de Ven and Huber 1995).
Both “real-time” longitudinal data to follow the goings-on in the firm and examined historical secondary data to understand the previous behavior of the firm were collected. This allowed for an extraction of theory from the ground up (Eisenhardt 1989; Eisenhardt and Graebner 2007; Yin 1984). The approach ensured that sampling was not based on the “success” of a firm and the feasibility of the opportunity. This was important, as definitions of opportunity are oftentimes only able to be determined ex post (Dimov 2011; Singh 2012). The first firm, a high-tech company named KeepOut,Firm and employee names have been altered for anonymity. was directly followed from its nascent stage before its inception, through its subsequent development and build-up of capital, until its eventual demise after approximately three years in business. The second firm, Buyonline, and their experiences with international e-commerce were under direct study for approximately one year as they underwent market expansion and organizational changes. Secondary data stretched back to the firm’s origin and the previous experience of the founder.
Using a theoretical sampling approach (Eisenhardt and Graebner 2007), the cases were selected because of their potential to offer unique insights into how new ventures pursue opportunities and how these opportunities change over time. Both firms fit the criteria of being (1) new ventures that were (2) operating in dynamic environments. Compared to firms in less dynamic environments, firms pursuing opportunities in more dynamic markets will likely experience greater change in the opportunities they pursue (Rindova and Kotha 2001). In addition to their theoretical relevance, both firms allowed extensive access to all company information. Because accessing archived documents, observing participant meetings, and interviewing all staff members was essential to gain a thorough understanding of the goings-on at the firm, full access was vital. Further, because the firms were in the nascent stages of development, it was not possible to infer any perceived viability of the original opportunities (i.e., they were not selected on the basis of the dependent variable). This is noteworthy because many studies of opportunities focus on “successful” firms, with opportunities defined retrospectively and tautologically (i.e., opportunities become inextricably linked with ex ante beliefs that prove true ex post through action) (Singh 2012). Hypothesis-testing research frequently espouses random sampling, but Pettigrew (1990) takes a more pragmatic approach for the employment of multiple longitudinal case studies, suggesting that intensive access to informants that can help to ensure that quality data is available. This method may be superior to other sample selection criteria. Access to data on a multitude of features (both external and internal) was of utmost importance for full comprehension of the central issues and also contributed to the choice of a limited number of cases that allowed for immersion by the research team (Siggelkow 2007).
The primary sources of evidence for both cases were a combination of personal interviews and secondary data. Interviews were semistructured in nature and took place between once a week and once every third week. Interviews generally lasted between forty-five minutes and two hours, with some lasting up to three hours. Interviews covered details of individuals (e.g., education, work tasks) as well as strategic issues (e.g., product development internal relationships and contact with other stakeholders). Over twenty interviews per case were carried out over a period of twelve months for Buyonline and over thirty months for KeepOut.
Open-ended questions were used to ascertain past and present beliefs, behaviors, and knowledge. We paid attention to both the prior knowledge of the individuals as well as the emerging knowledge levels via direct questions about contact with the market (customers, suppliers, industry reports, educational upgrading) and other staff members. Care was taken not to ask questions about specific constructs or other theoretical concepts that might constitute investigator bias. Most employees were interviewed more than once. All interviews, with the exception of one, were recorded.
Multiple informants holding different positions in the firms were interviewed. This only allowed for the collection of data on the executive perspective on knowledge and corporate actions, as well as the lower-level operational employees’ views of the daily goings-on. In the case of KeepOut, all employees were conversed with, including administrative staff and venture capitalists. With Buyonline, all top management team members were interviewed at least once, as were the majority of other employees until we reached saturation. This multiposition perspective is an advantage when researching emerging firms (Van de Ven and Huber 1995).
The personal interviews were complemented with secondary data including all board of director meeting minutes, earlier business plans, customer comments on products, published material about the firms, and financial and industry data. For KeepOut, a detailed diary that the founders kept concerning what took place in real time and their perceptions about their strategic actions was available. This provided us with the daily occurrences at the firm, the specific comments that the founders had received from different stakeholders, and their thoughts about the future. Buyonline kept extensive formal meeting minutes and renewed their business plans with greater frequency. Taken together, these sources provided detailed accounts of changes and when they took place.
We also engaged in participant observation. We kept a record of our impressions and feelings following observations at lunches, meetings, product demonstrations, and informal contact. Through comparison between interviews, other corporate documents, and the participant observations, the data received from single interviews was triangulated with other sources of evidence to ensure validity (Flick 1999; Miles and Huberman 1994). Additionally, the time span between interviews allowed for the measurement of changes to opportunities, information possessed, and corporate actions. Table 1 provides a brief overview of both firms and the interviews conducted.
Table 1. Overview of the Two Firms Under Study
Data Analysis
During data collection, field notes and interviews were transcribed. The most important issues that were perceived to be taking place were noted but no hypotheses about the phenomena a priori were made, allowing the theory to emerge from the empirical data (Glaser and Strauss 1967; Locke 2001). Interviews were analyzed following the guidelines of Matthew B. Miles and A. Michael Huberman (1994). Triangulation was used, whereby corroborating evidence to support main facts was gathered. In many cases, this involved speaking to multiple people within each firm to capture their shared view on new developments. In some cases, this new information was made tangible and visible in revised business plans or was present in meeting minutes or diary entries. Few contradicting accounts appeared. For those few circumstances where information appeared to be contradictory, follow-up questions via email or telephone were posed to gain clarity into the matter. The lower-level employees provided greater in-depth accounts of their contact with customers, technologists, or their daily activities on a number of occasions. Although some employees, at some stages, wondered aloud about the directions of the firms and the reasons for certain firm-level actions, all employees tended to agree about whether and when actions should be carried out. This was important for mapping out the opportunity and how it changed over time. Crosscase analysis provided us with the opportunity to compare our emerging conceptual categories and their properties with other data, iteratively refining impressions accordingly.
Once all data collection had occurred, extensive case studies were written about both of the firms. These were done following a temporal structure similar to an events-based case study (Van de Ven and Engleman 2004). The independent case studies were then compared to understand conceptual and temporal differences (such as changes in industry, changes in market demand, and new resource acquisition that encapsulated the opportunity dynamism at each firm over time). Given the significant amount of data collected, this process was both time consuming and informative. However, this method of analysis is typical for inductive research and where first- and second-order themes (Gioia, Corley, and Hamilton 2013) are examined over time. The writing and analyzing process took over one year, as new thoughts and the importance of earlier inputs and observations were constantly reviewed in relation to the cases. These findings were then presented to parts of the management teams to confirm that our analyses reflected the actual situations and experiences of the firms. Two researchers competent in this field read through the case studies and analyses for clarity. The (condensed) case studies were also used as teaching cases, which provided further feedback on the original findings as well as the understandability of the material. This further honed the ideas and implications of the respective cases.
TWO TALES OF OPPORTUNITIES SOUGHT AND FOUND Initial Opportunity Beliefs
KeepOut
KeepOut was founded by Andreas Gerber and Mathias Falcon on the basis of their shock in the number of theft of laptops. Statistics that underlied these opportunity beliefs included that over 4 million PCs under three years of age were in use in Sweden, of which approximately 55 percent were used by companies. Computers were quite expensive in Sweden at that stage, selling for between $1,500 and $2,000. As a result, purchasing new computers was a large investment. In the founders’ view, the current remedies focused on compensating the victim rather than preventing the crime. Andreas argued that “The best deterrent to a their is to ensure that he has absolutely no use of stealing the PC.”
Gerber and Falcon felt that there was need for a product that would prevent anyone from being able to use a stolen computer, thereby decreasing the demand for stolen computers and consequently the desire to steal them. This became the entrepreneurs’ initial opportunity belief. KeepOut identified potential customers who would use a large number of computers, such as management consultants and high-technology firms. The new venture began to collect market data, such as working with insurance companies to investigate the potential market size based on the total number of computers sold and thefts reported. KeepOut also began to examine competing or substitute products and expected growth patterns for the industry. They then approached potential customers to ascertain whether there was genuine interest in the potential product. Customers indicated that they believed the idea had huge potential. Because the data that is saved on the hard drives at work is imperative for a company’s success, customers suggested that KeepOut’s product would help them solve their problems with theft.
The KeepOut founders explained their idea for how the solution would work. An electrical pulse sent from the security card, their product, would destroy the functionality of these devices. By destroying these components, the computer would no longer be operational, the software and hardware could not be used, and any information or proprietary knowledge would be eliminated. The customers and KeepOut agreed that a $150 price tag would be reasonable for such a product.
Support of the initial opportunity belief was gained via external sources. For instance, KeepOut successfully competed in local business plan competitions. They were awarded a $10,000 grant from a local technology development organization. This recognition led to further positive reinforcement (in the form of venture capitalist investment) about the attractiveness of the initial opportunity belief. As one of the venture capitalists noted, “We evaluate this project as having great potential….We believe in the market, we believe that this team can bring this product to market, and we believe that they have the right business concept.” Thus, KeepOut’s initial opportunity belief, held by the entrepreneurial team members and supported by external sources, resulted in the decision to engage in further entrepreneurial action. The entrepreneurs felt that significant earnings were possible and estimated future sales and profits on the basis of this target price.
Buyonline
Buyonline’s founder, Freddy Tengblad, developed his initial opportunity belief while working in the software industry. His initial belief was based on the inefficiency of traditional software distribution through CDs packed in cardboard boxes and shipped around the world using several means of transportation and warehousing. If there was a flaw with the product or a canceled order, then the whole process would be carried out again in reverse order. He also thought about his own customers and the long delivery times for software. On this initial gist, he began examining industry reports and found that electronic downloads had growing demand and that software sales were increasing at 15 percent per year. What held these two factors back was the lack of an efficient method to manage both the purchase and the distribution of this software. Tengblad’s vision was to develop a way to pay for and receive the software electronically, thereby eliminating the challenges of traditional distribution. If possible, he would be able not only to transfer software between relatively close areas such as Latvia and Sweden, but also throughout the world.
This initial opportunity belief became the central business focus of Buyonline—to deliver software electronically via an online store. Tengblad clarified: “The original plan was to be a software reseller, a portal for software, a one-stop shop where you would find all kinds of software. And the only place you would need in order to buy software, wherever you lived, and whatever software you were looking for.”
To examine this belief further, he began to collect market data. Freddy contacted experienced managers in the software industry whom he trusted to discuss the potential of Buyonline. They were quite positive about the idea and agreed to become part of the firm. Additionally, industry reports at that time were extremely positive about future industry growth. Freddy’s experience meant that he also had some contacts in the venture capital industry. His contacts expressed eagerness for the opportunity that Freddy had identified; this further strengthened his belief in the viability of the initial opportunity.
Challenges to Opportunity Beliefs
KeepOut
Based upon their initial opportunity beliefs, KeepOut began to work on overcoming some of the technological complexities presented in their product. The two founders acquired the assistance of two German engineers who were to take care of product development and essentially all technical aspects. To finance product development, they acquired venture capital investment worth $400,000. The technology behind the product was still somewhat hazy at this point, although the idea and potential functionality were clear. The engineers, Loftus and Vittle, went through a stringent trial and error process, both alone and in connection with a university professor in Germany. This process was much slower than expected. Even though it took six months to develop the device’s specifications, the more detailed work with the sensor and software communication aspects still needed to be done. This required further testing and research before a prototype could be built. Gerber and Falcon were not pleased with the amount of time involved in developing this first functioning product. Gerber stated, “I threatened them….I asked them how they were going to be able to live without a salary for the six months extra than they had taken to finish the product…until they could fulfill their part of the contract.” Gerber was acutely aware of the potential impact of the unexpected delays. The issue of the length of time in product development led Gerber to begin to question the firm’s ability to develop the product they had hoped to. The German engineers had finally built a model that they felt had top-of-the-line technology, but they still needed to develop a satisfactory product suitable for the specified $150 price tag.
While this product development was going on, Gerber and Falcon engaged in growing the firm in preparation for the eventual sales of the final product. For example, they sought out a further capital injection, this time for $1,300,000. With this money, they arranged for a new, larger office space. An external CEO with extensive management and sales experience was also hired. Other lower-level employees were hired and marketing features (such as a logo and website) were developed to prepare the firm to sell the product effectively and provide structure for the firm. The team also began to examine the potential distribution routes for the final product once it was ready.
One year after the meetings with customers where the target sales price of $150 was established, the team had a working prototype that met that price demand. The plan was to produce ten thousand units. When the firm approached the potential customers again about sales, the reception was more tepid. One of the founders, Andreas Gerber, explained: “Our customers told us that computers are less expensive now compared to when we got started, and desktops are disappearing from the market more and more….If we were able to develop the first product quicker, like in a matter of one year, then there would still have been a large market for us. We simply didn’t invest enough money in getting this product out there in time.” This change in customers’ willingness to pay a certain price fundamentally challenged the initial opportunity beliefs of the KeepOut team.
Buyonline
The initial challenge for Buyonline was to develop a workable interface that met their aspirations to be a global player that would be able to accept payments online and to deliver the software electronically. This involved figuring out a way to provide a technical solution that would solve delivery and quality issues. From a delivery standpoint, Buyonline needed to guarantee that customers had the flexibility to determine how they were going to pay for their software. This incorporated different currencies, methods of payment, and timing of payments. Independent market research had suggested that customers from outside of the USA, which Buyonline also intended on targeting, refused to pay for something that they had yet to receive. This created a challenge, as the eventual technological solution would need to be able to send out deactivated software that only became active once payment was received. Receiving payment afterward would also alleviate the hassle of dealing with downloads that could not be completed or difficulties in internet connections. Because they could seriously derail customer interest in the (at that time) unproven method of downloading software via an e-store, these challenges presented a problem for Tengblad.
At first, Tengblad sought to circumvent these issues by finding existing software that would carry out these functions. The search ended fruitlessly, as Tengblad realized that a system that had met all these requirements and also had the capacity to hold at least 120,000 titles did not seem to exist. Realizing the importance of the technological solution, Tengblad decided to work closely with a group of programmers in Latvia. He had given them very clear instructions: “Make sure that this system you build is as secure and good as any other out there, hopefully better.” After a number of prototypes, the final product, known as Buyonline OS, could accept payment in thirty-four currencies, navigate six languages, provide antifraud reporting, and allow for multiple mediums of payment, including telephone, fax, and online methods. The technology could recognize which country the visitor was in and set the parameters accordingly—a notable innovation at that time. This technology was possible because Buyonline had secured $2.5 million from two experienced venture capitalist firms. This enabled the programmers to develop the platform in a period of approximately four months at a cost of roughly $2.3 million.
As Buyonline’s platform was approaching completion, Tengblad built industry relationships. For example, Tengblad attended a conference for the Association of Software Publishers where approximately nine hundred firms were present. At this conference a number of major firms volunteered to be the first publishers to provide titles for Buyonline’s e-store. The publishers felt that this business idea was fantastic and was going to revolutionize the industry, and they wanted to be part of it. Tengblad was able to learn more about the industry and publishers’ demands. Through these relationships, the Buyonline store had over twenty thousand software titles representing 170 publishers and customers in twenty- two countries. Sales initially grew but soon stagnated or decreased after a few months of operations. To drive more consumer traffic to their site, Buyonline experimented with marketing programs, advertising, etc., but nothing seemed to work. Tengblad realized that developing a brand name for end customers from scratch for a new global company was tougher than imagined: “It became too expensive for us to build our own brand with the end customer across the entire world.” Many competing firms were failing at the very same endeavor with much larger marketing budgets. Tengblad began to question his initial opportunity belief.
Updated Opportunity Beliefs
KeepOut
The length of time to develop KeepOut’s product, changes in customers’ willingness to pay the previously established price, and industry structural changes (such as expectations for network computer memory, increase in number of laptops, and price reduction for PCs), opportunity beliefs were seemingly altered. Based on these challenges to the perceived future feasibility of the opportunity being pursued, the main investors in KeepOut had a change of heart. This sentiment was shared by a member of the KeepOut board and the main venture capitalists, who realized that there was no longer the needed sales volume to make this opportunity feasible. The belief in the opportunity had been updated in a negative way; it was essentially determined that there was no longer a market for the KeepOut product.
Buyonline
At the same time that sales began to stagnate, companies interested in selling software online started contacting Buyonline, looking to buy or license the Buyonline operating system. However, Tengblad recognized that selling proprietary technology to competitors could mean the end of Buyonline if the new firms were more successful at marketing. This prompted Buyonline to develop its operating system so that it could build and host stores for other companies as well as their own. Buyonline then went back to the companies that wanted to license or buy Buyonline OS and offered them a new service as part of a new strategy. Tengblad clarified:
We could now go back to these companies and say, ”No, you cannot license our technology, but we have something better for you. We can build a store that looks like yours, and we will run it for you. And everybody will think they buy from you, but everything will happen here. And then we’ll send you part of the profits….And you don’t even have to pay a license fee; all you have to do is to take care of your own marketing.”
Demand for these stores grew faster than the sales from the regular Buyonline download store. Companies that had already spent funds on developing brand names for themselves also prospered in their own countries. They were able to tailor their sites and marketing to match their home cultures. Buyonline avoided having to spend extra money on something that did not seem profitable (marketing to the general population) as well as having to adapt all their marketing for each country. The Buyonline OS already allowed for language and currency differences and thus did not pose a major obstacle to international expansion. The initial belief in the opportunity had been updated; Tengblad recognized that there was potentially a more lucrative market than before in leveraging his existing technology to solve customer problems in a different industry sector (business to business).
Buyonline also began to examine other markets into which to expand the business, such as e-books, music, film, games, and similar downloadable transactions. They attended conferences and used their contact network to keep informed about these new possible opportunities. Buyonline decided to invest small amounts in these new opportunities in anticipation of the moment when the “window of opportunity” might open. In doing so, Buyonline could learn more about each new market, update its technology, and position itself for the future. As a result of the updated opportunity beliefs, the managers at Buyonline realized that some opportunities were not as viable as others and sought a more lucrative opportunity.
DISCUSSION The purpose of this study was to illustrate the role of time (as relevant changes in data) in the opportunity development process, from initial opportunity beliefs to challenges to those beliefs, to the updating of the beliefs (Shepherd, McMullen, and Jennings 2007). In the process, this empirical work revealed a more dynamic view of opportunity, one that takes into consideration potential changes to opportunity beliefs over time. This view of changing beliefs over time is not commonly found in the entrepreneurship literature (with a few exceptions), although some of the underlying logic is consistent with Austrian economics. By employing a well-established definition of opportunity (e.g., Shane and Venkataraman 2000) and examining how the initial opportunity beliefs of two entrepreneurial firms developed, were challenged, and were updated over a prolonged period of time as a function of market and industry dynamics, a framework is provided that is suitable for understanding how time affects opportunities. Table 2 below captures and shows the nature of these changes over time.
Table 2. Key Episodes in the Two Cases Over Time
The Formation of Initial Opportunity Beliefs
The beginning of the pursuit of opportunities stems from initial opportunity beliefs (Shepherd, McMullen, and Jennings 2007), and an opportunity’s perceived attractiveness (Wood and Williams 2014; Scheaf et al. 2019). These beliefs are interpretations of states, processes, events, and courses of action—interpretations that are considered to be true (McMullen and Shepherd 2006). They coalesce into a belief about the potential value and viability of an opportunity (Grégoire, Shepherd, and Lambert 2010; Scheaf et al. 2019; Wood and Williams 2014). In both of the cases examined, the initial opportunity beliefs were based on the combination of personal experience and market data that suggested that there was a potential market need. For KeepOut, that market data was based on the surprisingly high number of computer thefts. For Buyonline, the data concerned the ineffectiveness of current software distribution methods. These beliefs led the entrepreneurs to pursue the opportunities. Moreover, as they began to discuss their beliefs with others, both received additional data that supported the notion that they had discovered an opportunity worth pursuing.
In many ways, these observations fit well with current entrepreneurship models concerning the formation of opportunity beliefs and their connection to entrepreneurial action. For instance, Jeffery S. McMullen and Dean A. Shepherd (2006) note that the concomitant existence of knowledge about a potential opportunity and the motivation on behalf of the entrepreneur to act are constituents from which initial beliefs are formed. Others have argued that knowledge about a potential opportunity stems from changes in the environment (Davidsson 2015; Eckhardt and Shane 2003). This is also in line with Kirzner’s (1973) explanation of entrepreneurial alertness, wherein certain individuals identify opportunities that others do not. Alertness is based on the existence of prior knowledge and latent desire. Indeed, these findings resonate well with this area of the literature.
What is noteworthy with these models is that they primarily concern the “discovery” of the original opportunity. In other words, these theories focus on the development of the initial opportunity beliefs. For instance, in Kirzner’s view, the primary function of the entrepreneur is to discover price misalignments.Although Klein (2008) suggests that Kirzner’s treatment of opportunity was metaphorical and not to be treated literally, Kirzner’s view (literal or not) has been extremely influential in the development of the field of entrepreneurship and empirical research on opportunity discovery. Thus, despite Klein’s argument, we feel it useful to treat Kirzner’s views as being literal. One possible cause for the (mis)interpretation may be due to a change in the unit of analysis. Kirzner’s arguments are presented logically at the macro level (price system), whereas entrepreneurship researchers have tended to apply them behaviorally at the micro level (individual entrepreneur). However, the opportunity beliefs that are initially formed are always successfully pursued (Rothbard 1985). This is illustrated in Kirzner’s (1973) famous quote that “Entrepreneurship does not consist of grasping a ten-dollar bill which one has already discovered to be resting in one’s hand; it consists in realizing that it is in one’s hand and that it is available for the grasping.” Inspired by Kirzner’s ideas, much entrepreneurship research has focused on entrepreneurs’ initial opportunity discovery and individual differences that lead some people but not others to discover these opportunities (e.g., Gaglio and Katz 2001; Korsgaard et al. 2016; McCaffrey 2014; Shane 2000; Tang, Kacmar, and Busenitz 2012).Kirzner (2009) has emphatically denied that his theory of entrepreneurial alertness has anything to say about individual entrepreneurial behavior, explaining that it is intended only to explain the functioning of the economy given the existence of ignorance (Kirzner 1973) and to a lesser degree uncertainty (Kirzner 1982). He further notes that opportunities in his framework should be interpreted as analytical devices meant to highlight that the price system is encumbered by imperfect knowledge (Kirzner 1999), preventing applicability of Joan Robinson’s (1969) approach to decision-making (Kirzner 1979).
The data that precedes initial action is at least partially exogenous (Wood, McKelvie, and Haynie 2014). As a consequence, the data about possible market need is viewed subjectively (Barreto 2012; McMullen and Shepherd 2006) and subject to individuation (Scheaf et al. 2019; Wood et al. 2014; Wood and Williams 2014). This implies that the exogenous data is interpreted by evaluating the potential attractiveness of the opportunity through the unique lens of the entrepreneurs’ own skills, abilities, experiences, and personal circumstances. To that end, it is an individual judgment that determines whether and how action is ultimately taken (Dimov 2007; Foss and Klein 2018; Grégoire et al. 2010; Wood and McKelvie, 2015). Because the data represents “the possibility for entrepreneurial action” (Kirzner 2009), it creates the stimulus that prompts entrepreneurial action (McMullen 2015), such that the entrepreneurs in both cases believed that they faced opportunities worth pursuing.
Challenges in Opportunity Beliefs
With the passage of time, changes in data began to challenge the initial opportunity beliefs of both KeepOut and Buyonline. For KeepOut, the length of time involved in developing their product allowed conditions in both the external and internal environments to change. Doubt arose about their ability to produce a working product at the price needed to satisfy market demands. As KeepOut invested in learning how to reduce the costs of their production capability (in line with their opportunity belief), market demand changed in unexpected ways, such that other challenges to the opportunity beliefs began to develop. For Buyonline, the challenges to initial opportunity beliefs took the form of competitive challenges. Sales levels began to plateau, as similar firms began pursuing the same opportunity, albeit with a slightly different solution.
Challenges to initial opportunity beliefs are consistent with ideas on learning in entrepreneurship. There is research to suggest that entrepreneurial learning is mainly experiential in nature (Corbett 2005; Politis 2005); entrepreneurs generate new knowledge based on their experience with the entrepreneurial situation. In the case of KeepOut and Buyonline, this learning was only able to take place through entrepreneurial action. This corresponds well with Dimov’s (2011, 64) statement that “initial assumptions and intuition about future possibilities are gradually replaced with experiential facts and juxtaposition of circumstances.”
Further, this view on the opportunity process is similar to Ludwig von Mises’s view of entrepreneurship. For Mises, the entrepreneur is a coordinator of resources and bearer of uncertainty. He suggests that the “entrepreneurial function consists in determining the employment of the factors of production. The entrepreneur is the man who dedicates them to specific purposes” (1966, 290–91). Thus, Mises’s entrepreneur is a producer. Importantly, Mises’s (1966, 290) entrepreneur “deals with the uncertain conditions of the future. His success or failure depends on the correctness of his anticipation of the future.” Thus, Mises’s entrepreneur combines resources on the basis of beliefs about future demands, such that the exploitation of an opportunity starts with the initial opportunity belief, correct or incorrect. The issue of production also incorporates (subjective) time, which introduces the element of uncertainty into the entrepreneurial process, because (a) the preferences of customers may change between when the entrepreneur buys the resources to when s/he sells them (Kirzner 1973, 86; McMullen 2015); and (b) the entrepreneur may fail to produce the product at the estimated cost (Mises 1966, 343; McMullen and Kier 2016). It is these core components that are central in the Scott Shane and S. Venkataraman (2000) definition as well but are rarely addressed in empirical opportunity work.
Following in the footsteps of Mises, Lachmann (1976, 127–28), argues that all human action essentially happens over time, with time being the one dimension in which changes to beliefs take place: “As soon as we permit time to elapse, we must permit knowledge to change, and knowledge cannot be regarded as a function of anything else.” Because many entrepreneurial situations are unlikely to have instances where initial opportunity beliefs are likely to be developed and confirmed instantaneously, the Misesian entrepreneur, as the coordinator of resources and bearer of uncertainty, may provide a more robust description of entrepreneurial action, capturing the dynamic view of opportunity observed in the behavioral accounts of KeepOut and Buyonline.
Once the producing entrepreneur believes that there is an opportunity, s/he brings together resources to try to take advantage of this opportunity. In this process, the entrepreneur must take into consideration expectations for the potential of the underlying conditions to change before the end result is produced, such as whether resources can be better used for pursuing some alternative opportunity which may not have existed when entrepreneurial action began. Consequently, new data may lead the entrepreneur to reevaluate the initial assessment of the potential profitability of the opportunity because of changes in the availability, accessibility, or prices of resources used in production or because of actual or anticipated changes in consumer preferences induced by social, technological, economic, environmental, or political factors (McMullen 2015).
Updated Opportunity Beliefs
Because of learning that took place over time, both KeepOut and Buyonline updated their opportunity beliefs. For KeepOut, the updating involved a conclusion that the opportunity was no longer worth pursuing. This suggests that what was originally understood to be an opportunity in the case of KeepOut may never have been an opportunity in the first place. As they manifested, circumstances showed that revenues did not exceed costs to achieve the profit needed to meet the criteria involved in the Shane and Venkataraman definition. Scholars (e.g., Gras et al. 2020; Kirzner 1999; Ramaglou and Tsang 2016) would therefore likely suggest that the KeepOut case was not based on an opportunity at all. This same assessment likely holds for the case of Buyonline. The initial opportunity belief was not viable, but instead of obstinate persistence or abandonment, leadership chose to pivot, updating their opportunity beliefs to offer the software platform to competing firms and thus to pursue a more promising opportunity belief.
Opportunity research emphasizing the importance of learning (Cope 2005; Corbett 2005; Dimov 2007), pivoting (Fisher 2012; Grimes 2018; Navis and Glynn 2010), or happening (Dimov 2011)— i.e., maintaining a vision while experimenting to find the best path (Kirtley and O’Mahony 2020; Reis 2011)—suggests a process in which opportunity beliefs are continually updated (Shepherd, McMullen, and Jennings 2007; McMullen 2015). For instance, McMullen and Dimov (2013, 1491) note:
the importance of the time variable to entrepreneurship is more than a matter of logic, it can also pose structural challenges. As information is acquired over time, individuals organize it into useful knowledge structures. If new information is consistent with these knowledge structures, it is likely to augment or extend them, but in some instances, new information demands a reorganizing of existing knowledge structures in order for the information system to realize the full benefit of the new information.
It can be difficult, however, to reconcile this understanding of entrepreneurial action with a seemingly static notion of “opportunity,” a term often used to refer to both the stimulus and outcome of the entrepreneurial process (McMullen, 2015). As a result, a paradoxical deterministic portrait of entrepreneurship often emerges in which a beginning and end are discussed as if they were determined, while the journey in between is described as a discovery process requiring learning and pivoting (McMullen 2015). However, the case data for this study suggests that McMullen and Dimov’s description may only apply to forward-looking beliefs about opportunity, not to backward-looking beliefs about whether the original opportunity belief was properly justified as an opportunity in the first place.
Initial opportunity beliefs deemed promising in early temporal stages are oftentimes still considered “opportunities” even after changing conditions have caused them to lose their luster, even by the entrepreneurs who chose to either replace them through pivoting away from or abandoning them entirely. This suggests that entrepreneurs may conceive of opportunities both in ideal states when looking backward and actual states when looking forward, such that the initial belief continues to be considered an opportunity in the hypothetical, idealistic sense, regardless of subsequent facts. Consider KeepOut, for example. If we assume that KeepOut could have executed the original opportunity as intended under different circumstances, then a counterfactual belief remains justified that profit could have been realized. The actual failure to realize the ideal outcome can then be (and was) explained away as a matter of ineffective execution owing to unforeseen and unforeseeable circumstances, such that justification of the original opportunity belief was neither negated nor even undermined. Instead, the belief was relegated to a specific set of circumstances that the firm did not happen to encounter. Consequently, the original opportunity belief can be equated to a specific objective and a specific plan based on specific assumptions believed to make sense when formulated regardless of whether subsequent events reveal them as valid or not.
IMPLICATIONS Why Does Time Matter to Opportunity Beliefs?
Entrepreneurship scholars have noted that there needs to be greater concern for the role of time in entrepreneurship (Lévesque and Stephan 2020; Wood, Bakker, and Fisher, in press) and opportunity research (Dimov 2011; Short et al. 2010). Time affects our understanding of opportunities for a number of reasons. First, the supply and demand conditions that give rise to opportunity initially may change over time. For example, the KeepOut entrepreneurs clearly felt that there was an opportunity worth pursuing. Had they been able to produce and sell the security device at $150 when they first perceived the opportunity, customers would likely have bought it according to data on customer preferences at that time. This situation would therefore have been defined and treated as an opportunity. Had they asked whether customers would pay $150 for the security device two years later, those surveyed would more likely have answered no. This temporal boundary condition would most likely have gone unnoticed had KeepOut had a readymade product at the time that they received customer feedback or if they had had the ability to buy the product off the shelf somewhere. Thus, if KeepOut’s pursuit of the opportunity had been more arbitrage based (i.e., instantaneous), then their initial opportunity beliefs would likely have been more justified.
Second, both Kirzner (1973) and Mises (1966) noted that time and the pursuit of opportunities are inherently related, yet there remains a gap in understanding how an entrepreneur’s time perspective will determine his evaluation, and subsequent pursuit, of opportunities from an Austrian economics lens. When discussing the evaluation of an opportunity, both Kirzner and Mises limit the role of time, and timing within the context of the production of the proposed good or service. This overlooks the decision-making process by which an entrepreneur determines the (subjective) forecasted time, which is then used to evaluate the opportunity. In turn, future pursuits of opportunities are assumed to be viewed through the lens of prior knowledge (Kirzner 1973; Mises 1966). This conceptualization of the opportunity evaluation process overlooks an important time concept: time perspective. Despite the development of empirical measures for identifying the attractiveness of an opportunity (Scheaf et al. 2019) and the development of a time-based theory of entrepreneurial action (Wood, Bakker, and Fisher, in press), opportunities continue to be evaluated without taking an entrepreneur’s time perspective into account. This necessarily introduces noise when trying to identify the determinants of an entrepreneur’s forecasted time needed to pursue an opportunity. To bridge this gap, this study draws on an existing typology of time perspectives (Lévesque and Stephan 2020; Zimbardo and Boyd 1999), and limits its scope to two time perspectives: future time perspective and present-hedonistic time perspective (henceforth referred to as a present time perspective). A future time perspective focuses on plans that allow for the achievement of long-term goals, while a present time perspective focuses on the “here and now” (Lévesque and Stephan 2020).
Third, there are a number of areas that may begin to challenge initial opportunity beliefs. In returning to Shane and Venkataraman’s (2000) definition of an opportunity, it was noted that an opportunity involved a temporal overlap between the customer’s willingness to pay a certain price for a good or service and the entrepreneur’s ability to provide that good or service at a lesser cost. These two factors reflect both a market side and a production side of the opportunity coin. KeepOut faced challenges stemming from their ability to produce. However, it is argued that these issues stem primarily from KeepOut’s time perspective. During KeepOut’s market-side opportunity evaluation process, the entrepreneurs examined their opportunity using a present time perspective, asking potential consumers whether the product would be useful and whether a certain price would ensure that the product is still attractive to the consumer. Given the framing of KeepOut’s questions, their entrepreneurial responses assumed away potential future alternatives and focused on evaluating the product within the existing competitive landscape of the industry. As a result, the challenges that KeepOut faced on the production side were exacerbated by the market side, where customer preferences and their willingness to pay came into question. When reevaluating their opportunity using a future time perspective, combined with their newly gained knowledge of the prototyping process, KeepOut realized that the viability of the opportunity had passed.
Buyonline, utilized a future time perspective when forming their initial opportunity belief, as can be seen in their recognition that emerging solutions would not allow Buyonline to develop a viable product and meet its product goals. This future time perspective extended Buyonline’s estimated production timeline and drove them to develop proprietary software. In turn, this forced updated beliefs about original market entry timing and the initial opportunity belief. Therefore, the time perspective that each set of entrepreneurs used ultimately influenced their time management in pursuit of the opportunity as well as the subsequent time perspective lens used when their opportunity beliefs were challenged. For Buyonline the fact that other firms were pursuing a similar opportunity led them to question their initial beliefs, rather than technological or financial concerns. After investing a large sum of money in the development of their technological solution, they re-focused their attention on the market and its needs.
When Buyonline reevaluated its opportunity, they once again utilized a future time perspective, and realized that their original opportunity belief was indeed in need of change and that their chances for financial success were not what they had originally expected. This opportunity evaluation pattern was repeated, and subsequent opportunities were exploited, such as becoming a provider of download stores, a relationship manager for software publishers, and moving into other markets such as films, games, and e-books. Thus, during the time the firm was putting its resources in place to exploit the opportunity via product development, the management team was able to learn more concerning the nature of the market’s demands. This served Buyonline well by facilitating understanding of the consumers’ current needs, how they were changing, and where new needs were emerging.
Finally, the role of time as the potential for data to change illustrates important but differing views of opportunity in the literature impacting different temporal stages. This recognition can lead to further understanding of entrepreneurial behavior more generally. Alexander Ardichvili, Richard Cardozo, and Sourav Ray (2003) attempt to integrate the psychological approach to “perception of opportunities,” a more Schumpeterian “creation of opportunities,” and the Kirznerian “discovery of opportunities” in their theory of opportunity identification, but they do not overtly consider the role of updating opportunity beliefs in their exposé. Others have also adopted differing views of opportunity (Alvarez and Barney 2007; Barreto 2012; Klein 2008; Ramoglou and Tsang 2016). What has yet to be explicated, though, is how simply acknowledging the impact of time introduces fundamentally different assumptions about the ontology as well as the epistemology of opportunities. Implicit assumptions and theoretical blind spots could be revealed through a more precise articulation of whether prominent theories of entrepreneurship consider opportunities to be dynamic or static phenomena (see McMullen and Kier 2016 for an example of theoretical and phenomenological gains from such problematizing efforts). Doing so will likely lead to different research questions and approaches to understanding opportunity and the entrepreneurial process.
Acknowledging Time in Austrian-Influenced Entrepreneurship Theorizing
Opportunities are dynamic phenomena whose identification is dependent on the entrepreneur’s consideration of time. In this framework, the Kirznerian discovery of opportunities and the Misesian approach to updating opportunity beliefs are complementary theories that when viewed as a sequence can lead to a better understanding of the role of time and opportunities (Figure 1).
Figure 1. An Integrated Model of Entrepreneurial Action
Most entrepreneurial action scenarios are unlikely to involve instances in which entrepreneurial opportunities are both identified and exploited instantaneously, as Kirzner’s (1973) theory of entrepreneurial alertness would suggest. For this reason, the Misesian entrepreneur, as the coordinator of resources and bearer of uncertainty, may provide a more robust description of the entrepreneurial exploitation process. At the same time, Kirzner’s theory about ignorance and alertness provides valuable insights into how and why certain individuals identify opportunities while others do not.
For instance, Kirzner’s view of the arbitrageur appears to be most applicable when resources are already in hand or where there are opportunity beliefs that can be acted upon relatively quickly. Consequently, Kirznerian entrepreneurs are alert to data that is relevant to fulfilling their motives. The focus is therefore on the development of initial opportunity beliefs based on data that might otherwise go unnoticed. Whenever this data is superior to the data that their plans were previously based on, these entrepreneurs enjoy an immediate profit equal to the opportunity cost of foregoing the use of what would now be erroneous data in their decision-making. Situations where this view is most appropriate include pure arbitrage opportunities, such as importing and selling goods and services from previously unknown suppliers in countries where prices are lower, or in scenarios where the opportunities being pursued are based on established technologies and production methods (such as replicative business models). Such a scenario arguably falls within the domain of risk (Hebert and Link 2006), because the means-end relationship of which the opportunity consists is not new to the price system. That is, knowledge of the supply-demand relationship can be reasonably estimated based on, for example, having been tested in some form in another location (e.g., setting up an additional franchising outlet). Opportunities based on scientific discoveries and research and development (R&D) activities also seem to fit nicely with this model but more pertinently when knowledge is licensed or sold (e.g., patents) rather than exploited by its discoverers. Not surprisingly, conceptual and empirical microlevel research in the Kirznerian tradition has tended to focus on the role of prior knowledge and scientific knowledge that can be traded, including patents (e.g., Shane 2000; Shane and Venkataraman 2000).
On the other hand, the Misesian approach seems better equipped to embrace opportunities where there is a time lag between the entrepreneurial decisions being made and the outcomes of these decisions. This may include technological opportunities where resources must be invested before the opportunity can truly be evaluated. This is similar to Schumpeter’s (1934) focus on breakthrough innovations and overcoming what McMullen and Dimov (2013) refer to as “hardware” problems (i.e., problems involving access to the resources needed to transform an idea into a product). In other words, the Misesian and Schumpeterian approaches may exist in the realm of product innovations which take time to develop and may include more radically new innovations that are based on the discovery of new-to-the-world knowledge via R&D or some other methods. The focus of these types of opportunities, then, is not on the development of initial opportunity beliefs based on prior knowledge but rather on the process involved in learning, overcoming uncertainty, especially as it relates to production, and the challenges of updating existing opportunity beliefs.
More broadly, these contrasting views of the race to develop the capability needed to exploit the conditions believed to represent a fleeting opportunity stands in stark contrast to the misguided but fortuitous event in which one acts on what he or she erroneously believes to be an opportunity only to have the situation change in advantageous ways, such that “fortune favors the bold.” In this scenario, action creates opportunity by serving to enable development of the capability needed to exploit a situation that is in the process of emerging. Distal motives manifest as a goal intention that, when coupled with conducive environmental conditions, is converted into behavior that produces a positive outcome (McMullen and Kier 2016). Distal motives may remain constant while the particular goal intention sought to fulfill those motives evolves in response to both endogenous and exogenous changes in the environment (McMullen and Kier 2016). Environmental change allows eventual fulfillment of the motive through continued efforts to match various goals and situations made possible through action (McMullen 2015; Sarasvathy and Dew 2005). The economic viability of these moves is a function of the attractiveness of the initial opportunity beliefs relative to other alternatives at time zero. It is also these same factors that need to be updated as time changes to determine if the economic viability is still present (McMullen and Kier 2016).
CONCLUSION Some scholars have recognized that the pursuit of opportunities is a process, which, by definition, unfolds over time (McMullen and Dimov 2013; Short et al. 2010). However, despite the understanding of a temporal component to the pursuit of opportunities, acknowledgment of their temporal embeddedness is surprisingly absent from the entrepreneurship literature, although Austrian economists address it in different parts of the literature. It is hoped that this inductive empirical approach and discussion help bridge the gap between these currently disparate streams of work.
This study’s empirical findings have significant implications for the field. First, they go beyond the mostly conceptual discourse that has characterized much of the opportunity research to date. Much of that discourse has emphasized the formation of initial opportunity beliefs while neglecting the potentially extensive lapse of time that follows those initial impressions. In contrast, this study finds that much, if not most, of the story of opportunity, is one of an unfolding entrepreneurial process through which initial opportunity beliefs are precisely that: initial and beliefs. These beliefs evolve as both the environment and the entrepreneur’s understanding of the environment change. In acknowledging this, there are a few implications for future research. First, a more dynamic view of opportunities provides a new way to think about and research opportunities. Instead of viewing opportunities as the end of a journey whereby an entrepreneur exploits that opportunity, the dynamic view sees opportunities as moving targets that can be followed over time. Therefore, even though researching the formation of opportunity beliefs remains fruitful, more important lessons might be learned by focusing on the changes to and updating of these beliefs over time.
Second, this view serves to identify some boundary conditions of existing theories of entrepreneurial action, such as those rooted in Austrian economics. For example, Kirzner’s highly influential theory of entrepreneurial alertness (1973, 1985) may be well suited to the context of “passive opportunities”—i.e., situations in which the entrepreneur already possesses both the cognitive and material means, as well as the motive to act before encountering the “opportunity.” This would imply situations that are seemingly arbitrage-type opportunities. In contrast, there are a number of theories of entrepreneurial action that focus more on bearing uncertainty as a quintessential function of the entrepreneur within the price system specifically (e.g., Hayek 1945; Foss and Klein 2012; Knight 1921; Mises 1966) or social systems more broadly (McMullen and Shepherd 2006; McMullen, Plummer, and Acs, 2007). These theories often emphasize “active opportunities”—i.e., situations in which entrepreneurs are able to imagine a future situation to be an opportunity before they possess the cognitive or material means to act and/or fully understand their desire to do so. Identification of an active opportunity begins as an initial opportunity belief that endogenous or exogenous changes in the environment then discourage or encourage. These opportunities are more uncertain than “passive opportunities,” because they bear search costs and risk as resources are irreversibly committed to their pursuit (McMullen and Kier 2016). This latter approach more fully embraces Mises’s view of the entrepreneurial “producer.”
A temporal view may therefore have broad implications for the study of opportunity. These implications may impact the varying research questions than what the field of entrepreneurship currently considers. At the most basic level, a dynamic view of opportunity is more focused on what happens to opportunities over time rather than the formation and early stages of the opportunity process. This implies prioritizing the role of continuous learning in challenging and updating opportunity beliefs rather than the role of prior knowledge, where the focus is on an opportunity that already exists. Such a change would entail examinations of the nature of the perception and specific data or happenings that challenge initial opportunity beliefs. Are these primarily on the market or the production side? Does the process involved follow the same patterns and thinking as “alertness” or are there other processes involved? Do certain entrepreneurs react more quickly to these challenging signals than others, based on cognitive or motivational factors? What cues suggest updating opportunity beliefs and pivoting? What are the expectations of time in forming and changing such beliefs? What are the specific subprocesses that take place as part of this updating process? And is there ever a “finality” for the opportunity—where the perception of time “ends”? Or to what extent can a firm’s continuous pivoting still be considered pursuit of the same opportunity rather than a completely new one? These issues are addressed further in table 3 below.
Table 3. Core Distinctions and Implications for Future Studies of Time and Opportunities
To capture the temporal nature of opportunity development, it is suggested that scholars employ methods that can actually capture the dynamics involved in the particular entrepreneurial process they are examining. These may include repeated surveys that capture changes over time, ethnographic studies or longitudinal case studies (e.g., McMullen and Bergman 2017, 2018), or quasi experiments that follow the development of opportunities in real time. Regardless, ex ante identification of opportunities will be important if opportunities are to be disentangled from successful (profitable) outcomes (McMullen, Ingram, and Adams 2020). Otherwise, as Dimov (2007, 2011) argues, opportunity researchers will need to be satisfied with defining opportunities after they have been successfully exploited and with an ex post definition of opportunity. Finally, researchers should seek multimethod techniques drawing from multiple sources of data (see Autio, Dahlander, and Frederiksen 2013) that might represent specific opportunity beliefs and changes to beliefs from multiple perspectives.
In conclusion, although some scholars have suggested that opportunities lie at the heart of the field of entrepreneurship, there are still important insights to be gained. Although there is plentiful debate taking place in the literature, the intention is to help to move these discussions toward a dynamic view of opportunities. Further, Austrian economics continues to have a pervasive—albeit potentially underappreciated—role in most contemporary entrepreneurship discussions. The simple observation that this article began with—that it often takes time to respond to a situation viewed as an opportunity and that based on this temporal gap, conditions may change—is central to entrepreneurship and Austrian theorizing. By illustrating that opportunities are more fluid and dynamic than researchers previously have conceptualized, hopefully it has been shown that the field may need to employ different assumptions and methods to study opportunities. By integrating Austrian theory into mainstream entrepreneurship research, scholars will be able to develop a potentially valuable perspective for understanding the dynamic role of opportunities.
Abstract: Many scholars have pointed to Austrian subjectivism as an appropriate framework for understanding and studying entrepreneurship. Yet very few empirical studies in the field of entrepreneurship have applied a subjectivist lens. This research article responds to calls for more subjectivist entrepreneurship research by theoretically refining and empirically extending the subjectivist approach to team entrepreneurship. The findings presented in this study, which are based on data from 124 high-tech start-ups founded in Norway, suggest that positive internal and external team dynamics contribute to team effectiveness, as measured by the lead entrepreneur’s subjective assessment of his or her team. Implications for theory and practice are discussed.
JEL Classification: B53, D80, L26 Daniel Leunbach (daniel.leunbach@sfe.uio.no) is a lecturer at the University of Oslo. Truls Erikson (trulser@ifi.ulo.no) is a professor at the University of Oslo. Ekaterina S. Bjornali (ekaterina.bjornali@ntnu.no) is an associate professor at the Norwegian University of Science and Technology.
The authors would like to thank Professor Bylund and the two anonymous reviewers for their helpful comments.
INTRODUCTION One of the defining characteristics of the Austrian school is its commitment to subjectivism (Boettke, Lavoie, and Storr 2004; Horwitz 1994; Lavoie 1991; Storr 2010).The term subjectivism is difficult to pin down, as it is used differently in different contexts. In the context of Austrian economics, subjectivism refers to the explicit recognition “that the actions of individuals are to be understood only by reference to the knowledge, beliefs, perception and expectations of these individuals” (Kirzner 2002, 64). More broadly, subjectivism refers to “the pre-supposition that the contents of the human mind, and hence decision making, are not rigidly determined by external events.” (O’Driscoll and Rizzo 2014, 68). This is not to say that mainstream economics completely ignores that individuals hold different preferences, beliefs, and expectations, only that Austrians are far more consistent and thoroughgoing in their application of subjectivism (Foss, Klein, and McCaffrey 2019). Within the Austrian tradition, for example, “it is not merely the ends toward which actions are directed that are subjectively determined, but the means as well” (Dempster 1999, 76; see also Garello 1996).
Whereas subjectivism is a defining aspect of Austrian thought, most entrepreneurship scholars, by contrast, tend to adopt an “objectivist” or “functionalist” metatheoretic approach (Jennings, Perren, and Carter 2005; Grant and Perren 2002; Packard 2017). Stated differently, the predominant approach to understanding and explaining entrepreneurial action and outcomes in the field of entrepreneurship is one characterized by a realist ontology, a positivist epistemology, a deterministic view of human agents, and a nomothetic methodology (Grant and Perren 2002; Burrell and Morgan 1979).Notable exceptions include effectuation theory (Sarasvathy 2001) and the theory of entrepreneurial bricolage (Baker and Nelson 2005). Effectuation theory is partly grounded in American pragmatism (Steyaert 2007) and entrepreneurial bricolage draws on social constructivism, and more specifically on Penrose’s (1959) subjectivist distinction between the resources in a firm’s environment and the firm-specific services derived from those resources (Fischer 2012).
The tendency of Austrian economists and entrepreneurship scholars to adopt divergent starting assumptions may discourage or hamper intellectual exchange between these two knowledge domains (MacLeod 2018). Of particular importance to our explanations of social reality is how much agency we are willing to afford the human subject (see Bevir and Blakely 2018; Hacker 2001). If, for instance, we adopt a mechanistic/deterministic image of the human actor as “nothing more than some sort of piano key or organ stop;… so that everything he does is not at all done by his will but by itself, according to the laws of nature” (Dostoevsky 1864, qtd. in Frank 2010, 423), then this will undoubtedly shape our language and our explanations of economic life (Boettke, Coyne, and Leeson 2003). Likewise, if we adopt an image of the human actor as a self-determining and autonomous being, in absolute command of his or her beliefs and actions, then our explanations and our language will look accordingly different. Scholars who adopt polar opposite assumptions about human agency may therefore find themselves divided by “a gulf of mutual incomprehension” (Snow 1959, 4).
Philosophical differences notwithstanding, this article is written in the belief that mutual learning between the Austrian school of economics and the field of entrepreneurship is both possible and desirable. In fact, there is already a vibrant ongoing dialogue between these two areas of knowledge (Berglund 2009; Chiles, Vultee, et al. 2010; Chiles, Tuggle, et al. 2010; Foss, Klein, and McCaffrey 2019; Foss and Klein 2012; Foss et al. 2008; Kor, Mahoney, and Michael 2007; Korsgaard, Berglund, et al. 2016; Mahoney and Michael 2005). Moreover, many recent contributions have pointed specifically to subjectivism (or interpretivism) as a useful alternative framework for understanding and studying entrepreneurship (e.g., Chiles, Tuggle, et al. 2010; Chiles, Vultee, et al. 2010; Foss et al. 2008; Gilbert-Saad, Siedlok, and McNaughton 2018; Leitch, Hill, and Harrison 2010; Jennings, Perren and Carter. 2005; Kor, Mahoney, and Michael 2007; Mahoney and Michael 2005; Packard 2017; Pittaway 2005). Despite these praiseworthy efforts to articulate the potential relevance and value of subjectivism for the field of entrepreneurship, there are still very few examples of empirical studies in the field built on explicit subjectivist foundations (see Chiles, Vultee, et al. 2010). This is both surprising and unfortunate given the subjectivist emphasis on creative agency and imagination—human elements that seem central to any comprehensive understanding of entrepreneurship (Chiles, Vultee, et al. 2010; Gilbert-Saad, Siedlok, and McNaughton 2018; Kier and McMullen 2018; Kor, Mahoney, and Michael 2007; Packard 2017).
This paper responds to calls for more subjectivist entrepreneurship research (see, e.g., Jennings et al. 2005) by empirically extending the subjectivist approach to team entrepreneurship (henceforth, SATE; Bjornali et al. 2017; Foss et al. 2008; Leunbach, Erikson, and Rapp-Ricciardi 2019; Kor, Mahoney, and Michael 2007; Mahoney and Michael 2005; Penrose 1959). Briefly put, SATE is a distinctive approach to studying and understanding entrepreneurial teams—first outlined by Nicolai J. Foss, Peter G. Klein, Yasemin Y. Kor, and Joseph T. Mahoney (2008)—that brings together methodological insights and assumptions from Austrian economics, Edith Penrose’s (1959) subjectivist resources approach, and the modern resource-based view. It will be useful, for the sake of clarity, to provide some additional theoretical context before developing this study’s hypotheses. The next section therefore offers a condensed overview of SATE and briefly explains how SATE differs from the standard objectivist approach that tends to dominate the study of entrepreneurial teams.In this article, the terms entrepreneurial team and new venture team (these are used interchangeably in the literature) are defined as “the group of individuals that is chiefly responsible for the strategic decision making and ongoing operations of a new venture” (Klotz, et al. 2014, 227).
The Subjectivist Approach to Team Entrepreneurship Unlike classical accounts of entrepreneurship, which tend to portray entrepreneurship as a solitary undertaking (e.g., Cantillion [1755] 1931; Kirzner 1973 Knight 1921; Say 1814), SATE embraces the team as the key unit of analysis. At first glance, it may seem incoherent that an approach that purports to be subjectivist would embrace the team as a focal object of inquiry. As Foss et al. (2008) carefully explain, however, SATE is consistent with subjectivism in that it is cognizant of individual heterogeneity and takes as its starting point that entrepreneurial teams are comprised of individuals with different experiences, interests, interpretations, personality traits, skills, knowledge, expectations, and so on. Moreover, SATE is also consistent with methodological individualism in that it recognizes that we cannot meaningfully ascribe psychological predicates, such as beliefs and intentions, to the team itself, as if it were a kind of agent in its own right (Quinton 1975). In other words, SATE is consistent with the view that “[o]nly individuals have ends and can act to attain them” (Rothbard [1962, 1970] 2009, 2). Yet it is also the case, almost by definition, that there must be more homogeneity in purposes and intentions among the members of an entrepreneurial team than there is between members of different entrepreneurial teams (Elster 1989, 248–49). As King, Felin, and Wetten (2010, 297) explain:
Pursuing “all” heterogeneous goals or preferences simply is not feasible for an organization not only because of costs and identity violations but also because of the limits of organizational attention (Ocasio 1997). In this sense “organization by firm is variety reducing.” (Kogut 2000, 408, emphasis added)
Thus, a primary assumption of SATE is that entrepreneurial team members join forces for a strategic purpose and that their association is predicated on the achievement of that shared purpose (Penrose 1959).
Of course, the adoption of a “team perspective” on entrepreneurship is not unique to SATE in itself. In recent years, entrepreneurship researchers have become increasingly interested in entrepreneurial teams (Klotz et al. 2014). As Anna Brattström, Frédéric Delmar, Alan R. Johnson and Karl Wennberg (2020) and many others have explained, however, entrepreneurial team researchers have predominately focused on examining the relationships between team characteristics (e.g., size, demographic diversity) and various types of outcomes while often downplaying or ignoring how team members work together to achieve meaningful outcomes (see also Bjornali et al. 2017; Lechler 2001; Leunbach et al. 2019). SATE, by contrast, focuses explicitly on the ways in which team members with heterogeneous mental models act and interact in subjective and intersubjective processes of “discovery, creativity and learning” (Bjornali et al. 2017, 319) to achieve their shared purposes (Gilbert-Saad, Siedlok, and McNaughton 2018; Packard 2017).
Finally, SATE also differs from standard approaches to studying entrepreneurial teams in that it takes seriously the proposition from Austrian economics “that the future is not merely unknown, but unknowable” (Kor, Mahoney, and Michael 2007, 1188). This proposition follows quite naturally from Austrian assumptions about individual agency, imagination, and choice (see Beckert 2016; Bronk 2009, 215–16; Buchanan and Vanberg 1991; Shackle 1979).As Robert Jackson (2000, 72) has put it in another context: “Human behaviour cannot be predicted scientifically because humans have minds, and because they can make up their minds and change their minds concerning the basic question of how they wish to live. They can be quite unpredictable in doing that. They have fertile imaginations.” As Gerald P. O’Driscoll Jr. and Mario Rizzo (2014, 69, emphasis in original) point out:
A world in which there is autonomous or creative decision-making is one in which the future is not merely unknown, but unknowable. There is nothing in the present state of the world that enables us to predict the future state because the latter is underdetermined by the former…. Subjectivism and action under uncertainty are thus inseparable ideas.
By taking uncertainty seriously, SATE allows us to ask different questions, questions that are not being sufficiently addressed in the entrepreneurial team literature. For instance, if the modern capitalist economy is characterized by persistent “novelty, surprise, and instability” (Chiles, Vultee, et al. 2010, 138), and thus exhibits Knightian uncertainty (as opposed to measurable risk), then how can entrepreneurial teams overcome paralysis and make the decision to act, how can they form shared expectations, and how can they convince, communicate, and collaborate with external actors who may be needed in the commercialization effort (see also Beckert 2016; Beckert and Bronk 2018; Bronk 2009; Tuckett 2018)?
Although we still lack satisfactory answers to these questions, any subjectivist answer to them is likely to include some reference to our human capacity for imagination. As Jens Beckert and Richard Bronk (2018, 3) have put it, “imagination is not only the root cause of uncertain futures; it is also one of our principal tools for coping with them.” In Foss et al.’s (2008) subjectivist framework, for example, the creative imagination also takes center stage. Specifically, Foss et al. (2008, 88, emphasis original) portray entrepreneurship “as a creative team act, where heterogeneous managerial mental models interact in a process that produces a collective output, which is creatively superior to individual entrepreneurship.”
Although Foss et al.’s (2008) original formulation of SATE is theoretically rich and built on sound Austrian foundations, it arguably lacks the specificity needed for empirical research. Moreover, Foss et al.’s (2008) framework focuses almost exclusively on the social and cognitive interactions within the entrepreneurial team, thereby discounting the interface between the focal entrepreneurial team and other important constituents whose contributions may also be critical to the successful development of the venture (e.g., investors, pilot customers, alliance partners, suppliers, external advisors, government agencies; see Elert and Henrekson 2019; Garnsey and Heffernan 2005).
This article attempts to overcome these limitations by developing and testing a conceptual model that includes two key constructs, positive internal dynamics (Foss et al. 2008) and positive external dynamics, to explain team effectiveness. After developing and presenting said model, the research design is described and the findings, based on self-reported data from 124 high-tech start-ups founded in Norway, are presented. The article concludes with a discussion of the theoretical and practical implications.
HYPOTHESES DEVELOPMENT Positive External Dynamics and Entrepreneurial Team Effectiveness
For innovation-based start-ups, a basic challenge is how to successfully communicate and collaborate with external actors whose complementary capabilities and resources are required in order for the venture to survive and grow (Clough et al. 2019; Elert and Henrekson 2019; Gans and Stern 2003; Villanueva, Van de Ven, and Sapienza, 2012). Examples of externally held resources that entrepreneurs need to attract to build their ventures include financial resources (e.g., venture capital financing or bank loans), human capital (e.g., skills from employees, advisors, board members, and business partners), and social capital (e.g., information from customers, suppliers, or other social contacts; see Clough et al. 2019 for an excellent review of the research on entrepreneurial resource mobilization).
Resource mobilization becomes particularly challenging in an Austrian world of dispersed knowledge and heterogeneous expectations (Dew, Velamuri, and Venkataraman 2004; Zander 2007). That is, subjectively held knowledge and heterogeneous expectations imply that it can be prohibitively difficult or costly for entrepreneurs to articulate and communicate their ideas and plans in such a way that relevant others will be able to understand, assess, and accept them (Zander 2007). If the venture is based on complex and highly specialized knowledge, as is often the case with science-based ventures, the likelihood of communication difficulties increases (Miozzo and DiVito 2018). In such a context, an entrepreneurial team’s deep knowledge of a particular technological domain may paradoxically limit the team’s ability to communicate effectively with potential resource providers, a phenomenon known as “the curse of knowledge” (Froyd and Layne 2008; Leunbach et al. 2019). Indeed, the history of science is replete with examples that illustrate just how excruciatingly difficult it can be to champion new ideas based on specialized knowledge of “the particular circumstances of time and place” (Hayek 1945, 521), even when the ideas have clear advantages over existing alternatives (see, e.g., Rogers 2003; Weintraub 2010). The reasons for such communication difficulties include not only nonoverlapping mental models between an idea’s champions and potential supporters (Foss and Grandori 2020), but also cognitive biases against novelty (Mueller, Melwani, and Goncalo 2012). To gain acceptance for their ideas, entrepreneurs and innovators may have to frame and present their novel ideas with reference to existing and familiar activities. For example, Kathleen Eisenhardt (2003, ix), describes how managers and engineers at Amazon.com used familiar metaphors such as “shopping cart” and “checkout” to disguise their novel internet technology and overcome resistance.
Of course, many entrepreneurial teams try to circumvent aspects of the resource mobilization process by making creative use of the resources at hand (Baker and Nelson 2005; Penrose 1959) or by using their own personal funds to purchase the inputs they need to exploit an entrepreneurial opportunity (Shane 2003, 167–71). However, most entrepreneurial teams sooner or later have to confront the problem of mobilizing external stakeholder support if they want to realize their plans, even those teams that self-finance and engage in entrepreneurial bricolage (Zott and Huy 2007; Elert and Henrekson 2019).
Research suggests that resource mobilization is an inherently social process, involving communication activities such as persuasion, explanation, sharing of stories, interpretations, and so on (Martens, Jennings, and Jennings 2007; Zott and Huy 2007). In particular, to communicate effectively with a potential stakeholder, an entrepreneurial team must have a reasonably accurate understanding of what the potential stakeholder knows (Nickerson 1999).
The above considerations highlight the central importance of empathic accuracy for mobilizing stakeholders in support of a venture. Empathic accuracy can be defined as the “the ability to accurately infer the specific content of another person’s thought and feelings” (Ickes 1993, 588). Some people display a remarkable talent for understanding the states of others. It has been said of the philosopher and historian of ideas Isaiah Berlin, for example, that he had “the gift of self-identification with the outlook of holders of widely different, sometimes incompatible points of view—to a degree unique among philosophers.” (Magee 2009, 43). Similarly, the bestselling novelist James Patterson attributes his own success to a “golden gut—an ability to sense what’s going to appeal to a lot of people” (qtd. in Belsky 2010, 28). Although people differ in their basic skills of empathy and social understanding (Mar, Oatley, and Peterson 2009), it is reasonable to assume that most entrepreneurs can make a deliberate effort to successfully place themselves in the shoes of potential stakeholdersEntrepreneurs who fall on the autistic spectrum are a possible exception (see Currie and Ravenscroft 2002). and that such social imaginative efforts can translate into distinct advantages, including, for example, improved communication with relevant parties outside the focal team and improved venture ideation (Kier and McMullen 2018; McMullen 2015; Nickerson 1999). For example, an entrepreneurial team that strives to inform itself of a potential financier’s values, goals, and strategies before delivering a pitch will be more likely to secure financing for their project (all else being equal), than an entrepreneurial team that conducts no such research. Similarly, an entrepreneurial team that goes to great lengths to learn about the values, goals, and everyday concerns of potential customers will be more likely to detect relevant market problems than an entrepreneurial team which places less emphasis on such perspective- taking efforts—an informational advantage that should translate into improved venture ideation (Kier and McMullen 2018; McMullen 2010). The success of the Norwegian web series Skam, for example, has been attributed to a four-month preproduction period during which the series’s creators conducted about “50 in-depth 3-hour interviews and 200 school class ‘speed interviews’ with Norwegian 16-year-old girls and boys” to learn about their everyday concerns and dreams (Redvall 2018, 151).
To summarize, entrepreneurial teams that comprise members who value and engage in positive external dynamics will be more effective than entrepreneurial teams composed of members whotalent for understanding the states of others. It has been said of the philosopher and historian of ideas Isaiah Berlin, for example, that he had “the gift of self-identification with the outlook of holders of widely different, sometimes incompatible points of view—to a degree unique among philosophers.” (Magee 2009, 43). Similarly, the bestselling novelist James Patterson attributes his own success to a “golden gut—an ability to sense what’s going to appeal to a lot of people” (qtd. in Belsky 2010, 28).
Although people differ in their basic skills of empathy and social understanding (Mar, Oatley, and Peterson 2009), it is reasonable to assume that most entrepreneurs can make a deliberate effort to successfully place themselves in the shoes of potential stakeholders5 and that such social imaginative efforts can translate into distinct advantages, including, for example, improved communication with relevant parties outside the focal team and improved venture ideation (Kier and McMullen 2018; McMullen 2015; Nickerson 1999). For example, an entrepreneurial team that strives to inform itself of a potential financier’s values, goals, and strategies before delivering a pitch will be more likely to secure financing for their project (all else being equal), than an entrepreneurial team that conducts no such research. Similarly, an entrepreneurial team that goes to great lengths to learn about the values, goals, and everyday concerns of potential customers will be more likely to detect relevant market problems than an entrepreneurial team which places less emphasis on such perspective- taking efforts—an informational advantage that should translate into improved venture ideation (Kier and McMullen 2018; McMullen 2010). The success of the Norwegian web series Skam, for example, has been attributed to a four-month preproduction period during which the series’s creators conducted about “50 in-depth 3-hour interviews and 200 school class ‘speed interviews’ with Norwegian 16-year-old girls and boys” to learn about their everyday concerns and dreams (Redvall 2018, 151).
To summarize, entrepreneurial teams that comprise members who value and engage in positive external dynamics will be more effective than entrepreneurial teams composed of members who place less emphasis on engaging in positive external dynamics. Positive external dynamics are social and cognitive interactions between an entrepreneurial team and actors outside of the team (e.g., funders, suppliers, and customers) involving: 1) perspective taking, which helps ensure effective communication between the parties, and 2) a balancing of self- and other interest, which helps facilitate intersubjective agreement between the entrepreneurial team and external actors (McMullen 2010; Nickerson 1999; Galinski et al. 2008). Thus, this study’s first hypothesis is: positive external dynamics are associated with venture team effectiveness.
Positive Internal Dynamics
In explaining team effectiveness, positive external dynamics have been highlighted; however, the social interaction within the team is no less important (Lechler 2001). A key ingredient in Foss et al.’s (2008) original formulation of SATE is the “positive team dynamics” which enable team members to continually (re)combine their knowledge-based assets. Positive team dynamics, according to Foss et al. (2008, 84), “involves a healthy mix of debating, which stimulates members to think differently and consider new insights, as well as a shared sense of respect, support, and care for members.”
Foss et al. (2008) mainly stress the beneficial role that positive team dynamics play in enabling the team to imagine and create “a collective output that is creatively superior to individual output” (Foss et al. 2008, 73). However, teams that display positive internal dynamics are likely to enjoy a host of other advantages as well, including, for example, improved task coordination, fewer information processing failures, and increased action propensity (Leunbach, Erikson, and Rapp-Ricciardi 2019). Indeed, it is difficult to imagine how a shared sense of identity and purpose can be sustained in the team without mutually supportive interactions within it (see, also, Hambrick 2007).
The discussion above can be summarized in the following hypothesis: positive internal team dynamics will moderate the relationship between positive external team dynamics and the effectiveness of the venturing teams.
RESEARCH METHODS Research Design and Data Collection
This study is based on survey data collected between 2015 and 2018. The sample was collected in Norway from a population of all the high-tech start-ups satisfying the high-tech NACE categories. A criterion for selection was that the businesses had to fit two main NACE categories: “high-tech knowledge-intensive service” or “high-technology.” From an initial sample of around nine hundred firms, a total of 761 firms were contacted, and 149 firms completed the survey, generating a response rate of 20 percent. However, there is complete data for only 124 firms. The survey questionnaires targeted the CEOs of these firms.
Measurements
This study is based on carefully selected validated items from previous team studies. All measures, with the exception of firm age and team size, were collected using a seven-point scale.
Team Effectiveness
Although scholars have tried to develop overall measures of organizational financial performance for the field of entrepreneurship (Carton and Hofer 2007), there is still no agreement in the literature on what constitutes the best way to measure entrepreneurial team or venture performance (Blatt 2009; Foo 2011). From a subjectivist standpoint, poor team performance can be seen as an outcome that has fallen short of team members’ own goals for their collective activities—goals which are themselves highly idiosyncratic to the team and context dependent (see also Tiplic 2016). If we are committed to a subjectivist perspective, as Dempster (1999, 76) points out, then “we must realize that that we cannot, with certainty, identify either the goals of economic actors or even the means by which they perceive those goals may be met”(see, also, Garello 1996). Along such subjectivist lines, Penrose (1959) argued that management teams develop subjective images of the firm’s resource base and external environment through learning and that these images, in turn, shape the distinct “productive opportunity set” of the firm, i.e., “what the firm can see and take advantage of” (Foss 1998, 484).
In keeping with the Penrosian insight that each entrepreneurial team is unique in the productive possibilities that it collectively envisions and seeks to exploit (Bjornali et al. 2017; Foss et al. 2008; Miozzo and DiVito 2018), the dependent variable in this study reflects the lead entrepreneur’s subjective judgment of how well his or her team is doing. Specifically, the following six items from Pearce and Sims (2002) were used to measure team effectiveness: my team copes with change very well; my team changes behavior to meet the demands of the situation; my team is highly effective; my team faces new problems effectively; my team works on important problems; my team does very good work.
Respondents were asked to indicate their level of agreement with these statements on a scale ranging from “totally disagree” (1) to “totally agree” (7). The Cronbach’s alpha coefficient for this scale was .895.
Internal Team Dynamics
One way in which Foss et al.’s (2008) concept of positive team dynamics can be measured is by using the well-established construct of behavioral integration. Behavioral integration, which was originally introduced by Hambrick (1994) as a way of capturing the essence of “teamness” in top management teams, is a metaconstruct comprised of three key elements: the level of collaborative behavior in the team, the quality and frequency of information exchange between team members, and the degree of shared decision-making that takes place in the team (Mendenhall, Butler, and Ehar 2014).
The behavioral integration items used in this study are derived from Mooney, Holahan, and Amason (2007) and read as follows: team members are mutually responsible for decisions; team members have a clear understanding of the issues and needs of each member; team members help each other solve problems; team members share relevant information with each other; team members share resources with each other. The response options ranged from “totally disagree” (1) to “totally agree” (7). The Cronbach’s alpha coefficient for this scale was .911.
External Team Dynamics
Positive external dynamics were measured with the following six items from Walter, Auer and Ritter(2006): we analyze what we would like and desire to achieve with each partner; we match the use of resources (e.g., personnel, finances) to the individual relationship; we inform ourselves of our partners’ goals, potential, and strategies; we judge in advance which possible partners to talk to about building up relationships; we appoint coordinators who are responsible for the relationships with our partners; we discuss regularly with our partners how we can support each other in our success.
The response options ranged from “statement does not apply at all” (1) to “statement applies completely” (7). The Cronbach alpha for this construct was .831. This variable was also mean centered. Further, team size and firm age were controlled for.
RESULTS Table 1 shows the descriptive statistics of the main variables in this study. We can see from the table that the average size of the new venture team is 3.50 members (standard deviation of 1.67) and the average firm age is 10.31 years (standard deviation of 3.50). We can also read items’ reliability in parentheses. These variables will be elaborated on in subsequent sections. After the two focal variables were mean centered, the collinearity diagnostics showed acceptable scores (e.g., VIFs < 1.57).
The data set was analyzed with PROCESS macro scripts from Hayes (2013). The next table, table 2, shows the findings of the analysis. The initial column shows the control model. Model 1 shows that the overall relationship between external dynamics and the effectiveness of venturing teams is statistically significant (B = .183; p < .01). This means that external dynamics relate positively to the effectiveness of the venturing teams, as judged by the lead entrepreneur, in support of hypothesis 1.
From table 2, we also see that the moderator variable directly influences the effectiveness of the venturing teams (.450, p < .001). With respect to the interaction hypothesis, we find that internal team dynamics moderate the relationship between external team dynamics and the effectiveness of venturing teams (B = –.061; p < .1).
Balancing Type I and Type II errors, the traditional cutoff for interaction is at the .1 level (Aguinis et al. 2011). The interaction term is significant at the .1 level. As such, there is support for hypothesis 2 regarding interaction. That is, not only does the moderator variable directly influence the effectiveness of the venturing teams, but the variable also negatively moderates the relationship between external dynamics and the effectiveness of the venturing teams, which means that higher levels of internal team dynamics reduce the influence of external team dynamics. Figure 1 below visually shows how the interaction works. The figure illustrates that higher levels of external team dynamics relate to improved effectiveness and that this is especially true when the internal team dynamics are high.
DISCUSSION As noted in the introduction, in spite of commendable efforts by many scholars to articulate the potential relevance and value of subjectivism for the field of entrepreneurship, entrepreneurship researchers have generally refrained from adopting subjectivism as a framework for their empirical research. To address this state of affairs, this paper has endeavored to provide a useful example of subjectivism in action which hopefully can inspire other entrepreneurship scholars to consider subjectivism as a metatheoretical foundation for their empirical research.
Although subjectivism may seem of concern only to a small group of scholars interested in the philosophical foundations of entrepreneurship research, it should in fact concern anyone who cares about the practical relevance of the field of entrepreneurship. In a recent essay, for example, Dimo Dimov, Reiner Schaefer, and Joseph Pistrui (2020) warn that the field of entrepreneurship is in danger of becoming irrelevant to practicing entrepreneurs unless entrepreneurship scholars take more seriously “entrepreneurs’ first-person practical decision-making perspective” (p. 2). Similarly, James C. Hayton and Magdalena Cholakova (2012) argue that we cannot understand the emergence of entrepreneurial opportunities without examining “the microprocesses by which entrepreneurial ideas and intentions are represented and interpreted in the minds of those who develop them.” (p. 41). These arguments are in basic accord with subjectivism, and suggest that the field of entrepreneurship can benefit from a much closer dialogue with the Austrian tradition.To be clear, while we agree with Dimov et al.’s (2020) basic claim that the field of entrepreneurship can gain in practical relevance by taking more seriously the ‘subjective perspectives’ of the entrepreneurs that it studies, we do not think that subjectivism is immune from criticism. For example, because subjectivism is an epistemological framework that axiomatically presumes human agency, it leaves itself open to the critique that it underestimates the extent to which situational factors (Ross and Nisbett, 2011) and unconscious processes (Wilson, 2004) drive human choices and behavior.
In addition to highlighting the potential value of Austrian subjectivism for the field of entrepreneurship, this study presents empirical findings that should be of interest to both entrepreneurial team researchers and Austrian economists. Specifically, by clarifying and highlighting the important role that positive external team dynamics play in promoting team effectiveness, this study not only extends the subjectivist approach to team entrepreneurship as originally formulated by Foss et al. (2008), but it also adds empirical weight to Austrian arguments about the practical need for entrepreneurs to invest in what Hunter Hastings, Fernando D´Andrea, and Per Bylund (2019) call “market-making activities.” The concept of market-making activities still lacks a crisp definition, but it includes (for example) information-gathering attempts by entrepreneurs to understand customers’ “felt uneasiness” (Hastings, D’Andrea, and Bylund 2019, 7) for the purposes of framing and designing a solution which can help alleviate that uneasiness (see also Godley and Casson 2015).
As with all studies, however, there are also limitations that offer opportunities for further research. For example, the key informants approach used in this study rests on the assumption that there is considerable homogeneity in perceptions and interpretations within the entrepreneurial team. However, other members of the entrepreneurial team could potentially have rated their team differently, which would have led to different results. In the earliest stages of entrepreneurial team formation, for example, there is likely to be considerable heterogeneity of perceptions and interpretations among prospective team members. Although we are beginning to learn more about entrepreneurial team formation processes (for an overview of this literature, see Lazar et al. 2020), we still lack a clear understanding of how team members are able to negotiate and arrive at a shared understanding of their team’s overall means-ends framework. Indeed, research has tended to focus primarily on the practical challenge that entrepreneurs face in negotiating intersubjective agreement with external market participants, whose resource contributions may be needed in order for the venture to develop and grow (Clough et al. 2019; see also Dew, Velamuri, and Venkataraman 2004; Zander 2007). However, reaching intersubjective agreement within the initial founding team itself is no less important. To borrow a fitting phrase from Roger Scruton (2014, 33), “There has to be a firstperson plural, a ‘we,’” if team members are to stay together and remain excited about their ideas (see also, Higgins 2019). Future research could shed light on this important topic by observing entrepreneurial teams closely from their earliest inception. This could be achieved, for example, in an incubator or entrepreneurship education setting.
Abstract: New institutional economics (NIE) and Austrian economics (AE) both emphasize the role that institutions play in facilitating or impeding entrepreneurship and hence economic growth. In this paper, we discuss the complementarities between AE and NIE for advancing our understanding of the relationship between institutions and entrepreneurship. We argue that a subjectivist view of institutions, entrepreneurial microfoundations, and capital heterogeneity can enrich our understanding of within-country variation in entrepreneurial strategies, institutional evolution, and the relationship between institutions and production processes. We hope our discussion serves as an invitation both for further theoretical collaboration between the two camps and as a spur to applied research at the intersection of institutions and entrepreneurship.
JEL Classification: H35, L5, M13, 031, P14 Scott Burns (scott.burns@selu.edu) is assistant professor of economics at Southeastern Louisiana University. Caleb S. Fuller is assistant professor of economics at Grove City College.
We thank Ennio Piano, David Lucas, Jeff Herbener, Rosolino Candela, and Chris Coyne for helpful commentary. We are also grateful to two anonymous referees and the editor for insightful remarks. The standard disclaimer applies. Both authors shared equally in the writing of this paper.
INTRODUCTION New institutional economics (NIE) has made important contributions to our understanding of the relationship between institutions and entrepreneurship.The term institutional economics is probably now more commonly used than is NIE, but we prefer NIE nomenclature to distinguish from old institutionalism. Eggertsson (1990) draws a distinction between neoinstitutional economics and new institutional economics, with the latter rejecting more of the “hard core” of neoclassical economics. While recognizing the differences between many contemporary institutional thinkers, we do not draw that distinction. NIE scholars stress the critical function that institutions—society’s “rules of the game”—play in constraining and enabling entrepreneurial action (North 1986; Baumol 1990; Murphy et al. 1991; Williamson 2000). Austrian scholars have also written extensively about institutions and entrepreneurship, work that predates the mid-twentieth-century advent of NIE. Beginning with Carl Menger’s ([1871] 2007; 1883) analysis of the spontaneous emergence of social orders, as well as Ludwig von Mises’s ([1920] 1990) and F. A. Hayek’s (1945; 1948) comparative analyses in the socialist calculation debate, Austrians have always been concerned with how choice generates institutions and how these institutions influence social outcomes in turn (Lavoie 1985; Langlois 1986, 1992, 165; Foss 1997; Garrouste 2008). Especially in the twentieth century, Austrians have also stressed the central role that entrepreneurs play as the “driving force” of the market process (Mises [1949] 1998; Hayek 1968; Kirzner 1973; Klein and Bylund 2014; Bylund 2019).
Given these overlapping themes, it is unsurprising that there has been some collaboration between the traditions. At the same time, it is also surprising that this exchange of ideas has not been more thoroughgoing. Numerous authors have suggested that there are gains from trade to be had from merging aspects of each tradition (see Langlois 1986, 1992; Boettke 1989; Foss 1994, 1997; Boettke and Coyne 2003, 2009; Sima 2004; Foss and Klein 2009; Manne 2014; Bylund and McCaffrey 2017; McCaffrey 2018; Piano and Rouanet 2020). These contributions represent promising movements in the direction of integration; nevertheless; we believe that there remain unseized profit opportunities from further integrating the two traditions to improve our understanding of the institutions- entrepreneurship link.
This paper identifies three areas where NIE literature on entrepreneurship may benefit from more thoroughly incorporating Austrian insights. The first deals with a recent puzzle in NIE literature: explaining within-institution variations in entrepreneurial strategy––that is, why some entrepreneurs abide by existing rules while others seek to alter or evade them. The second deals with a subject that prominent NIE scholars such as Douglass C. North (1994) contend has not been satisfactorily resolved: explaining why and how institutions evolve over time. The third area addresses an even less well-established but promising research stream: the interaction between institutions, capital heterogeneity, and entrepreneurial action.
Suggesting how long-established Austrian insights can enrich NIE thinking on entrepreneurship is not to imply that the influence should be unidirectional. As this paper will demonstrate, Austrians can also incorporate NIE ideas in several areas. These include extending well-developed Austrian notions of entrepreneurship beyond “productive activity” and the adoption of new approaches which emphasize the distinction between “economic” and “legal” property rights.
This article achieves three tasks. First, it demonstrates the overarching complementarity between Austrian economics and NIE, particularly for furthering understanding of the institutions-entrepreneurship “black box.” Second, it highlights existing work that points in the direction of synthesis. Third, it proposes future research avenues based on our proposed integration of the traditions. The objective here is not to provide a comprehensive overview of the ways that these traditions can benefit from each other, nor is it to provide a final word on the proposed research ideas. However, the hope is that this article will spur further collaboration between the two traditions that will help resolve ongoing puzzles in the entrepreneurship literature.
The article proceeds as follows. First, the elements of both Austrian economic (AE) and NIE that are crucial for better understanding institutions and entrepreneurship are reviewed. A discussion of the prior interaction between the two traditions follows, and some ways in which they can complement each other are suggested. The final section builds on that synthesis to identify concrete ways that Austrian ideas can inform our approach to questions at the intersection of institutions and entrepreneurship. In doing so, it also raises several questions which will hopefully inspire future research. The article concludes with implications.
AUSTRIAN ECONOMICS AND THE NIE–KEY THEMES FOR ENTREPRENEURSHIP Austrian Economics
Austrian economics is marked by its subjectivist foundations. Of course, all contemporary economic traditions recognize the subjective nature of value, though the Austrian emphasis is the most thoroughgoing (Stringham 2010).Hayek (1955, 52) famously quipped, “it is probably no exaggeration to say that every important advance in economic theory during the last hundred years was a further step in the consistent application of subjectivism.” A key aspect, though, of the Austrians’ encompassing subjectivism has been to show that each person evinces not merely different preferences, but also divergent knowledge and expectations. Unsurprisingly, then, Austrians have been the most systematic exponents of subjectivism within economics, an emphasis that extends to Austrian theorizing on entrepreneurship and management (Klein et al. 2008, 4).
The subjective nature of knowledge is likely the most widely recognized aspect of Austrian subjectivism. In his much-cited 1945 paper, Hayek argued that prices serve as knowledge surrogates since “local knowledge” is not given in its totality to any single mind; rather, it is dispersed throughout society in the minds of individuals.Salerno (1990) initiated a debate, centered on the calculation literature, regarding the similarities and differences between Mises and Hayek. Specifically, Salerno (1990, 1993, 1994), Rothbard (1991), Herbener (1996), and Hülsmann (1997) argue that Mises’ emphasis on monetary calculation was substantively different from Hayek’s emphasis on knowledge dispersion. Although conceding some points advanced by the “dehomogenizers,” such as the renewed emphasis given to forward-looking appraisement, Yeager (1994), Kirzner (1996), Boettke (1998), and Horwitz (1998, 2004) argue that such a position rests on the tenuous (in their view) idea that Hayek treats prices as “sufficient statistics” in the neoclassical sense (also see Stalebrink 2004). Although these differences in interpretation are worth noting, any further adjudication of this debate is beyond the scope of this paper, as we see both sides as likely being amenable to the insights offered here. As Hayek emphasized, this knowledge “of the particular circumstances of time and place” can only be discovered in the context of a market economy.
Although Austrians have consistently integrated subjectivism with their theories of value, knowledge, expectations, and even capital (described below), they arguably have not applied it as thoroughly to institutions. This gap is puzzling given that many of the most seminal Austrian contributions (i.e., the emergence of money and law, the socialist calculation debate) either explained the origins of institutions or engaged in comparative institutional analysis (Menger [1871] 2007; 1883; Mises [1920] 1990, [1949] 1998; Hayek 1945, 1948). These contributions were deeply rooted in subjectivism, as they sought to explain real-world institutions in terms of the personal values and knowledge of the relevant actors. (The way that further application of subjectivism to institutions can provide answers and generate new research directions at the interchange of institutions and entrepreneurship is described below.)
The Austrian tradition is also widely recognized for its pioneering work on entrepreneurship and the central role accorded to entrepreneurs in driving the competitive market process (Mises [1949] 1998; Kirzner 1973; Boettke and Coyne 2003; Foss et al. 2008; Klein and Bylund 2014).A formalistic approach to entrepreneurship has gained traction in the mainstream economics profession. For example, Lazear (2004) offers a formal model of entrepreneurship with the primary prediction being that “generalists,” rather than “specialists,” will become entrepreneurs. Austrians eschew static general equilibrium models, with their assumptions of perfect information, which dominate neoclassical economics.The Austrian conception of the “evenly rotating economy” is an analogue to “general equilibrium,” though Austrians do not derive welfare implications from this construct, nor is it held as being attainable in the real world. Still, Cowen and Fink (1985) have criticized this construct. Instead, they favor a dynamic, processoriented approach—one that emphasizes how entrepreneurs utilize their unique knowledge while responding to continuous profit and loss feedback. Mises ([1949] 1998, 249) famously described the entrepreneur as the “driving force” of this process, the catalyst of change who drives the dynamism of the market economy. Whereas the defining feature of long-run equilibrium in the neoclassical approach is zero economic profits, Austrians place the ceaseless earning of profit and loss at the forefront of the dynamic market process (Mises [1922] 1951).
Austrians have advanced somewhat differing perspectives on the so-called market process. For Israel M. Kirzner (1973, 1996, 1997, 2009), the market process describes entrepreneurs’ ceaseless attempt to seize profits, which via arbitrage, continually drive disequilibrium states toward equilibrium. Continuous learning is key to this framework. Joseph T. Salerno (1993, 1994) argues for a narrower conception of market process that emphasizes how those less skilled at forecasting the future are continuously and systematically weeded from the marketplace. Arguably, both of these ideas find textual justification in Mises ([1949] 1998, [1922] 1951), but what these varying conceptions share in common is that entrepreneurs, responding to profit and loss, are the primary drivers of this competitive process, once more standing in sharp contrast to general equilibrium models, where, based on the assumptions, the entrepreneur has no role to play.
A corollary of market process analysis is that entrepreneurial decision- making cannot be characterized by stochastic models, where outcomes are unknown but which are drawn from a known probability distribution. Instead, it is better characterized by the uncertainty described by Frank Knight (1921),Klein (2010) discusses the overlap between Knight’s and Mises’s approaches to entrepreneurship and uncertainty. where the distribution of possible outcomes is itself unknown. Entrepreneurs therefore act under conditions of uncertainty, drawing on their subjective knowledge to anticipate opportunities, a function eliminated by static equilibrium models that assume perfect information and thus preclude genuine uncertainty (Mises [1949] 1998, 249–56).
The speculative function of entrepreneurship is a universal human function, not a job title or characteristic of a subset of individuals (Klein 2008). This universal speculative element owes to the fact that action is future oriented, that the future is uncertain, and that all actions therefore confer either psychic profits or losses. At the same time, the Austrian tradition also designates a specific set of economic actors as “entrepreneurs,” in contrast to wage earners, landowners, or consumers. In the Austrian framework, entrepreneurship is the element which organizes and arranges the factors of production but is not a factor of production itself.
This basic conception of the entrepreneur has generated a flurry of literature attempting to demonstrate that “innovation” (Schumpeter 1934), “alertness” (Kirzner 1973; Sautet 2018), “judgement” (Foss and Klein 2012), or “creativity” (Alvarez and Barney 2007) is the essence of the entrepreneurial function. These debates have important implications for market theory and for integrating entrepreneurship with organizational economics, but they have less direct bearing on the interface between institutions and entrepreneurship that is central to NIE literature. We concur with Matthew McCaffrey (2018, 190) that “a major advantage of [William J.] Baumol’s argument is that its value does not depend on any particular theory of entrepreneurship.” To that end, entrepreneurship is here defined as “profit seeking”—a “big tent” description broad enough to capture all major conceptions. Additionally, the phrase “entrepreneurial action” is often used, because “discovery,” “judgment,” and “creation” all require subsequent action for there to be any real-world impact.
Austrians have also long stressed the heterogeneity of capital, an emphasis that begins with Menger’s ([1871] 2007) development of an intricate capital—or production—structure. At least until the emergence of certain NIE concepts, Austrians were unique in stressing that capital is heterogeneous not only in form but also in function (Lachmann [1956] 1978; Lewin 1998; Garrison 2001). As Ludwig M. Lachmann ([1956] 1978, 2) argued, heterogeneity in function, or “use,” refers to the multiple specificity of capital goods, meaning that “each capital good can be used for a limited number of purposes.” Capital goods also vary according to their complementarity with other capital goods, a point that is implicit in Hayek’s (1945) argument. Knowledge of the “particular circumstances of time and place” includes the degree to which capital goods (and labor) are substitutable for one another.
As with subjectivism, capital heterogeneity and entrepreneurship are inextricably linked. Entrepreneurs must continuously allocate capital goods to what they perceive is their most profitable use, which requires that they judge their complementarity (Mises [1949] 1998, 252-254; Lachmann [1956] 1978; Foss 2012).Mises (1949, p253) emphasizes this point, noting that “the various complementary factors of production cannot come together spontaneously. They need to be combined by the purposive efforts of [entrepreneurs].” The heterogeneous attributes of capital goods must first be subjectively perceived and interpreted by entrepreneurs before they can be integrated into their production plans (Kirzner 1966). A key aspect of entrepreneurship, then, is exercising judgment over how to best combine and utilize heterogeneous capital goods (Foss et al. 2007). As Lachmann ([1956] 1978, 16) notes, “As long as we disregard the heterogeneity of capital, the true function of the entrepreneur must also remain hidden.”
New Institutional Economics NIE arose in the latter half of the twentieth century as an effort to revive core elements of classical political economy and to return institutions to the forefront of economic analysis. Rooted in Ronald H. Coase’s seminal contributions (1937, 1960), the term new institutional economics was coined by Oliver E. Williamson in 1975. NIE, which came to represent an amalgam of transaction cost, property rights, law and economics, public choice, and agency theorizing, blossomed around the time the Austrian tradition was experiencing its own revival, sparked by seminal publications (Rothbard [1962, 1970] 2009; Kirzner 1973), the famed South Royalton conference in 1974, and Hayek’s Nobel Prize in 1974. NIE scholars frequently addressed institutional issues that, with a few notable exceptions, were not systematically examined by Austrians in the decades between the Keynesian Revolution and the Austrian revival (Foss and Klein 2009). Coase and Williamson devised transaction cost theories of the firm and other organizations. Armen A. Alchian and Harold Demsetz (1972), Steven N. S. Cheung (1983), and Yoram Barzel (1997) offered somewhat differentiated transaction cost theories of the firm, while also seeking to explain how alternative property rights arrangements affect and are affected by economic activity.Just as in the case of the Austrians, these contributions are not monolithic and scholars continue to debate their commensurability. For example, Coase (1937) focused primarily on the transaction costs associated with discovering market prices, whereas Williamson focused on the transaction costs stemming from the ex post appropriation of quasi rents (Bylund, forthcoming). Similarly, Williamson (1991) argued that Alchian and Demsetz (and, by extension, Cheung) were mistaken to downplay the hierarchical nature of the firm. North and Baumol examined the role that society-wide institutions play in providing a framework for economic activity.
What unites these various strands of research is their focus on the role that institutions—the “humanly devised constraints that structure human interaction”—play in providing guideposts for human activity (North 1994, 360; Foss and Garzarelli 2007). Naturally, NIE’s emphasis on how institutions structure incentives has had an important influence on the emerging economics of entrepreneurship. This focus on the guiding role of institutions for entrepreneurial actors was most famously noted by Baumol (1990), who argues that what differs between nations is not the supply of entrepreneurial talent but its allocation between productive (e.g., innovation), unproductive (e.g., rent seeking), and destructive (e.g., crime) activities. This allocation is determined by the relative payoffs that a society offers to such activities, and these payoffs are determined by the prevailing institutions (Baumol 1990; Boettke and Coyne 2003; Boettke and Piano 2016; Lucas and Fuller 2017; McCaffrey 2018). The primary conclusion is that entrepreneurship is a proximate cause of growth but institutions are the fundamental cause.
Baumol’s classic 1990 paper has sparked a research program spanning both NIE and the “mainstream” entrepreneurship literature, with scholars deploying his framework to explain variation in the allocation of entrepreneurial activity across different nations—that is, why some nations have high rates of productive entrepreneurship while others have a larger share of unproductive activity (see, for instance, Coyne and Leeson 2004; Acs 2008; Aidis, Estrin, and Mickiewicz 2008; Sobel 2008; Bjørnskov and Foss 2008, 2016; Minniti 2008; Estrin et al. 2013; Stenholm et al. 2013). Furthermore, Baumol’s work opened the door to extending entrepreneurship beyond the application to “productive activity” found in the works of Mises, Murray N. Rothbard, and Kirzner. At the same time, his framework stands to be enriched by further incorporation of subjectivism, process, and heterogeneity––a project that is advanced in the final section of this article.McCaffrey (2018) notes that Baumol’s account also overlooks uncertainty.
FINDING COMMON GROUND: SYNTHESIZING AUSTRIAN AND NIE SCHOLARSHIP Institutional Environments
What might a synthesis between the Austrian and NIE approach look like, specifically for furthering our understanding of the institutions-entrepreneurship nexus? To answer this question, one first must ask whether a synthesis is possible given the methodological differences between the two traditions. Certain strands of NIE are, indeed, deeply rooted in neoclassical economics, though it is generally seen as a relaxation of the stricter, more unrealistic assumptions of the neoclassical framework (Eggertsson 1990). Given that Austrians came to understand their unique identity in a sharp critique of core aspects of the emerging “neoclassical synthesis” during the socialist calculation debate, some may question whether such an integration is possible.For this reason, Palermo (1999, 277–78) argues that the Austrian and NIE traditions are “methodologically incompatible.” NIE analysis dating back to Coase, he argues, is “explicitly developed within a neoclassical context.” Its goal, according to Williamson (1985), is to explain all capitalist institutions by means of neoclassical tools and assumptions. Palermo therefore concludes that any attempt to reconcile the two traditions is “fundamentally misguided.” We disagree strongly with this conclusion. It is worth noting, for instance, that both traditions have leveled critiques of Walrasian general equilibrium (Mises [1949] 1998; Kirzner 1997; North 1990; Barzel 1997).
To provide an overview of the Austrian assessment of NIE, we find it useful to follow Lance Edwin Davis and North (1971) in distinguishing between the “institutional environment” (society- wide rules that often arise spontaneously) and “institutional arrangements” (organizations that are usually the consequence of conscious design).See Klein (2000) for a discussion of the distinction between the “institutional environment” and “institutional arrangements.” This bears a striking semblance to Menger’s distinction between “organic” and “pragmatic” institutions and Hayek’s distinction between “cosmos” and “taxis,” or planned versus spontaneous orders. Sometimes the distinction is described as being between “institutions” and “organizations,” though admittedly, this line is not always easy to draw and some have challenged its existence altogether (see, for example, Cheung 1983).
Most Austrian criticism of NIE has focused on institutions, specifically Coase (1960), the locus classicus of what, under Stigler’s influence, came to be known as the “Coase theorem.” Austrian scholars advanced the idea that Coase was hostile to private property rights because his work can be read as suggesting that courts could reallocate rights on the basis of perceived willingness to pay when transaction costs are prohibitive (Block 1977, 1995; Rothbard 1979, 1982; Lewin 1982; Cordato 2004; Hülsmann 2004). Additionally, Austrians have argued that courts striving for Kaldor-Hicks efficiency encounter insuperable difficulties, namely that subjective costs cannot be aggregated and that assigning property rights encounters the calculation problem (Rizzo 1980; Lewin 1982; Stringham 2001). Given the “Posnerian” wealth maximization appropriation of Coase, such criticisms are justifiable, yet they may also explain why there has been more synthesis of Austrian ideas with NIE thinking on “organizations,” rather than with “institutions” proper.
Institutional Arrangements
With a few notable exceptions, Austrian assessment of NIE contributions to organizations has been largely positive, beginning with Rothbard ([1962, 1970] 2009) and including Nicolai J. Foss and Peter G. Klein (2012). The first noteworthy exception is Donald J. Boudreaux and Randall G. Holcombe (1989), who argue that the Coasian equilibrium framework is in tension with Austrian concerns for disequilibrium, and the second is Per Bylund (2014), who argues that Coase (1937) was attempting to provide justification for central planning. In contrast to these misgivings, Klein and Foss develop a theory of the firm—a subject that has been the primary NIE focus from its beginning—by incorporating Austrian insights into a framework that is grounded in Coase (1937; Klein 1999; Foss and Klein 2009, 2012). Foss and Klein (2012) see the Austrian emphasis on the entrepreneur as necessary for a robust theory of organization, arguing that entrepreneurs establish firms because the judgment they exercise is noncontractible and can thus only be expressed by forming a firm.The emphasis on firm formation as a way for entrepreneurs to express the noncontractible element of the entrepreneurial function is also present in Manne’s (2014) argument that entrepreneurship should be viewed as idea generation. It is also closely related to Barzel’s (1987, 1997) notion that the residual claimant will be the party whose contribution to production is costliest to measure. Note that the Kirznerian (1973) concept of “alertness” is also noncontractible.
More recently, Ennio E. Piano and Louis Rouanet (2020) have argued that NIE scholars should incorporate insights bequeathed by the calculation debate. For their part, Austrian scholars ought to adopt a greater appreciation for the fact that private property rights are costly to establish and the corollary that, even in unhampered markets, not every asset will be privately owned due to the existence of transaction costs (Barzel 1997; Allen 2000; Piano and Rouanet 2020).the party whose contribution to production is costliest to measure. Note that the Kirznerian (1973) concept of “alertness” is also noncontractible. Furthermore, Piano and Rouanet (2020) maintain that economic calculation over which property rights to establish can only occur in an institutional environment where some prices already exist and are free to arise. However, like Foss and Klein (2012), Piano and Rouanet (2020) develop their arguments in the context of organizational economics. Thus, one irony given the Austrians’ Mengerian origins is that in the last thirty years Austrian work in “institutions and organizations” has tended to shift toward “institutional arrangements” and away from the “institutional environment.” Yet, although the focus of their own argument is on organizational issues, Piano and Rouanet (2020, 16) hope their work “will build a bridge” between NIE and AE “with respect to…interventionism, entrepreneurship, and the economic analysis of law.”
A Path Forward
A call for integration between the two traditions is supported both implicitly by NIE thinkers who have developed similar concepts to those in the Austrian tradition and explicitly by other scholars who have developed direct arguments in favor of synthesis. Implicit support for integration can be found in the mutual emphasis on (some form of) certain concepts ignored in the sterile general equilibrium approach. These concepts include a shared focus on (some form of) capital heterogeneity, exemplified in Williamson’s “asset specificity” or Barzel’s “attributes” (Lachmann [1956] 1978; Williamson, 1975, 1985; Barzel, 1982, 1997). Additional Austrian themes can be found in other aspects of Williamson’s transaction cost economics, such as his frequent citations of Hayek on the nature of knowledge and adaptive learning (cf. Williamson 1985, 8). Similarly, North credits Hayek’s work on how knowledge is generated and transmitted through time, specifically highlighting his idea of “collective knowledge,” socially useful learning that is embodied in institutions as they evolve (North 1994, 364).Also note the heavy citations of Hayek by North in his work on institutional change (North 2005).
Of course, drawing a direct line of influence between Austrian themes and the development of NIE thought is fraught with difficulty.See Bylund (2014) for one such attempt which draws this conclusion. Still, these overlapping themes are worth noting, especially as explicit calls for integration have been sounded by scholars such as Richard N. Langlois (1992, 165), who was among the first to outline points of tangency between the two traditions. Like the NIE tradition, he argues, “the Austrian school of economics is and has been fundamentally concerned with the theory of social institutions.”
This concern can be seen in Mises, who combined institutional analysis with a processual perspective by endogenizing institutions all while conducting institutional analysis using choice theoretic tools, methods that later became a staple of the NIE approach (Foss 1997). That Mises consistently rooted his institutional analysis in a market process approach is best exemplified in the socialist calculation debate. As he famously remarked, “the problem of economic calculation is of economic dynamics: it is no problem of economic statics” (Mises [1922] 1951, 139). Unlike the general equilibrium approach, Mises’s analysis was not constrained by unrealistic assumptions of perfect knowledge or static equilibrium, and unlike old institutionalists, his analysis of institutions was not beholden to excessive historical details or atheoretical descriptions. The institutional analysis practiced by Mises therefore occupied a middle ground between formalism and old institutionalism (Lavoie 1985).Nonetheless, the institutional context was so front and center in Mises’s analysis that Lange accused him of being an old institutionalist for his emphasis on the importance of private property (Boettke 2018). As Foss (1997, 77) argues, Mises was “much more than a precursor” to NIE; he, in fact, managed to “blend institutional and process analysis in a way that is still yet to be achieved by modern neo-institutionalists.”
Hearkening back to one of the key Menger-Mises themes, more recent scholarship has renewed the call to explain the origins and evolution of institutions using the tools of economics (Leeson 2012).This view is in stark contrast to Coase and Kirzner, who preferred to take institutions as exogenous with the task of the economist being to examine the economic activity occurring within those rules (Coase 1977; High 2009; Leeson 2012; Boettke 2014). As Menger himself asked, “How can it be that institutions which serve the common welfare and are extremely significant for its development come into being without a common will directed toward establishing them?” (1883, 146). The following section shows that in the same way that Austrian insights have enriched NIE understanding of organizations, AE-NIE integration can also enhance our understanding of the institutions-entrepreneurship “black box.”
TOWARD AN INTEGRATED RESEARCH PROGRAM IN INSTITUTIONS AND ENTREPRENEURSHIP Institutions and Subjectivism
Within-Institution Entrepreneurial Variation
Although the literature inspired by Baumol (1990) can be described as an “empirical success story” in explaining variation in entrepreneurial activity between nations, it has generated fewer answers regarding what causes entrepreneurs within a given nation to respond to the same institutional rules in vastly different ways. As Christopher J. Boudreaux, Boris N. Nikolaev, and Peter Klein (2019, 1202) describe Baumol’s approach, “incentives are clear and unambiguous and do not need to be interpreted.” In other words, once institutions are exogenously determined, “Baumolian” entrepreneurs seemingly respond to the institutional environment by solving an objectively given maximization problem, that is, by directing their energies toward “productive,” “unproductive,” or “destructive” efforts (McCaffrey 2018). This approach renders the Baumolian “entrepreneur” little different from the “entrepreneur” (really, manager) of neoclassical producer theory, who “chooses” (really, reacts) to a given constellation of prices. The Baumol framework is certainly valuable for explaining differences in the overall allocation of entrepreneurial talent between nations, where the rules may vary considerably from one society to the next. To put it another way, this approach is helpful in generating an “average treatment effect” of the institutional environment. However, this framework has had less success explaining why entrepreneurs within the same country (and even producing similar products) often interpret and respond to the same rule in different ways.
Until recently, this question has received little attention. Preliminary attempts at addressing this puzzle can be seen in the emerging literature that examines the range of potential entrepreneurial responses to various institutional rules. This work expands on Baumol (1990) by demonstrating that entrepreneurial response, like entrepreneurial outcome, may also be divided into three broad categories: entrepreneurial actors may abide by, alter, or altogether evade the rules of the game (Coyne and Leeson 2004; Li, Feng, and Jiang 2006; Henrekson and Sanandaji 2011; Elert and Henrekson 2016). An abiding strategy refers to entrepreneurial action that complies with the institutional status quo; an altering strategy occurs when entrepreneurs lobby rule makers for change; an evasive strategy seeks to circumvent the rules entirely (Henrekson and Sanandaji 2011; Elert and Henrekson 2017).
Although this taxonomy of entrepreneurial response to the institutional context has expanded Baumol’s taxonomy, additional research ought to explore the factors that influence an entrepreneur’s decision to abide, alter, or evade. Perhaps one reason why NIE scholars have not made more progress on this question is because the standard neoclassical toolkit has limitations that render it difficult to open this black box. For instance, many, though certainly not all, NIE scholars have treated the formal institutional rules that govern a society as not only objectively given to entrepreneurs, but also uniformly interpreted by them.Leeson’s (2012) distinction between the “Coasian” and “Posnerian” approach to institutions is apropos. The former approach takes institutions as both exogenous and beyond the reach of economics to explain. Within economics, Allen (2011) and Leeson (2017) are excellent examples of endogenizing a wide range of social institutions to the choices of individuals who solve problem situations by devising new institutional constraints.
Incorporating Austrian insights may shed light on the question of why entrepreneurs adopt different strategies by further “disaggregating” the relationship between entrepreneurship and institutions. Entrepreneurs possess not only different values and preferences, but also different knowledge and expectations of the future. Institutions are therefore perceived as they are filtered through the subjective lens of each economic actor. This implies that all entrepreneurs face differing and subjectively determined costs and benefits associated with alternative ways of interacting with the institutional environment. They also possess different propensities for noticing perceived profit opportunities.
Imagine two rock climbers attempting to surmount the same wall at a rock-climbing gym. In this case, the constraint of geography is undoubtedly “real,” but the perception of it must still be filtered through the climbers’ minds. An unnuanced reading of Baumol (1990) may tempt some economists to assume that each climber’s (i.e., entrepreneur’s) approach to this challenge will be identical because the challenge they face is identical—they are both trying to summit the same (objective) rock formation. But the “institutional entrepreneurship” literature has highlighted that such an assumption is likely misleading (Henrekson and Sanandaji 2011; Elert and Henrekson 2020).
Consider the following reasons for why one of the climbers may attempt a different approach to ascending the rock wall. Suppose one climber has already scaled that particular wall or was able to learn from observing the successes and failures of other climbers (in other words, he is more experienced). To explore another possibility, suppose a climber is being radioed by his friend who works at the gym and who is able to describe a pass that remains hidden to the climbers from their current vantage point. In either of these cases, both climbers seemingly face the same objective constraint. Yet one has unique (i.e., subjective) knowledge about a superior route that may not be visible to the other climber from their current vantage point. In Hayek’s words, one climber’s superior knowledge of the “particular circumstances of time and place” may lead him to adopt a different route.
The analogy is somewhat crude. Nevertheless, it conveys the point about how two actors may adopt different strategies based on their subjective perceptions of what is seemingly the same objective constraint. In this example, one climber not only perceives the costs and benefits of a route differently than his counterpart, but he may also be aware of a route that is hidden to his friend. This analogy suggests two important avenues of research. The first possibility, that each climber simply assesses the costs and benefits of alternative routes differently, demonstrates that “judgment” is required in all contexts (Boudreaux, Nikolaev, and Klein 2019). A subjectivist perspective emphasizes that, even when placed in identical environments with identical knowledge, not all entrepreneurs will form the same conjectures about the future, perhaps due to differing sociocognitive traits or other factors that lie beyond the realm of economics and in the domain of thymology (Boudreaux, Nikolaev, and Klein 2019).
The second possibility, that entrepreneurs may possess differential knowledge, suggests that more remains to be understood about the use of institutional knowledge in society. Austrians are known for their concern with the epistemic properties of institutions, but to the extent that they have developed this research agenda, they have tended to focus on how different institutional environments influence entrepreneurial learning in market settings, such as how alternative contract regimes facilitate or impede the market process (Wonnell 1985). Although an important line of inquiry, understanding how market actors acquire knowledge of their institutional environment is another promising topic.
Knowledge of institutions includes awareness of “institutional contradictions,” such as when the costs of regulation are prohibitively high. Levying noncompliance fines on AirBnB hosts in New York City is one example, as the costs of monitoring by regulators are prohibitive in this case, allowing for a profitable opening (Elert and Henrekson 2016). It also includes knowledge of the institutional players themselves, of their ideologies, experiences, and what they can do for market-based entrepreneurs in particular contexts. Unsurprisingly, the importance of these considerations grows when the agency in question wields discretionary powers (Newman 2019).
A way for Austrians to build on these insights is in developing a concept that parallels the so-called knowledge filter of mainstream entrepreneurship literature. The knowledge filter either facilitates or impedes the diffusion of technical knowledge (Acs et al. 2004). Factors such as the university innovation system and the structure of intellectual property rights comprise the “filter,” determining how much technological knowledge disseminates to others who then deploy it in new entrepreneurial ventures. Yet, in many circumstances, knowledge pertaining to the institutional environment can be just as important for profit seekers as is technological know-how. This is particularly true in environments with a large divergence between de facto and de jure rules.
A concrete example of the importance of institutional knowledge is the informal blat system of graft that enabled superior navigation of the commercial realm during the post-Soviet transition years (Ledeneva 2009). Being “embedded” in this informal and corrupt network proved a key determinant of entrepreneurial success in this environment (Aidis, Estrin, and Mickiewicz 2008). Social embeddedness was critical for understanding which rules would be enforced and which officials were susceptible to bribery. Given their historic strength in examining “organic” institutions, Austrians might turn their attention to exploring the emergence and roles played by such “meso-level” institutions as informal or black market networks (Kim, Wennberg, and Croidieu 2016). “Meso” institutions, the informal network of ties that exists “between” formal institutions and spontaneously arising norms, may thus enable some entrepreneurial action even in contexts subject to regime uncertainty, but the extent of it is not yet well understood (cf. Bylund and McCaffrey 2017).
More obvious in transition economies, the divergence between de facto and de jure is important in less corrupt environments too, suggesting a list of questions that Austrians are poised to address (Colombatto 2003). Is institutional knowledge diffused through meso-level networks? Are such networks an emergent response to weak formal rules? Are entrepreneurs without political or informal connections more likely to engage in evasive entrepreneurship due to their unfamiliarity with the rules and rule makers? Most importantly, can attention to institutional knowledge help scholars understand within-country entrepreneurial variation and therefore within-country economic development? To provide concrete answers for this variation, scholars should conduct intensive research that takes subjectivism seriously by allowing for a looser link between “given” institutions and entrepreneurial response.
Economic vs. Legal Property Rights
Applying subjectivism to institutions helps to avoid the pitfalls in the seemingly harmless assumption that there is no ambiguity, contradictions, or gaps in a society’s formal rules, nor in the interstices formed by imperfect alignment between formal and informal rules (Boettke, Coyne, and Leeson 2008). One notable NIE scholar sidesteps this pitfall by offering what might be considered an idiosyncratic definition of property rights but one which bears marked similarities to the way that Mises understood property rights. Barzel (1994, 394) defines a property right as “an individual’s net valuation, in expected terms, of the ability to directly consume the services of an asset, or to consume it indirectly through exchange.” He adds: “A key word is ability: The definition is concerned not with what people are legally entitled to do but with what they believe they can do,” (ibid. 1994, 394). Meanwhile, Mises ([1949] 1998, 678) defines a property right as “full control of the services that can be derived from a good.” Kirsten Foss and Nicolai J. Foss (2002) argue that Barzel’s conception of a property right, by placing the emphasis on individuals’ beliefs, is highly consistent with the subjectivism of the Austrian tradition.Both Barzel (1994, 1997) and Mises (1949) identify control as the locus of ownership. However, Barzel’s definition is arguably rooted in “expected utility,” a framework which Mises rejected for its failure to incorporate true uncertainty. Substituting the word belief for expectations, as the second part of Barzel’s definition does, certainly bring the two conceptions closer together.
In his landmark 1997 text, Barzel describes how this definition leads naturally to a distinction between “economic” and “legal” property rights, where the former are what a person can actually do (de facto), while the latter are what the legal apparatus, usually the state, permits (de jure). Despite the subtle differences in these definitions of property rights, this foregoing distinction can also be found in Mises ([1922] 1951), who emphasizes the distinction between “having” something and legal ownership, stating: “Economically, however, the natural having alone is relevant, and the economic significance of the legal should have lies only in the support it lends to the acquisition, the maintenance, and the regaining of the natural having,” (p. 37, emphasis in original). We concur with Foss and Foss (2002) and Piano and Rouanet (2020) that this Mises-Barzel distinction is more than mere theoretical curiosity. Indeed, it has already been deployed in Austrian work on organizational economics. In similar fashion, incorporating this subjectivist understanding of property rights into the analysis of society-wide institutions also has important implications for how scholars might conduct research at the institutions-entrepreneurship interface.
Take the work on legal origins by Andrei Shleifer and various colleagues, which is among the most cited economics research of the last three decades. This research seeks to illuminate the influence of legal institutions, such as shareholder rights, on commercial activity and economic growth.See Glaeser and Shleifer (2002) and La Porta, Lopez-de-Silanes, and Shleifer (2008) for overviews of this literature. Some scholars have even argued that this body of work represents a “missed opportunity” for those in the Austrian tradition because it essentially turns Hayek’s arguments on law into an empirically testable research agenda (Subrick and Beaulier 2004).Arguably, another missed opportunity for Austrians is the “new economics of management” literature, which examines the connection between labor regulations and management practices worldwide (Bloom and Van Reenen 2010; Bloom et al. 2019). It can be interpreted as empirical support for Mises’s argument that “bureaucratization” of business is a result of government intervention (Mises 1944; Klein 1999, 36).
The work of Shleifer (and coauthors) might be faulted for relying too heavily on de facto measures of institutional quality. Though having missed the opportunity of generating this literature, Austrians still have the opportunity of sidestepping these criticisms of overreliance on de facto measures by embracing the Mises- Barzel definition of property rights in their empirical work. To do this, scholars might conduct surveys of entrepreneurs to ascertain their perceptions—their “expectations,” in Barzel’s terminology—of the institutional environment. Such an approach is particularly important because Austrian work in the theory of institutions has emphasized that formal institutions only “stick” when they exhibit strong correspondence with the underlying, informal norms of a society (Boettke, Coyne, and Leeson 2008; Williamson 2009). Some preliminary work in this direction has already been conducted by mainstream scholars, such as Simon Johnson, John McMillan, and Christopher Woodruff (2002), who survey entrepreneurs about the institutional environment in transition economies and reject the hypothesis that liquidity constraints are responsible for low reinvestment rates.Shleifer and Fyre (1997) have employed a survey method to investigate entrepreneurs’ perceptions of government quality in transition economies. Public predation is the culprit.
This subjectivist approach to institutions accounts for “what people think and believe” (Hayek 1943), their expectations about the “institutional environment,” and thus helps to open the “black box” of de facto measures. By incorporating the Misesian (and NIE) distinction between “legal” and “economic” property rights, scholars can better build on the empirical forays into the institutions-entrepreneurship relationship (Bowen and DeClerq 2008; Bjørnskov and Foss 2008; Sobel 2008). A subjectivist approach naturally suggests that scholars investigate the moderating and mediating interactions of formal and informal institutions (which may be measured via survey) for entrepreneurial outcomes. How important are “productive” formal institutions if the underlying informal institutions are sound (and vice versa)? This approach also suggests the development and use of more fine-grained measures of the informal institutional environment, such as asking entrepreneurs questions about their commercial interactions with others, as a substitute for the typical reliance on society-wide measures of “trust.”
Institutions and Process
Intended Institutional Change
NIE scholars have criticized general equilibrium models that assume perfect information and zero transaction costs and are thus poorly suited to explain why and how economies and their institutions evolve. Indeed, as has been widely noted, such models are ill equipped to explain the very existence of institutions at all. In his Nobel Prize address, North (1994, 359) pinpointed these shortcomings. “Neoclassical theory,” he argued, “is simply an inappropriate tool to analyze and prescribe policies that will induce development.” North even acknowledges that one of the goals of economic historians working in the NIE tradition is to “not only shed new light on the economic past, but also to contribute to economic theory by providing an analytical framework that will enable us to understand economic change” (359). He concluded that economists studying institutions need to shift from general equilibrium models that posit a “static and frictionless world” and toward a dynamic framework “capable of increasing our understanding of the historical evolution of economies over time”––one that takes seriously how “the learning process of human beings shapes the way institutions evolve” (360).
North’s plea for scholars of institutions to discard static equilibrium models in favor of a dynamic framework invites those who embrace the compositive method adopted by Austrians dating back to Menger in his pioneering analysis of the origins of money. As Langlois (1992, 170) notes, this causal-genetic approach explains how social institutions evolve over time by “tracing out a sequence of events rather than merely constructing the conditions for an equilibrium.” This approach to institutional analysis relies on “invisible hand explanations” built on the foundations of subjectivism and methodological individualism, allowing it to explain social phenomena as emerging in bottom-up fashion from the purposive actions of individuals.
For Austrians, entrepreneurial action is the driving force behind this institutional evolution. Identifying the entrepreneur as the catalyst of change has allowed Austrians to avoid the puzzle posed by Kenneth J. Arrow (1959), who pondered who is responsible for changing prices in a general equilibrium world. However, similar quandaries may be generated by viewing institutions as merely exogenous constraints to which entrepreneurs helplessly react. Adopting such a perspective would import a version of the bloodless price-taking “entrepreneur” (really, producer) who populates the static world of general equilibrium models.
By contrast, incorporating an entrepreneurial agent who drives institutional change is important, because, by NIE scholars’ own admission, institutional dynamics are largely treated as a “black box.” Perhaps nothing better illustrates this claim than the Demsetz (1967) analysis of the transition from common to private property. In this landmark account, changes in the relative costs and benefits of private property are translated seamlessly into a change in the property regime. To paraphrase Garrison (1995), “it’s ‘costs and benefits’ the whole way down.” Because of their focus on process over equilibrium states and their emphasis on entrepreneurs as catalysts of change, Austrians are well positioned to contribute to theories of institutional evolution (Leeson and Suarez 2015). To be sure, repeating the phrase “entrepreneurs matter” as an explanation for institutional change is no better than repeating the mantra that “institutions matter” to explain economic outcomes. What is needed are “entrepreneurial microfoundations” that illuminate the mechanisms by which entrepreneurs spur institutional change.
Jack High (2009) offers one such account in which new institutions emerge as a result of entrepreneurial actors attempting to realize “gains” (not necessarily money profits). In this story, an alert entrepreneurial actor introduces an “institutional innovation,” such as indirect exchange. The second step in this sequence also requires an act of entrepreneurship. As High argues, a second adopter of the new institutional innovation must recognize it and then decide upon adoption. He notes: “Observation requires alertness of the kind emphasized by Kirzner; deciding whether or not to adopt the new practice requires judgment in the face of uncertainty, as emphasized by Mises” (High 2009, 8). That economic activity takes place in close social proximity provides opportunity for “observation and communication” (8). People are convinced to adopt the institution via “imitation” (emphasized by Menger) and persuasion (not explicit in Menger’s story). High deploys this framework to examine the emergence of money, the division of labor, accounting, and the transition from common to private property.
High’s analysis is fruitful because it raises a host of research questions that Austrians are positioned to integrate with existing thinking on institutional change. For example, appealing to Williamson’s (2000) hierarchical approach to analyzing institutional structures, Bylund and McCaffrey (2017) describe how entrepreneurs shift activity between institutional “levels” when government policy reduces the profitability of acting on one level relative to others. The highest level in Williamson’s hierarchy— L1—consists of informal norms and rules (i.e., religious beliefs, customs, etc.), and Williamson contends that L1 changes only slowly, usually on the scale of a century to a millennium. Bylund and McCaffrey (2017, 461, 465) likewise argue that “entrepreneurs can experience extreme difficulty when trying to act in L1,” because the “social embeddedness level (L1) is far less amenable to direct and frequent change.”
However, Robert C. Ellickson (2001) advances a theory of “norm entrepreneurs,” while North (1990) sketches the concept of “ideological entrepreneurs,” developed further by Virgil Henry Storr (2011). These change agents aim at shifting society’s slowest moving, most spontaneous rules. Austrians will appreciate the general thrust of Ellickson’s theorizing because of his explicit emphasis on purposive action but will also find ways to improve and extend his analysis. For example, Ellickson’s (2001) entrepreneurial actor is someone who simply adjusts conditions to changes in the relative prices imposed by changing constraints, rather than acting as an agent who might also introduce relative price changes. Secondly, Ellickson’s analysis focuses on individuals who introduce norm changes to gain social applause, but what of entrepreneurs who introduce “L1” changes in anticipation of money profits because a combination of government intervention and existing norms would otherwise curtail their ability to do so? To what extent, and when, do market entrepreneurs undertake “norm entrepreneurship” as a means of augmenting their profitability? Because such pursuits have society-wide implications, are they often pursued collectively by profit seekers, and if so, what institutional innovations do entrepreneurs implement to monitor and enforce contribution to this “public good” (Dorobantu, Kaul, and Zelner 2017)?
Regardless of one’s stance on the alterability of L1 rules, research on intentional institutional change by entrepreneurs, even that occurring at a lower level of Williamson’s hierarchy, raises a host of questions that Austrians are poised to address. The first question has to do with the nature of the feedback guiding an actor like High’s “institutional entrepreneur” (our term, not his). Entrepreneurial activity within the context of private property yields money prices, profits, and losses, which facilitate monetary calculation. Does entrepreneurial activity over the rules of the game also generate high-quality feedback (Boettke and Coyne 2009, 192–95)? What substitutes for money profits and losses when entrepreneurship is occurring over the institutional prerequisites to profit-and-loss accounting?
Second, Austrians might deploy this step-by-step approach to better understand entrepreneurial solutions to the “grand challenges” that societies face, such as the private provision of goods with “publicness” characteristics, the prevention of war, the mitigation of diseases, development, immigration, aging populations, or the supplying of “missing” institutions.See George et al. (2016) for a discussion of how management scholars are tackling “grand challenges.” On this last topic, Boettke and Peter T. Leeson (2009) show that, especially for the underdeveloped world, the traditional view of entrepreneurs acting within a given institutional framework is highly deficient.This point is also applicable to many “pockets” of underdeveloped institutions in the developed world. See, for example, David Skarbek (2014) on prison gang governance. In underdeveloped nations, formal institutions of property and contract enforcement are often severely lacking (Rajan 2004). Because there is gain to be had in supplying this missing framework, entrepreneurs work to directly supply these institutions. Once again, though, questions of feedback arise. There are also questions about the antecedents to success; for instance, how weak must public governance be for entrepreneurs to successfully provide and enforce the overarching legal framework?
Third, some Austrians have argued that market entrepreneurship yields a “multiplier effect” whereby entrepreneurial action generates subsequent profit opportunities (Holcombe 1998; Coyne, Sobel, and Dove 2010).Hülsmann (1999) disputes this mechanism by arguing that it is impossible to know whether an act of entrepreneurship, on net, creates additional opportunities for subsequent entrepreneurship. He also objects to what he sees as a passive conception of entrepreneurship in Holcombe’s argument. Holcombe (1999) responds by granting that it is impossible to know the counterfactual pertaining to additional acts of entrepreneurship. However, he makes the subtler point that the new opportunities are better suited to satisfying consumer preferences. The mechanism by which this occurs has been spelled out for market entrepreneurship within a set of institutional rules. Austrians might contribute to the entrepreneurship literature by examining whether similar mechanisms are at work in the case of institutional entrepreneurship. Lastly, the High (2009) account is focused on institutions which arise out of purely voluntary interactions, so what must be modified to understand the evolution of institutions, such as slavery, which are undergirded by violent actions?
Unintended Institutional Change
Although the High (2009) analysis suggests that institutional change results from an entrepreneurial actor who explicitly attempts to alter the existing institutional framework, this is not always the case. Entrepreneurs may (unintentionally) reinforce the status quo through abiding entrepreneurship or (unintentionally) alter that status quo through evasive entrepreneurship, even when institutional alteration is not their explicit aim (Elert and Henrekson 2016, 2020). As an illustration, David S. Lucas and Caleb S. Fuller (2018) explore the “market-making” activities of entrepreneurs in the face of interventionist policies. Certain interventions—such as bounties—“commodify” products which did not previously possess “goods-character” in the Mengerian sense. For example, they describe how entrepreneurs increased the supply of pests for which public authorities had set a bounty. In the cases they examine, entrepreneurship undermined the stated rationale of the intervention, leading to its eventual repeal. Institutional alteration was the outcome, though not the intention, of the market-making entrepreneurs who responded to the intervention.
Similarly, Niklas Elert and Magnus Henrekson (2016) describe how evasive entrepreneurship may also foster formal institutional change, despite that not being any entrepreneurial actor’s explicit intent. Consider the following examples that they provide: the success of Chinese farmers’ (illegal) experiments with private property subsequently undergirded arguments that facilitated China’s move in the 1990s toward agricultural privatization; a private network of TV stations in Italy undermined the public telecommunications monopolies; and the rise of Uber caused taxi monopolies to implement “surge pricing” to compete with their new rivals.
These examples are preliminary attempts at opening the “black box” that conceals the mechanisms by which entrepreneurs generate institutional change; much more work is yet to be done. For example, is institutional change usually a result of intentional action by entrepreneurs, as in the case of “altering” activity (Elert and Henrekson 2017), or is institutional evolution more commonly an unintentional by-product of entrepreneurial behavior, as in the cases described by Lucas and Fuller (2018)? Furthermore, evasive entrepreneurship clearly does not always precipitate formal institutional change. Uber’s evasive activity vis-á-vis taxicab monopolies has eroded the latter’s rents and forced pricing adjustments, but has not yet generated wholesale repudiation of transportation licensure.
Additionally, when evasive entrepreneurship does generate institutional change, the mechanisms driving that change are also largely unclear. For example, some instances of evasive entrepreneurship might render a public monopoly unprofitable, whereas others might bring public pressure to bear on existing institutions. In yet other cases, evasive entrepreneurship might simply serve as the template for public entrepreneurs attempting to implement reforms (Klein et al. 2010).Cf. DiLorenzo (1988). Future research might explore the conditions under which evasive entrepreneurship tends to result in explicit institutional change while also better enumerating the mechanisms by which evasive entrepreneurial activity translates into institutional change.
Institutions and Heterogeneous Capital
Another hallmark of the Austrian tradition is its emphasis on capital as a network of interconnected, heterogeneous, and multispecific produced factors of production (Mises [1949] 1998; Lachmann [1956] 1978; Rothbard [1962, 1970] 2009; Kirzner 1966; Lewin 1998; Powell 2010; Burns 2018a). This stands in marked contrast to mainstream economic theorizing going back to Knight that treats capital as an undifferentiated blob of “shmoo” (Foss and Klein 2012, 105–07). Historically, the Austrian emphasis on capital heterogeneity has played an important role in macroeconomic or systemwide analyses, specifically trade cycles and the calculation debate.Famously, it was Mises’s emphasis on capital heterogeneity that led Frank Knight to pan Human Action. Capital heterogeneity featured prominently in the calculation debate, because if capital goods are costlessly interchangeable between production processes, the calculation problem becomes much less severe even if not altogether irrelevant.There is ambivalence on whether perfect capital homogeneity would eliminate calculation problems. Horwitz (1998, 438) states: “If all capital goods are perfectly substitutable, no calculation is necessary….If all capital goods are perfectly specific, such choices are also not necessary.” Foss (2012, 152–53) argues: “In fact, even if capital were homogeneous, there would still be calculation problems left (how much homogeneous capital to devote to production now versus later).” Foss and Klein (2012) cite Mises ([1949] 1998) saying that only “trivial calculation” problems exist in a world of “shmoo” capital. It was also a centerpiece of early twentieth-century Austrian development of the trade cycle. This emphasis continues to this day, particularly as mainstream macro continues to deploy homogenizing assumptions about capital that obscure the ways that monetary policy generates booms and busts (Garrison 2000; Boettke and Piano 2019).
Given these historical foci, there is promise in examining the more strictly microeconomic implications of capital heterogeneity, especially those which pertain to institutions and entrepreneurship. In fact, several NIE scholars have also relaxed the capital homogeneity assumption to generate explanations of microeconomic phenomena. Williamson (1975, 1985), for instance, leans heavily on his notion of “asset specificity”—investments that have transaction- specific characteristics which reduce their value in alternative lines of production—to explain the wide array of institutional arrangements that firms devise, including “arm’s length” contracts, vertical integration, and in-between hybrids.For Williamson, the other determinants of contractual form include transaction frequency and uncertainty, but he has argued that asset specificity is the most determining. Another notable example is Barzel’s (1982, 1997, 2005) contention that capital assets are best characterized as bundles of “attributes,” arguing that it is costly to completely and perfectly define property rights over each of an asset’s attributes. He deploys these insights to explain why some attributes are left in the “public domain” (that is, are not privately owned) and also reexamines classic questions pertaining to the widespread variation in contractual forms.
Arguably, Barzel’s notion of asset attributes is inherently more amenable to Austrian theorizing—it maps almost perfectly onto Lachmann’s ([1956] 1978, 2–5) notion of multiple specificity—than is Williamson’s concept of asset specificity, since the latter has specific users rather than specific uses in mind (Klein 2009). There are still ways, however, that Austrian concepts can further enrich and build on the framework provided by the attributes concept. To begin, Barzel’s conception of heterogeneous goods implicitly assumes that all attributes have been discovered but that it is prohibitively costly to define property rights over each of them (Foss and Foss 2002). Kirzner (1966), however, argues that a capital good’s multispecific uses (“attributes” in the Barzelian terminology) must be subjectively perceived by entrepreneurial actors who integrate them into a production plan. This point has been used to explain firm and asset ownership (Foss and Foss 2001), but we see room for more work that links entrepreneurs’ discovery of valuable assets to society-wide institutions.
Clearly, not all institutional environments are equally conducive to the perception of asset attributes nor how they can be profitably deployed. Kirzner (1985), for instance, recognizes that government intervention alters the market process by stifling some discoveries and in generating superfluous avenues for profit making (i.e., rent seeking). This logic might be extended to explore how the institutional environment facilitates or impedes discovery of asset attributes under an entrepreneur’s control. Alternatively, interventionist institutions may generate discovery of attributes which prove useful in evasive entrepreneurship but which may not have been discovered absent the intervention.
Cell phones provide a useful illustration of both cases. As Burns (2018b) documents, permissive regulatory environments in Sub-Saharan Africa facilitated the discovery of cell phone attributes which would allow them to serve as a platform for a banking system. Yet a laissez-faire environment is not the only context under which valuable attributes may be discovered. For example, that smartphones could coordinate a ride-sharing platform was only discovered when it was due to the existence of interventionist institutions. Of course, to note this is to say nothing of the welfare implications in either case. More research is needed to understand the conditions which facilitate the first or second outcome.
Other research demonstrates that the “elasticity of substitution” between capital goods is endogenous to the institutional environment (Bjørnskov and Foss 2016). Such reasoning naturally generates a host of follow-up questions. How do entrepreneurs structure contracts (e.g., duration, asset ownership, etc.) to protect their assets’ most valuable attributes in the face of known interventionist institutions? Furthermore, how do contractual arrangements change when entrepreneurs confront institutional uncertainty regarding intervention (Higgs 1997; Terrell 2013; Baker, Bloom, and Davis 2016; Bylund and McCaffrey 2017)? Relatedly, do entrepreneurs who command highly specialized assets devote more resources to the political process to better secure their rents? Entrepreneurs in these contexts are presumably more “exposed” by the thin markets in which they operate, suggesting higher payoffs from political activity.
CONCLUSION The Austrian and new institutional economics traditions both place an emphasis on the vital role that institutions play in guiding human affairs. They also acknowledge the central role of the entrepreneur in the economy. This article contributes to prior efforts at bridging the gap between the two traditions by identifying some unrealized gains from trade: a more thoroughgoing subjectivism, an emphasis on process, and an incorporation of capital heterogeneity will open new areas of inquiry for the project of examining the relationship between institutions and entrepreneurship.
Scholars might shrink remaining gaps between AE and NIE by viewing transaction costs as the by-product of choice rather than objective, unalterable, exogenously given constraints (Robbins 1934; Buchanan 1969; DiLorenzo 1990). Indeed, North’s thinking evolved in this very direction over the course of his career (Candela, forthcoming). One implication is that scholars might turn their attention to entrepreneurial activity that is aimed explicitly at reducing transaction costs (Candela and Geloso 2019). Transaction costs, the costs of establishing property rights (Allen 2000), may arise out of either private opportunism or public predation. Although Austrian economics has emphasized the rivalrous striving by entrepreneurs to satisfy consumer preferences by discovering least-cost production techniques (Hayek 1948), these insights can be profitably extended to entrepreneurial action whose aim is to reduce transaction costs specifically. This research program will identify a host of institutional constraints that are devised to address the problem situations that consumers and producers confront. It will also reveal the entrepreneur as not only the driving force of change within a given institutional context, but also as the driver of institutional change itself. As has been argued, simply positing the existence of a change agent is insufficient. The antecedents, mechanisms, and feedback for institutional change should be elaborated.
This article is not intended to provide a comprehensive overview of all the ways that the Austrian and NIE traditions can learn from one another. Nevertheless, the hope is that this preliminary theoretical sketch will open up profitable new avenues for institutional research that incorporate important insights from both traditions. If this goal has been achieved, future scholarship on institutions and entrepreneurship will be grounded in Austrian insights and yield fruitful empirical findings.
Abstract: Entrepreneur-promoters, or the pioneers of economic improvement, provide an essential market function which economics cannot do without. Yet Ludwig von Mises maintains that this function lies beyond what can be defined with praxeological rigor. This paper attempts to find a praxeological subcategory of entrepreneurship that conforms with Mises’s indeterminate references to the entrepreneur-promoter in Human Action. Rather than relying on the evenly rotating economy, which is commonly used for analyzing entrepreneurship, the imaginary construction of a specialization deadlock is employed, adapted from Per Bylund’s Problem of Production. This construction allows for the derivation of a praxeological subcategory of entrepreneurship, distinct from the general function of uncertainty bearing, which suggests a theoretical explanation for what constitutes the driving force of the market process.
JEL Classification: L11, L26, O12 Per L. Bylund (per.bylund@okstate.edu) is assistant professor of entrepreneurship and Records-Johnston Professor of Free Enterprise in the School of Entrepreneurship in the Spears School of Business at Oklahoma State University. He is also a fellow of the Mises Institute and an associate fellow of the Ratio Institute in Stockholm.
The author has benefited from thoughtful comments on previous versions of this paper by Porter Burkett, Fernando D’Andrea, Sinclair Davidson, Hunter Hastings, and Mark Packard. He has also benefited from feedback from two anonymous reviewers. All remaining errors are the author’s.
Austrian economics has found a resurgence through the increased attention to entrepreneurship in policy and research (Klein and Bylund 2014). This should not be surprising. Although mainstream economic theory has long been uninterested in the topic (Baumol 1968; Hébert and Link 1988), entrepreneurship is core to the Austrian understanding of the market as a process (Kirzner 1992, 1997). Indeed, the school’s founder himself discussed entrepreneurship in his groundbreaking magnum opus (see Menger [1871] 2007, 160–61). But it was not until much later that Austrians developed a theory of the entrepreneur, with Israel M. Kirzner’s theory (1973, 1979, 2009) being the most widely known. Kirzner (1973, 84–87) builds explicitly on Ludwig von Mises’s ([1949] 1998, 254, 255) praxeological definition of the entrepreneurial function (contra Menger) as “acting man exclusively seen from the aspect of the uncertainty inherent in every action,” that is, “in regard to the changes occurring in the data of the market.” Mises also famously observed that entrepreneurship, due to its uncertainty-bearing and therefore speculative nature, is the “driving force of the whole market system” (Mises [1949] 1998, 249). It is Mises’s definition of entrepreneurship and its limitations that is of interest to us here.
Mises substantiates the conception of the entrepreneur as bearer of uncertainty using the imaginary construction of the evenly rotating economy (ERE), a fictional economy “characterized by the elimination of change in the data and of the time element” (Mises [1949] 1998, 247). The ERE thus encompasses all the elements of the real economy, including production, exchange, market prices, and so on, but without the uncertainty of change. Consequently, Mises ([1949] 1998, 247) notes, “The system [ERE] is in perpetual flux, but it remains always at the same spot. It revolves evenly round a fixed center, it rotates evenly.” In this unchanging world of the ERE, therefore, there is no uncertainty and, consequently, “there is no room left for entrepreneurial activity” (Mises [1949] 1998, 247).
What is curious is that Mises at the same time affords the entrepreneur-promoter,I will henceforth, following Mises, refer to this function simply as “promoter.” a subcategory of entrepreneurship that “cannot be defined with praxeological rigor” (Mises [1949] 1998, 256), a premier role for understanding the market process. In fact, the promoter embodies, as it were, the incessant change in the market: “One enters the ranks of the promoters by aggressively pushing forward and thus submitting to the trial to which the market subjects [everybody]” (Mises [1949] 1998, 309). The market process, in other words, progresses primarily through the actions of promoters, who push forward and thereby challenge the status quo. For this reason, “economics cannot do without the promoter concept” (Mises [1949] 1998, 256). However, Mises maintains, the promoter nevertheless lies beyond what economic theory can explain.
This article will show, first, that the importance of the promoter is that Mises saw in this role the actual driving force of the market: the cause of the progression of the market process and the economy’s development. Rather than entrepreneurship in general, the uncertainty-bearing aspect of any action, it is the promoter’s speculative undertaking of novel production processes and new ways of doing business that create the specific future market conditions under which all types of entrepreneurs can earn profits (or suffer losses).
Second, an economic (praxeological) definition of this category that largely conforms with Mises’s indeterminate references to the promoter in Human Action ([1949] 1998) will be suggested. To distinguish promoters from nonpromoters, the imaginary construction of the specialization deadlock adapted from Per Bylund (2016) will be used. It has previously been used to determine the economic function of the firm as a means for implementing novel production structures beyond the extent of the market (Bylund 2011, 2015a, 2015b, 2016) but can be applied more broadly. The specialization deadlock can be understood generally as an adaptation of Mises’s ERE where the assumptions have been significantly relaxed. Thereby, and due to the model’s focus on the evolution of the market’s production structure, it is a useful means for distinguishing between and explaining the driving force of production. In other words, the specialization deadlock can be applied to distinguish between categories of entrepreneurship, i.e., the types of productive progress taking place side by side in the market process, and it can identify their respective causes. Specifically, it is argued that the role of the promoter as pioneer of economic improvement can be defined praxeologically, by way of Bylund’s (2016) model, as that entrepreneurial function which breaks the specialization deadlock and thus acts in pricelessness.
In what follows, it will first be substantiated that Mises saw in the promoter specifically, and not entrepreneurship more broadly, the driving force of the market. The ERE will then be used as a contrast to explain the workings of the specialization deadlock and how their respective assumptions differ. Thereafter, an economic definition of the promoter will be presented and then used to shed light on Mises’s varied treatment of the market’s driving force in Human Action. Finally, the praxeological definition of the promoter will be related to the entrepreneurship theories of Kirzner (1973) and Joseph A. Schumpeter ([1911] 1934).
Throughout this discussion, both Mises’s nontheoretical notion and the praxeological category derived here will be referred to as “promoter.” All references to apparent actors (entrepreneurs, promoters, etc.) are to their economic functions unless stated otherwise.
THE PROMOTER AS DRIVING FORCE Mises holds that uncertainty “means acting man in regard to the changes occurring in the data of the market” (Mises [1949] 1998, 255). These data do not comprise only consumers’ preferences, which do change unpredictably, but their preferences relative to the totality of the goods offerings by entrepreneurs (the structure of supply). The entrepreneur, therefore, bears uncertainty by speculating about the unknown future market conditions: the entire situation in which the entrepreneur’s good will be offered for sale. As the market data for this future situation do not yet exist and behaviors of both producers and consumers are unpredictable, there is (and can be) no reliable knowledge in the present on which to base entrepreneurial decisions.
Uncertainty is different from imperfect knowledge, which is a problem that can be overcome at a cost. For example, a producer’s lack of technological know-how can be remedied before or during production and is ultimately a calculated tradeoff between the cost of acquiring information and that of an estimated risk of problems in production. Although economic actors are affected by both imperfect knowledge and uncertainty, and it may often be difficult to distinguish between them in reality, the concepts are theoretically distinct and require separate analyses (Townsend et al. 2018). It is specifically due to the function of uncertainty bearing that “the entrepreneur earns profit or suffers loss” (Mises [1949] 1998, 255):
the specific entrepreneurial profits and losses are not produced by the quantity of physical output. They depend on the adjustment of output to the most urgent wants of the consumers. What produces them is the extent to which the entrepreneur has succeeded or failed in anticipating the future—necessarily uncertain—state of the market. (Mises [1949] 1998, 290)
Entrepreneurs, who as uncertainty bearers are always speculators, are responsible for all adjustments of production in the economy. But such adjustments can be of different magnitudes, and Mises distinguishes between the “great adjustments,” for which mainly the promoter is responsible, and the “many small adjustments [that] may seem trifling and of little bearing upon [production],” for which he is not:
Adjustment of production to the best possible supplying of the consumers with the goods they are asking for most urgently does not merely consist in determining the general plan for the utilization of resources. There is, of course, no doubt that this is the main function of the promoter and speculator. But besides the great adjustments, many small adjustments are necessary too. Each of them may seem trifling and of little bearing upon the total result. But the cumulative effect of shortcomings in many of these minor matters can be such as to frustrate entirely the success of a correct solution of the great problems. At any rate, it is certain that every failure to handle the smaller problems results in a squandering of scarce factors of production and consequently in impairing the best possible satisfaction of the consumers. (Mises [1949] 1998, 300)
Having earlier noted that the promoter cannot be defined praxeologically, Mises ([1949] 1998, 300–07) focuses on distinguishing entrepreneurship, which can be defined, from nonentrepreneurial functions that also can. The latter, he argues, do not bear the uncertainty of the undertaking, but act on behalf of the entrepreneur. So “[t]he entrepreneur hires the technicians, i.e., people who have the ability and the skill to perform definite kinds and quantities of work” (Mises [1949] 1998, 300). The entrepreneur also typically appoints “[a] manager [who] is a junior partner of the entrepreneur, as it were, no matter what the contractual and financial terms of his employment are” (Mises [1949] 1998, 301).
Of interest to us here, however, is the distinction Mises makes between “regular” (nonpromoter) entrepreneurs and promoters. Mises is uncharacteristically imprecise, but this should be expected: having already asserted that promoters cannot be theoretically distinguished from nonpromoters, there is no basis for precision and no means to address the boundary conditions of the subcategories. We should not expect Mises (or anybody else) to use very precise language with respect to an undefined concept, because to do so is impossible. Mises is nevertheless clear that the “main function” of the promoter, which gets to his specific role, is to bring about “[a]djustment of production to the best possible supplying of the consumers with the goods they are asking for most urgently” and that it “does not merely consist in determining the general plan for the utilization of resources” (Mises [1949] 1998, 300; emphasis added). Indeed, as Joseph T. Salerno (2008, 195) summarizes, it is the promoter entrepreneur’s role to have “the will and ability to assume leadership in the social division of labor by pushing or promoting oneself into a position of organizing and directing the factors of production.” What characterizes the nonpromoter entrepreneurs, then, is that they are uncertainty bearers who are not making those great adjustments and thus not assuming such leadership—they instead focus on the “many small adjustments,” which, at least individually, appear to have little effect on the organizing of market production overall. Nonpromoters also, although only in aggregate, “[determine] the general plan for the utilization of resources” in the economy.
This suggests that the nonpromoter entrepreneur has a primarily allocative role with respect to productive factors, the shifting of productive efforts from one line of production to another so that output better meets consumers wants. The promoter, in contrast, adjusts production beyond simply “determining the general plan for the utilization of resources” by instead “assum[ing] leadership in the social division of labor.” Consequently, the promoter causes change to the structure of production. Following this reasoning, then, it can be posited that nonpromoters typically bear the uncertainty of the common, but not pioneering or disruptive, business enterprise. To use a common dichotomy in the entrepreneurship literature, nonpromoters would be more akin to imitator entrepreneurs, who may start new businesses but ones without structural implications, than they would be to disruptive innovators, who revolutionize production. Although nonpromoters provide a valuable (if not essential) function, their role is predominantly allocative, and they make adjustments within the existing structure of production rather than change it. They thus earn the profits of running the business, and also suffer the losses, and respond to changes in demand. Their actions cause continuous adjustments to the market’s overall allocation of productive resources between lines of production.
Although this is illustrative of the main dividing line, it does little to provide a scientific definition of the role of the nonpromoter entrepreneur—those entrepreneurs who are not promoters and thus do not go beyond the “many small adjustments” and thereby do not determine the “general plan” of production. Nonpromoter entrepreneurs do, however, determine resource utilization, and this suggests that their function is primarily allocative (rather than disruptive). Promoters, in contrast, are “especially eager to profit from adjusting production to the expected changes in conditions, those who have more initiative, more venturesomeness, and a quicker eye than the crowd, the pushing and promoting pioneers of economic improvement” (Mises [1949] 1998, 255). The promoter is different from the nonpromoter in degree but not in kind:
The mentality of the promoters, speculators, and entrepreneurs is not different from that of their fellow men. They are merely superior to the masses in mental power and energy. They are the leaders on the way toward material progress. They are the first to understand that there is a discrepancy between what is done and what could be done. They guess what the consumers would like to have and are intent upon providing them with these things. (Mises [1949] 1998, 333)
As they focus on “guess[ing] what the consumers would like to have” (but are not offered) and adjusting production toward that end, promoters’ impact on the economy is much greater than nonpromoters’. By being responsible for the major shifts in production, as opposed to the allocation and utilization of resources, the promoters exercise greater influence on the direction in which the market’s overall production apparatus progresses (Bylund 2015b, 2016). Consequently, promoters, as the “pushing and promoting pioneers” and “leaders on the way toward material progress,” epitomize the driving force of structural change in the market. Mises agrees:
The driving force of the market, the element tending toward unceasing innovation and improvement, is provided by the restlessness of the promoter and his eagerness to make profits as large as possible. (Mises [1949] 1998, 256)
And similarly:
The driving force of the market process is provided neither by the consumers nor by the owners of the means of production—land, capital goods, and labor—but by the promoting and speculating entrepreneurs. (Mises [1949] 1998, 325)
The promoter is the real driving force of the economy, the disruptor of the status quo who leads the way toward greater productivity and value creation by “guess[ing] what the consumers would like to have” and “pushing and promoting” the structure of production in this direction.
Considering the importance of this role in the unfolding of the market process, it is important to theoretically be able to distinguish the promoters from those entrepreneurs who do not constitute this “driving force.” Yet as has been seen, Mises finds no basis for a theoretically rigorous distinction. The difference between promoters and nonpromoters, per Mises, exists only in the relative magnitudes: promoters’ attempted and achieved adjustments to production are “great” (not “small” or “trifling”) and they are “leaders on the way toward material progress” (as opposed to followers or imitators). Based on this observation, Mises properly concludes that the distinction lies beyond what can be determined with praxeological rigor.
However, as shall be seen, this is an unwarranted conclusion that follows from a misapplication of the imaginary construction used. Mises’s conclusion, I argue, is based on specific limitations of the ERE, not of praxeology per se. In fact, the ERE’s assumptions are appropriate for distinguishing the function of entrepreneurship from other functions, but it thereby disallows distinguishing different types within this function.
FROM THE EVENLY ROTATING ECONOMY TO THE SPECIALIZATION DEADLOCK Mises astutely notes that “[t]he use of imaginary constructions to which nothing corresponds in reality is an indispensable tool of thinking” (Mises [1949] 1998, 202). These constructions, including the ERE, are indispensable because they allow for rational analysis of complex processes, delineation of causal relationships, and examination of interactions that may not exist independently and cannot be observed in complex real-world situations. Their power for developing our understanding of and interpreting the economy is practically irrefutable.
However, as Mises also notes, “one of the most important problems of science is to avoid the fallacies which ill-considered employment of such constructions can entail” (Mises [1949] 1998, 202–03). The misapplication of imaginary constructions can cause “serious blunders.”
Using the ERE to distinguish between types of entrepreneurship would be such a serious blunder, because the ERE is formulated to eliminate uncertainty, by excluding change, and thereby separate uncertainty bearing from other functions in the market. As Mises ([1949] 1998, 249) summarized it, “In order to grasp the function of entrepreneurship and the meaning of profit and loss, we construct a system from which they are absent.” The ERE is indeed appropriate for this particular end, but this also makes it unsuitable for the purpose of distinguishing between types of uncertainty bearing. It relies on assumptions that all but exclude those adjustments to the production structure that are the main function of the promoter, and thus it cannot assist in distinguishing promoters from nonpromoters.Mises cannot be blamed for making such an error (because he did not), but he appears to have overlooked the possibility of creating and employing other imaginary constructions to analyze entrepreneurship subcategories.
The Evenly Rotating Economy
The ERE creates a fictional economy in which all causes of change in the market data have been theoretically removed. As these data are constants rather than variables there is no uncertainty about the future (it will be just like the present), which means that there are also no opportunities for entrepreneurs: adjustments to the production apparatus or resource allocations could not better satisfy consumers than the status quo. The economy that emerges is thus necessarily entrepreneurless. Mises explains:
In the frame of this imaginary construction no change occurs; there prevails an unvarying course of all affairs. In the evenly rotating economy consequently nothing is altered in the allocation of goods for the satisfaction of wants in nearer and in remoter periods of the future. No one plans any change because—according to our assumptions—the prevailing allocation best serves him and because he does not believe that any possible rearrangement could improve his condition. No one wants to increase his consumption in a nearer period of the future at the expense of his consumption in a more distant period or vice versa because the existing mode of allocation pleases him better than any other thinkable and feasible mode. (Mises [1949] 1998, 482)
Murray N. Rothbard elaborates on the difference between the ERE and the real economy and adds specificity to what the ERE entails and its rationale:
the real world of action is one of continual change. Individual value scales, technological ideas, and the quantities of means available are always changing. These changes continually impel the economy in various directions. Value scales change, and consumer demand shifts from one good to another. Technological ideas change, and factors are used in different ways. Both types of change have differing effects on prices. Time preferences change, with certain effects on interest and capital formation. The crucial point is this: before the effects of any one change are completely worked out, other changes intervene. What we must consider, however, by the use of reasoning, is what would happen if no changes intervened. In other words, what would occur if value scales, technological ideas, and the given resources remained constant? (Rothbard [1962, 1970] 2004, 321)
The ERE, per Rothbard, holds four types of changes constant: consumers’ value scales, technological ideas used in production, available supply of resources, and individuals’ time preferences. If we were to theoretically fix those four variables in the present economy, an evenly rotating economy would emerge after a period of transition. During this transition stage, actors (as both producers and consumers) find their maximizing behavior through value-seeking trial and error. As the data of the market do not change, the actions that maximize each actor’s satisfaction remain constant and are thus attainable. As actors try to find their max, this process eventually brings about a state of affairs in which each individual will no longer choose to adjust their behavior but will repeat those actions that they have learned maximize their satisfaction. This final stage is not without production, consumption, and so on but is unaffected by the aforementioned types of changes so there is no uncertainty—the economy is “evenly rotating.”
The specific assumptions of this imaginary construction allow the theorist to analyze the impact of individual variables, jumbled and indistinguishable in the constant flux of the empirical world, by introducing specific changes and then reasoning through the implications. For example, by theoretically changing the rate of time preference in the ERE, the theorist can logically reason through how actors’ behaviors change and can therefore analyze the effect on the time structure of production of a change in time preference alone. Similarly, one can change or relax other ERE assumptions and thereby analyze the impact of specific changes in value scales, technological ideas, etc.
The limitation of the ERE’s usefulness is evident from its assumptions: the ERE can be used to analyze specific changes and responses to them, because all other changes have been theoretically eliminated. Although each of the changes assumed constant can be relaxed, the ERE can only be used to analyze uncertainty bearing per se with respect to those particular variables (value scales, technology, etc.). But entrepreneurship cannot be decomposed using the ERE, as the former is defined as those speculative undertakings “exclusively seen from the aspect of the uncertainty inherent in every action” and thus “in regard to the changes occurring in the data of the market” (Mises [1949] 1998, 254, 255). Outcome magnitudes, such as Mises’s distinction between great and small adjustments, or types of actions, such as the distinction between directing production and allocating resources, remain out of reach when using the ERE. But this does not mean that all imaginary constructions must fail at this task. This article argues that the specialization deadlock is suitable for determining the function of the promoter.
The Specialization Deadlock
Bylund (2016) formulates a praxeological explanation for the economic function of the business firm. In order to do so, he adopts Mises’s ([1949] 1998, 238–39) imaginary construction of the pure market economy, unhampered by political restrictions but without any form of organizations or coordinated production structures that can be interpreted as firms. The assumption underlying this model is that coordination can only take place through the price mechanism, which is commonly recognized as the alternative to intrafirm organization (cf. Coase 1937). Then, applying the Misesian fact that “[s]ociety is concerted action, cooperation” that arises due to the fact “that work performed under the division of labor is more productive than isolated work and that man’s reason is capable of recognizing this truth” (Mises [1949] 1998, 143, 144), Bylund analyzes the dynamics of productive adjustments (in other words, entrepreneurship) in the price-coordinated market. The aim is to analytically uncover the processes by which an unhampered economy adopts, improves, and implements more intensive specialization under the division of labor. In other words, to answer the question of economic development: how a market progresses through ever more intensive specializing to achieve greater productivity and thereby attains higher standards of living.
Bylund (2016) finds that this decentralized, price-coordinated market hits a development ceilingThis ceiling is contingent on population density, as discussed by Durkheim ([1892] 1933), and is thus a moving target. Yet it constitutes an effective conclusion, or at any rate a dramatic slowdown, of the market’s progression. beyond which autonomous actors are unable to adopt more intensive specialization. To progress beyond this limitation, and thus achieve greater specialization intensity, requires advanced splitting of production tasks—typically the introduction of new production processes to replace existing tasks—and thus coordination beyond what the price mechanism can provide (Bylund 2011, 2015a). Any such action would take place in pricelessness, beyond the realm of economic calculation through market prices, because there is no existing market for novelty. This type of entrepreneurial undertaking goes well beyond the simple arbitrage of, e.g., Kirzner’s (1973) entrepreneur, which requires no additional coordination, and it is also beyond the firm as theorized by, e.g., Ronald H. Coase (1937), which is practically a mirror image of market production (Bylund 2015c, forthcoming). To establish a new production process requires imagination, financing, and coordination as well as leadership (Witt 1998), and it can often also include experimentation and development of new capital.
Compared to the ERE, Bylund’s imaginary construction, called the specialization deadlockFor details, see Bylund (2016, 60–65). (referring to the ceiling), allows change in all four types of market data that the ERE holds constant. Uncertainty is therefore present in the specialization deadlock construction, and consequently it includes entrepreneurship. However, the focus on specialization introduces a new distinction that decomposes technological ideas (which guide and limit the scope of production undertakings) into those that (1) can be implemented through decentralized means (through price mechanism coordination) and those that (2) require centralized (nonprice) coordination of the implementation process in order to bring about the imagined production structure.
The former type includes specialization by the individual actor or that can be attained through coordination with others using simple exchange or market contracts. These are the types of divisions of labor that Adam Smith famously discusses in The Wealth of Nations. To Smith, “the division of labour is limited by the extent of the market” (Smith [1776] 1976, bk. 1, chap. 3). This “extent” can be understood as the degree to which “individuals [are] sufficiently in contact to be able to act and react upon one another…and the active commerce resulting from it” (Durkheim [1892] 1933, 257; cf. Land 1970). This limitation allows for a sphere of dynamic actions, including uncertainty-bearing entrepreneurship in response to changing market data, within the limitation of the specialization deadlock. These specializations that do not require centralized coordination can also build on previous specialization efforts incrementally, thereby pushing the extent of the market outwards.
Importantly, however, this incremental progression would not generate the pin factory that Smith uses to exemplify the productive powers of specialization under the division of labor. The incremental progression of the division of labor would not facilitate specializations far beyond what has already been implemented in the market, since this would require the form of coordination excluded from the specialization deadlock. In other words, while the incremental intensification of specialization could eventually generate a highly specialized process, similar to the one taking place within Smith’s pin factory, it would do so without need for the centralized organizing of the factory and also without being substantially different from specializations already supported in the market.
This incremental progression within the specialization deadlock can, however, be upset by the implementation of novel technological ideas (including new types of organization) that require centralized coordination to be feasible. In other words, to establish for the first time a highly specialized production process, akin to what Smith observes in the pin factory, is to go beyond and thus break out of the specialization deadlock. This would require centralized coordination and up-front financing: the creation of a factory. From the point of view of the market’s existing production structure, then, there is a categorical difference between changes in the form of adjustments that are compatible with the existing division of labor and therefore take place within the extent of the market, coordinated through the price mechanism and simple contracting, and those attempted changes that fall outside the market’s extent, challenge the status quo, and will, if successful, bring about disruptions to it. Rothbard helps illustrate this difference:
While a continuing and advancing division of labor is needed for a developed economy and society, the extent of such development at any given time limits the degree of specialization that any given economy can have….Economic and social development is therefore a mutually reinforcing process: the development of the market permits a wider division of labor, which in turn enables a further extension of the market. (Rothbard 1991, 26)
Per the assumptions of Bylund’s imaginary construction, this “mutually reinforcing process” is limited to such division of labor as does not require coordination of factors beyond what can be achieved through the price mechanism and simple contracting. In other words, the opportunities for adopting more intensively specialized production in the decentralized market process are subject to (and thus limited by) the specialization deadlock—the specialization intensity beyond which decentralized economic actors cannot go without effecting incompatibility with the existing production structure. This provides insight into what types of entrepreneurial undertakings are excluded from the specialization deadlock model: those implementations that cannot be coordinated through market prices. They would, assuming that they take place, be located beyond the deadlock and therefore break it.
We can conceive of two types of distinct changes that entrepreneurs can effect in the structure of production that go beyond and so break the specialization deadlock and thus require coordinated action. First, the production of a new type of consumers’ good that cannot be assembled through simple means from standard components already available in the market. The production process would introduce novelty in both the consumer’s good, which has not previously been offered for sale and for which demand is therefore unknown (no value has been realized), and in its production. Second is the introduction of an innovation in the form of novel organizing of existing production stages through the splitting of tasks (Bylund 2011, 2015a), new combinations of factors (Schumpeter [1911] 1934), or creation of new and adapted capital structures (Lachmann [1956] 1978). Both types of changes depend on the utilization of novel technology, broadly conceived, whose implementation institutes a change in the production apparatus in some significant way. In other words, these types of changes constitute “great adjustments” of production by the entrepreneur who, in undertaking their implementation, “assume[s] leadership in the social division of labor by pushing or promoting oneself into a position of organizing and directing the factors of production” (Salerno 2008, 195).
The latter case will be elaborated here to illustrate the specialization deadlock, which is also the focus of Bylund’s (2016) discussion. Assuming an existing roundabout production process in which a good is produced through several conceptually separate stages, each with their own specializations, novelty would be introduced in new ways of organizing and therefore replacing (at least) one stage. In other words, an entrepreneur conceives of a new and potentially more productive way of producing such that an existing stage is replaced by several more intensively specialized tasks (a new subprocess). So the new way of producing must be compatible with the remainder of the production process—unless this new process is in the highest- or lowest-order stages, the new process must procure inputs in the open market from producers at prior stages and also sell the produced outputs to producers in subsequent stages. In other words, for an innovation to be successfully implemented, it must achieve three things. First, it must be adapted or positioned to use inputs that are already available for purchase in the market. Second, it must similarly produce outputs that the subsequent production stage is equipped to use in its production. These are both required in order for the innovative production process to be compatible with the existing production structure. Third and final, the novel production process must be organized and coordinated such that it constitutes a complete chain of productive tasks that produce compatible outputs from existing inputs. Also, for this undertaking to be successful, the new process must be more valuable overall than the mode of production already existing in the market that it (competes with and) attempts to replace.
Bylund (2015a) illustrates this with a theoretical existing production process that consists of only three stages (tasks) from start (only original factors) to finish (consumer’s good), t1–t2–t3. The entrepreneur envisions a means to improve production by changing the process. Specifically, the entrepreneur’s imagined solution consists of replacing the existing stage t2 with three separate and much more highly specialized (and therefore expected to be more productive) tasks in a subprocess: t21–t22–t23. Thus:
The [envisioned] efficient process comprises t1–[t21–t22–t23]–t3 where the intermediate tasks t21–t22–t23 are more highly specialized (sj>>Sm) and therefore jointly more productive than the market-traded task t2. The input for [t21–t22–t23] remains the output of t1, and the process’s output is the input of t3—both are traded (or tradable) in the market, and so the new and more specialized process is compatible with the market and complete in replacing task t2. In fact, in order to successfully compete with and supplant t2 by exploiting the productive capability of [t21–t22–t23], the mutually specialized subprocess must be compatible with the existing productive structure (i.e., t1 and t3) or, alternatively, rely on substitute inputs that do not require new production structures (they should already be available in the market). Incompatibility with either t1 or t3 suggests failure by disconnecting the encapsulated subprocess from the market. (brackets in original)
This thought experiment provides several important insights, but it is sufficient for our purposes to note that this type of novel production process requires more than the coordination offered by the price mechanism (Bylund 2016, 67–85). Indeed, as the new tasks and structure [t21–t22–t23] are new, there can be no existing market prices for their contributions. These tasks are also not marketable, since they have not previously been observed. This suggests not only that the entrepreneur will need to provide coordination to accomplish the envisioned structure but also that up-front financing will be needed in order to attract factors from their current market positions. Factors will command prices higher than the prevailing market wage to become part of the new and untried (and thus more vulnerable) position (Bylund 2016, 107–20; cf. Bylund and Bylund, forthcoming). This undertaking is speculative, uncertainty-bearing entrepreneurship, but it is significantly different from the types of uncertainty bearing through arbitrage and production that can take place within the extent of the market. It is of a specific kind because it (per our assumption) utilizes specialization beyond the intensity that the economy is currently able to support—beyond what can be coordinated through existing market prices. In other words, this entrepreneurship must have an internal coordinative component in addition to the coordinative implications of resource allocation for the market. It is also blind to the relative economic efficiency of the parts of the (sub)process that it implements because there are (and can be) no market prices. In other words, when this new structure is implemented, it becomes an “island of specialization,” or what Bylund (2016) argues is properly (and praxeologically) a firm. We do not need to take that full step to the firm here, however, but need only recognize the specialization deadlock and that although it is an obstacle, it is not insurmountable. Indeed, as has been shown, markets can and do overcome the deadlock, specifically through innovative coordinated entrepreneurial undertakings that establish new and more intensive divisions of labor.
DETERMINING THE ROLE OF THE PROMOTER The discussion in the previous section suggests a framework for analyzing the economic nature of what Mises ([1949] 1998, 300) refers to as “great adjustments” of production as compared to “small adjustments.” It is also clearly relevant to Salerno’s (2008, 195) view of the promoter as having “the will and ability to assume leadership in the social division of labor by pushing or promoting oneself into a position of organizing and directing the factors of production.” Seen through the lens of the specialization deadlock, rather than the ERE, we can distinguish between entrepreneurship as uncertainty bearing within the limits of the market’s existing specialization intensity (that is, within the present extent of the market and without challenge to the specialization deadlock) and uncertainty bearing (through coordinated production undertakings) beyond the market’s existing specialization intensity (that is, outside the extent of the existing market and thus taking place despite and in direct conflict with the specialization deadlock).
These are not arbitrary classifications but are distinct by being either compliant with or directly challenging the specialization deadlock, which is an implication of the interdependence of factors that arises under the division of labor. Importantly, they are also not adjacent from a specialization point of view. There are two reasons for this. First, as Bylund (2011, 2015a, 2016) emphasizes, the “splitting” of a task into many, thereby replacing a standard task with a process, is not an incremental but a discrete change—there are no feasible solutions in between. Also, even if in-between solutions were possible, new production that utilizes specialization intensity just beyond what is compatible with the existing production structure would be unlikely to provide sufficient efficiency gains to cover the costs of implementing and bearing the uncertainty of such production. Thus, these are discrete types of entrepreneurial undertakings, because between the innovative, deadlock-defying “great adjustments” and the market-compatible “small adjustments” exists an “infeasibility zone” where no production undertakings will or can take place:
This ‘zone’ arises due to the fact that all productive innovations that are impossible to realise through market means suffer from unknowability and that their internal strict interdependence suggests incompleteness even from failure in one of their parts. (Bylund 2016, 100)
In other words, the costs of implementing novel production beyond the specialization deadlock are significantly higher than production within the extent of the market. For such an undertaking to make economic sense, the entrepreneur must rely on significant gains from specialization to cover those costs. Unless the new division of labor takes a significant leap forward as compared to the within-market intensity of specialization, the costs exceed the gains and the undertaking would thus generate a loss to the entrepreneur.
In sum, there are two distinct categories of entrepreneurial action. Entrepreneurial action in the first category consists of implementing innovative production structures through advanced task splitting (division of labor) and specializing beyond the specialization deadlock by some magnitude. The other category consists of the efficiency-improving adjustments that take place within the specialization deadlock.
Nonpromoter Entrepreneurs
The entrepreneurial actions taking place within the specialization deadlock, and thus within the existing extent of the market, are, relatively speaking, small and, in Mises’s words, “may seem trifling and of little bearing upon the total result.” They include the allocations of resources between production processes for arbitrage gain as well as so-called imitative entrepreneurship, including where the entrepreneur introduces to an industry ideas and technologies already implemented elsewhere. But these actions, which individually are of little magnitude from the perspective of the economic system, are still highly important for the market process as “the cumulative effect of shortcomings in many of these minor matters can be such as to frustrate entirely the success of a correct solution of the great problems” (Mises [1949] 1998, 300). Although the individual nonpromoter entrepreneur does not exercise much influence, the aggregate effect of such actions, including the weeding out of less productive entrepreneurs, is essential.
Entrepreneurs of this type respond to and attempt to second-guess changes in market conditions so as to position their ventures in the best possible way. They allocate factors between and organize production within the structure of production. They also competitively bid for resources in the open market, which effectuate changes to market prices that facilitate improved economic calculation. As a result, their efforts bring about continuous minor changes to the production structure through shifting allocations of resources in response to expected or foreseeable changes in the market data and through incrementally adopting more intensive specializations. But these adjustments are limited in economic scope, as they do not attempt to innovatively disrupt the existing structure of production—these adjustments happen within the extent of the market and are compatible with production in the status quo. Nevertheless, they serve a very important function in the market economy though their constant adjustments and attempted responses to changes (Hayek 1945).
This entrepreneur, acting within the confines of the specialization deadlock, is primarily a responsive agent who is alert to and thus discovers opportunities revealed within the present extent of the market (cf., Kirzner 1973). Whether these opportunities are due to changes in the market data, such as changing consumer preferences or shocks to production, nonpromoter entrepreneurs profit from swiftly adjusting their efforts to the change or exploiting a previously undiscovered misallocation of resources. It is thus, from the point of view of the new market data and whether the data are themselves new or simply new to the actor (or perhaps all actors), accurate to refer to such actions as corrections of errors made by previous entrepreneurs (Kirzner 1978). They could also be characterized as discoveries, since they are in fact already existing, as it were, within the fabric of the market but have, for whatever reason, remained unnoticed and unexploited (Shane and Venkataraman, 2000; Shane, 2003). These adjustments would consequently always, when successful, be equilibrating, since the discovery and correction of an error (or inefficiency) cannot be anything else (Kirzner 1973, 1978).
Yet given the discussion above, the limited impact of this type of entrepreneur on the market process and the structure of production is obvious. Corrections of errors, continuous adjustments of existing production processes, and the (re)allocation toward more valuable production in response to new (or expected new) data are just that: responsive. This is not to say the nonpromoter entrepreneur is passive, only that the opportunity for profit, existing in the form of a discovered disequilibrium (an “error”), emerges before the action to exploit it. The impact of the alertness on which this type of entrepreneur acts is limited by what opportunities he discovers, but the opportunities themselves are not actively created (cf. Alvarez and Barney 2007). From the perspective of this entrepreneur, disruptions are of exogenous origin (Shane 2003); nonpromoter entrepreneurs only respond to them as they discover them.
Promoters
The promoter’s role as producer of “great adjustments” to the market’s production, as a leader in the social division of labor, is distinct from that of the nonpromoter—and significant. Promoters are the entrepreneurs who, through attempting to coordinate and organize disruptive production processes, establish production significantly beyond the limit of the market’s existing specialization intensity and thus are positioned (and intended) to break free from the specialization deadlock. Rather than responding to the discovered opportunities within the market’s extent, already existing in its fabric, they imagine new ways of structuring and organizing production. This may take the form of a new type of consumer’s good or a new type of production, as noted above, but common to their efforts is an active pursuit of what does not yet exist. Their imagined production also cannot be obvious or limitedly innovative, since such novelty would either be reachable through within-system specializing, and therefore would be in the realm of the nonpromoter, or would fall within the unfeasibility zone and so would be economically unfeasible. Typically, producing a new good or replacing an existing production stage with a new, more roundabout process would entail task splitting and, consequently, would not be an incremental change. As a result, entrepreneurs attempting this must break new ground and, where successful, bring about changes in the data on which other entrepreneurs (primarily nonpromoters) base their decisions. Their actions, and the economic impact thereof, thus go well beyond what nonpromoter entrepreneurs undertake. The promoter’s entrepreneurial undertaking is different and constitutes much more than being “more adept than others at anticipating and adjusting to change” (Salerno 1993, 123).
Although their actions may indirectly affect consumers’ value scales (by offering new goods), their time preferences (by, for example, improving the standard of living), and the supply of resources (through refined production techniques), they comprise the development and implementation of novel technology—recipes for production (Rothbard [1962, 1970] 2004, 11). To be positioned beyond the specialization deadlock, and thus outside the extent of the market, these ideas must be novel and original and thus, to again refer to Bylund (2016), utilize more intensive specialization. But note that the “entrepreneur’s technological ability does not affect the specific entrepreneurial profit or loss” (Mises [1949] 1998, 288; emphasis added). It is not the technological production recipe that makes the promoter, but that the implemented ideas are novel from an economic perspective (they must better satisfy consumers), which means that the entrepreneur cannot rely on the price mechanism for coordination. He can only to a limited extent apply existing knowledge of what is economically feasible—there is only imagination and judgment to guide his uncertainty bearing.
To use Schumpeter’s (1947) well-known phrase, these entrepreneurs cause “creative destruction” to market production by challenging and, where successful, undermining and undoing the status quo.Interestingly, Schumpeter (1961, 107) also noted that that “[t]he promoter may indeed be…the purest type of the entrepreneur genus. He is then the entrepreneur who confines himself most strictly to the characteristic entrepreneurial function, the carrying out of new combinations.” From a Misesian perspective, promoters disrupt the existing market’s production structure by envisioning and implementing novel production beyond the extent of the market, thereby undermining and ultimately dissolving the specialization deadlock. Our analysis categorizes as promoter entrepreneurship specifically such novelty as is not incrementally pushing the boundary of but defies the specialization deadlock and thus must be implemented in the realm of pricelessness. This type of undertaking cannot be accomplished, as Bylund (2016) argues, without up-front financing of the endeavor—the successful implementation of new production depends on productive completeness through coordination, compatibility with the surrounding production structure, and sufficient use of intensive specialization to produce gains in excess of cost. In this sense, to borrow a phrase from Rothbard (1974, 903), “the entrepreneur and the capitalist are one and the same”—there can be no promoter without a capitalist investment in novel production.
The unique role of the promoter, then, is not to perfect existing production, which is rather the role of nonpromoter entrepreneurs. Instead, promoters challenge the status quo by replacing production processes, stages, or tasks with novel production structures that are imagined more in line with the wants that consumers are eager to satisfy. Specifically, promoters imagine and implement production processes that are more intensively specialized than is realizable through the price mechanism and market contracting. The application of the specialization deadlock here makes clear that this promoter role can be defined praxeologically as that which revolutionizes the structure of production by bringing about more roundabout production processes.
As the new process implemented by the promoter is untried, its economic efficiency relies solely on the entrepreneur’s judgment. Therefore, it is likely to be quite ineffective, both technologically and economically speaking. As is the case with first-generation devices, any success is a proof of concept and reason to further refine the ideas and their implementation. Consequently, the first attempt can be largely misaligned with the imagined consumer wants but still profitable. The bar that the promoter needs to initially meet is not impeccable implementation, but better satisfaction of consumers than existing production. The promoter’s undertaking is successful if more value is facilitated through his endeavor than previously in the market, through either producing a better (more highly valued) good or reducing the cost of production (or both). “The only source from which an entrepreneur’s profits stem is his ability to anticipate better than other people the future demand of the consumers” (Mises [1949] 1998, 288). It does not matter if the production technology can still be (greatly) improved, the offering better positioned, or the business model tweaked. It is possible, if not likely, that the promoter’s novel contribution is not initially maximized or efficient, and thus encompasses many and potentially significant “errors” (inefficiencies, both technological and economic) that can be corrected over time by the original promoter or competing entrant entrepreneurs.
This depiction of the promoter is fully compatible with Mises’s view:
The driving force of the market, the element tending toward unceasing innovation and improvement, is provided by the restlessness of the promoter and his eagerness to make profits as large as possible. (Mises [1949] 1998, 256)
The promoter is responsible for this “unceasing innovation” that, in Mises’s words, “[adjusts] production to the best possible supplying of the consumers with the goods they are asking for most urgently” that “does not merely consist in determining the general plan for the utilization of resources” (Mises [1949] 1998, 300; emphasis added). Rather than resource allocative, the role is innovative and disruptive to the structure of production. Thus, rather than improving the effectiveness of the economic system by correcting existing errors, the promoter brings about improvements by revolutionizing the overall structure of production and changing the market data for nonpromoter entrepreneurs, who to earn a profit must respond to this change.
It has been shown, then, that by using the specialization deadlock, an imaginary construction complementary to the ERE, it is not only possible to praxeologically offer a definition for the promoter, but also to distinguish this actor from nonpromoter entrepreneurs.
CONCLUDING DISCUSSION The discussion above offers a theoretically sound definition of the promoter as producer of great adjustments of production that distinguishes promoters from nonpromoter entrepreneurs. Although Mises asserted that this is not possible, that the promoter “cannot be defined with praxeological rigor” (Mises [1949] 1998, 256), his conclusion rests on an analysis of entrepreneurship using the ERE. This imaginary construction, however, is inappropriate for distinguishing between types of entrepreneurs, because it excludes all change and, consequently, does not allow for distinction between types (or magnitudes) of change. To alleviate this shortcoming, the specialization deadlock and the theory of how decentralized market production can(not) adopt innovative divisions of labor were instead applied to show that there is a real and theoretically determinable difference between promoters and nonpromoters: the former introduce novel production beyond the current extent of the market and thereby provide direction for the overall structure of production.
What remains is to briefly address what the praxeological determination of the promoter role means in terms of the “driving force of the whole market system.” First, the market process following the promoter’s realized profits will be addressed, and then the way in which Mises’s varying uses of the “driving force” come together in the promoter as he is here defined will be shown.
Subsuming the Promoter
The viability of the promoter’s project is temporary. Where successful and earning above regular returns, it will set market processes in motion that undermine and eventually will dissipate the economic profits by attracting other entrepreneurs. These entrepreneurs are eager to share in the profits and thus attempt similar production structures by emulating the promoter’s new solution. While emulating the promoter,The exact role of the follower entrepreneurs is beyond the scope of this paper’s discussion. However, it appears their actions constitute a type of arbitrage that goes beyond and is different from regular within-market resource allocation between production processes. Their actions constitute arbitrage between two alternative production structures rather than different production processes: the promoter’s newly created structure of production and the existent market. This role should be further analyzed in future research. they also make adjustments to and so aim to improve on the promoter’s original recipe and contribution to consumer welfare by incorporating their own knowledge and expertise. This is partly due to not being able to fully reproduce the promoter’s production structure, which, because its parts are not subject to market exchange, could to some extent be hidden. Part of the reason is also that the followers may have different conceptions of what constitutes the actual economic value of the novel production and use their idiosyncratic expertise to further improve on the original attempt. These emulators would therefore need to rely on their own judgment rather than reproduce the original exactly. Although the promoter has provided direction and proof of concept, the emulators are still not acting within a fully formed market but must imitate the promoter’s complete project. And to capture the promoter’s profits, they must overtake the pioneer in terms of value creation and produce a better offer for customers.
Through these followers’ investments in similar structures of production, they augment the impact of the promoter’s own actions by further shifting resources in the promoter’s indicated direction. As they compete for the same (types of) resources, the follower entrepreneurs, “eager to earn profits, appear as bidders at an auction, as it were, in which the owners of the factors of production put up for sale land, capital goods, and labor” (Mises [1949] 1998, 332). Because of the promoter’s realized profits, the followers can bid higher than within-market actors for the needed resources and thereby bid up their market prices. They may also attempt to bid for the promoter’s, and each other’s, resources and thereby generate market prices for the novel factor specializations. As market prices are determined, the promoter’s “island of specialization” eventually disintegrates and the entrepreneurs can replace previously unique “internal” functions with market services (cf. Rothbard [1962, 1970] 2004, 609–16). As a result, the extent of the market is expanded, and the specialization deadlock shifts outward so that the promoter’s original contribution is subsumed within what is now the market. By means of the promoter’s imagined and implemented production structure, and through the actions of those entrepreneurs eager to capture the his new profits, the market has overcome the previous specialization deadlock.
As we can see, then, the promoter is the instigator of increased specialization intensity in the market, and thus what brings about ever-deeper divisions of labor through leaps forward—not incremental improvements. Promoters are in this sense leaders “in the social division of labor by…directing the factors of production” (Salerno 2008, 195). They do this by establishing “islands of specialization” (Bylund 2016), or intensively specialized production structures that must be implemented beyond the extent of the existing market. These pioneers are thus necessary for and constitute the vanguard of progress in the market process, and promoters are therefore core to understanding the driving force of the market.
Mises on the “Driving Force”
Mises is often quoted as saying that entrepreneurship is the “driving force” of the market, by which he specifically meant the promoter, as has been shown here. Using the theoretical definition of this role as developed here, further support for this conclusion is found.
Reading Human Action, however, it becomes clear that Mises uses that same phrase in several different ways. It is not immediately obvious that he was referring to one and the same driving force. In light of the foregoing discussion and the definition developed above, his references to the “driving force” come together and thus Mises, rather than being inconsistent, appears to really have been referring to important nuances of the very same thing.
In this section three specific uses of the “driving force” are examined and reinterpreted using the definition elaborated in this article.
- “Profit-seeking speculation is the driving force of the market as it is the driving force of production” (Mises [1949] 1998, 325–26).
Mises here notes not simply that profit seeking is the driving force or that speculation is, but that profit-seeking speculation is. Both profit seeking, in the sense of economic and not merely accounting profits, and speculation in the market process are virtually synonymous with uncertainty bearing. Thus, there is reason to believe that Mises may have been making a deeper point, a suspicion that is further augmented by the reference to production. The distinction made in this article between entrepreneurship within the extent of the market (nonpromoter) and entrepreneurship that breaks free from it (promoter) reveals that there is a significant difference in their speculative undertakings. The former speculates, as does any actor, about future market conditions but only attempts to respond to what is expected. The profit sought is that attainable through discovering opportunities that already exist as “errors” because the economy is not fully equilibrated. Nonpromoters’ role is primarily to effect allocation of resources toward those production processes that are expected to become most profitable, not to change production processes.
In contrast, the latter speculates about bringing about a new future by creating new production structures beyond the specialization deadlock and, as a result, disrupting the status quo. Profits are for the promoter not due to corrections or arbitrage opportunities within the normal progression of the market that are attainable through exchange, but are new profits that do not derive from, and may not even be related to, the status quo. In contrast, the followers of the promoter do not speculate about the economic feasibility of the undertaking in the sense that promoters do, because the promoter has already broken the new ground and shown that it is profitable.
The nonpromoters’ profits should be relatively temporary, since competitors can rather easily acquire similar (or identical) means to copy the what the profiting entrepreneur did. But for the latter, the promoter’s profitable undertaking is not easily, and perhaps not even entirely, reproducible, which suggests the original profits may last comparatively longer. Also, improvements to the original innovation can potentially extend profitability by keeping ahead of competitors and/or lowering production cost. It is also possible that follower entreprenuers can sufficiently improve on the original innovation to outcompete the promoter and create renewed (and extended) profitability.
It is possible that Mises had a similar distinction in mind and therefore pointed out profit’s role as driving force of the market through its being a driving force of production. This is indeed the implication of our analysis here. Although allocating resources between existing production processes (those that can be established within the extent of the market and, thus, the limitations of the production structure) will shift relative quantities of output, these are adjustments of production in degree, not kind. This is also the case for those entrepreneurs following and attempting to emulate the successful promoter, although their actions adjust the structure of production from the status quo to the novelty created by the promoter. These are all different from the promoters, who break new ground by establishing novel production processes and, as a result, extend the division of labor.
- “[The free enterprise system’s] driving force is the profit-motive the instrumentality of which forces the businessman constantly to provide the consumers with more, better, and cheaper amenities” (Mises [1949] 1998, 611)
This is similar to the quotation above but, in contrast, appears to downplay the distinction between promoters and nonpromoters somewhat and instead elevates the businessman as an important actor in the market process. However, this may be a contextual interpretation.
In a market without promoters, the market is purely “driven” by entrepreneurs’ responses to discovered price discrepancies and expected changes. There is little novelty in production and the market lacks the means to disrupt the structure of production—it lacks the means to move beyond the specialization deadlock (i.e., the extent of the market) other than through minor, incremental changes. Although improvements are possible building on previous incremental improvements, this is a slow and steady process unable to take the leaps forward provided by promoters (cf. Bylund 2015b). Advanced task splitting and the establishment of new processes that are more than a recombination of already existing tasks are beyond the market’s reach without promoters.
But added promoters, who are potentially always present in the free enterprise system, the adjustments carried out by nonpromoting entrepreneurs must always take into account also imagined disruptions by promoters. Empirically, therefore, in markets where there are promoters, all entrepreneurs must adjust their production to the imagined future market conditions that must include also potential disruptions by promoters. In other words, in a market that does not preclude promoters the task for nonpromoters will be much more difficult, because market data can undergo dramatic, promotor-caused change. It may not be sufficient to discover the arbitrage opportunity of a price discrepancy if that discrepancy can be made an irrelevant error (and thus unprofitable) by a promoter’s disruptive innovation.
This suggests that in the empirical market, which is always subject to potential disruption, there may be less difference between within-market nonpromoters and those entrepreneurs who emulate promoters. Both would need to position themselves and their businesses with respect to existent “errors,” whether those errors exist as price discrepancies between market-priced actions or between market-based and promoter-innovated production. As the former are dissipated by the emergence of the latter, there may be no time-extensive simple arbitrage entrepreneurship in the empirical market.
Also, in this situation, where the market can potentially be disrupted, an entrepreneur who is not herself seeking to disrupt the market may still do so. Consider an entrepreneur who aims to adjust his production to what he imagines will be the true future market conditions using resources already available in the market. He assumes or must at least account for potential disruptions in his calculations. As a result, his nonincremental positioning, in effect an attempt to exploit an expected price discrepancy emerging from expected (but not yet occurred) disruption, could itself cause a disruption (if the expected disruption does not happen but the positioning turns out profitable) to which other entrepreneurs will then have to adapt.
This suggests that there may be less difference empirically between the actions of promoters and nonpromoters than the distinction determined theoretically suggests. In fact, the potential for disruption should increase the difficulty of “regular,” nonpromoter entrepreneurship, thereby potentially increasing the burden of uncertainty that they bear.
- “Profits are the driving force of the market economy” (Mises [1949] 1998, 805)
Similar to the second quote above, it is new economic profits that bring about the change in direction for the market economy. Although resource allocation is undertaken for profit, and changes in consumer preferences can shift profitability across production processes, such profit seeking will only redistribute productive effort. Nonpromoters equilibrate the production structure by earning profits from correction of errors, thus responding to what is.
In contrast, promoters break new ground and attempt to create new profits by disrupting production of existing goods or creating new ones. As discussed above, those new profits created by the promoter then attract follower entrepreneurs who attempt to capture part of the profits by emulating the promoter. The island of specialization that is established beyond the specialization deadlock thereby expands to eventually become subsumed under the general market as entrepreneurial bidding determines market prices for the new factors and processes. While the promoter is the entrepreneur instigating the process by earning above regular profits, the follower entrepreneurs also earn such profits but act to undermine them by bidding up the prices of factors. The followers’ profits, however, do not constitute the driving force but are the result of successfully following the promoter. They are also indicative of the end of such profits, since the followers through their actions undermine the promoter’s profitability and allow for the remainder of the market to “catch up” with the innovation and subsume the new specialization intensity. The new profits are then extinguished such that there is no remaining economic surplus available from the original innovation. What remains at that point are profits available through correcting the errors made by entrepreneurs in the market-based production processes, which should be attainable primarily through arbitrage. Such arbitrage profits do not, however, “drive” the market in any direction other than making comparatively incremental progress toward less costly production (i.e., with fewer/lesser errors).
Finally, it should be noted that it is only the successful promoter that revolutionizes the market. A promoter’s failed undertaking does not cause substantial or lasting change to the market. Thus, as Mises notes, it is the profits earned by the promoter that, through profit-seeking follower entrepreneurs, take the market in that particular direction. Promoters suffering losses do not change the course of the market, but can only indicate to potential follower entrepreneurs that the route they chose was not, at least in the way they attempted it, feasible.
The Promoter and Austrian Entrepreneurship Theory
Finally, it behooves us to briefly comment on the nature of the promoter as the driving force of the market economy from the perspective of contemporary entrepreneurship theory. Austrian entrepreneurship theory has over the past decades been dominated by Israel Kirzner’s entrepreneurship as alertness (Kirzner 1973, 1979, 1997). Kirzner borrows from and elaborates on Mises’s conception of “pure entrepreneurship” (Mises [1949] 1998, 254); his entrepreneur is primarily an agent responding to and discovering opportunities in the form of errors (inefficiencies) remaining after previous entrepreneurship (Kirzner 1978). This entrepreneur neither owns capital nor can suffer losses but is defined by alertness—the ability to discover opportunities for arbitrage gains. Thus, entrepreneurship is purely equilibrating.
Although Kirzner’s alert entrepreneur has been subject to criticism, both in the past (Rothbard 1974; High 1982) and more recently (Foss and Klein 2010; Bylund, forthcoming), there are important similarities between his entrepreneur and Mises’s nonpromoter. For example, both are nondisruptive and responsive to change; they strive for improved adaptation through adjustments and reallocations, and they deal primarily with discovering and correcting already existing errors (opportunities) within the market. This is different from the promoter’s attempted disruptions. As Salerno (1993, 123) notes, “For Mises, the promoter concept goes beyond the category of the pure entrepreneur derived from the action axiom.” In contrast, “Kirzner’s analysis of the market process has no use for the concept of the dynamic promoter-entrepreneur who is perpetually forecasting and appraising the future in quest of anticipated profit opportunities” (Salerno 1993, 127).
The promoter’s placing of new production beyond the extent of the market, and thus outside of the specialization deadlock, is the market’s “driving force.” Entrepreneurial discovery of arbitrage opportunities can only bring the market closer to realizing what is already possible given the present structure of the economy. In other words, these opportunities are profitable corrections to the allocation of resources, a result of previous entrepreneurs’ inefficient solutions.
In contrast, the actions of promoters should undermine the alert entrepreneur’s attempted equilibratory actions by actively causing change to the market data by disrupting production, introducing new goods, etc. They create, when successful, new profits through novel production that is impossible to undertake within the present market’s production structure. In this sense, it seems that Mises’s promoter, as compared to the “pure entrepreneur” and the nonpromoter, may have more in common with both Schumpeter’s ([1911] 1934) innovator as instigator of “creative destruction” and Lachmann’s ([1956] 1978) reformer of the capital structure (see e.g., Horwitz 2019) than with Kirzner’s alert entrepreneur.
Abstract: This article develops a typology for making sense of the numerous strands of Austrian (and Austrian-related) economics and demonstrates how this typology can guide organizational entrepreneurship scholars wishing to ground their research in Austrian thought. In the process, not only are existing insights from the history of Austrian economic thought rediscovered, but clearer light is also shed on important perspectives from that tradition that have received less attention in entrepreneurship research. Based on the Austrian concept of entrepreneurial production and its relationship with the core concepts of knowledge and change, the typology yields four perspectives—equilibration, punctuated equilibrium, disequilibration, and punctuated disequilibrium. These perspectives’ different paradigms as used in organizational research are explored, along with their ontological, epistemological, and methodological assumptions. The typology is illustrated with selected empirical examples from organizational research to spotlight the types of questions that contemporary scholars may appropriately ask and answer from each perspective.
JEL Classification: B53, D24, D50, D81, L26, M10 Sara R. S. T. A. Elias (selias@uvic.ca) is an assistant professor of entrepreneurship at the University of Victoria’s Peter B. Gustavson School of Business and a research associate of the Center for Psychosocial Organization Studies.
Todd H. Chiles (chilest@missouri.edu) is a senior research fellow at the Center for the Study of Complexity, Creation and Change and an emeritus professor at the University of Missouri’s Trulaske College of Business.
Qian Li (qian.li.5@cass.city.ac.uk) is a PhD candidate at the Cass Business School, City, University of London.
Fernando A. Monteiro C. D’Andrea (fernando.dandrea@okstate.edu) is a PhD student in entrepreneurship at the Spears School of Business, Oklahoma State University.
The authors thank Joseph T. Salerno and two anonymous reviewers who helped them sharpen their thinking and refine their arguments, as well as the special issue guest editor, Per Bylund, for his encouragement and thoughtful guidance throughout the review process.
INTRODUCTION Austrian economics, which will celebrate its sesquicentennial in 2021, has long had a seat at the table of the history of economic ideas (Ekelund and Hébert 2014), and its proponents have played a particularly important role in building the economic foundations of entrepreneurship (Hébert and Link 2006). More recently, it has become a central pillar of organizational entrepreneurship research, featured in theoretical (Cheah 1990; Chiles, Tuggle, et al. 2010; Dew, Velamuri, and Venkataraman 2004; Mathews 2010; McMullen and Shepherd 2006), empirical (Chiles, Meyer, and Hench 2004; Chiles et al. 2013; Dean and Meyer 1996; Dolmans et al. 2014; Keyhani and Lévesque 2016; Shane 1996 2000), and programmatic (Chiles, Bluedorn, and Gupta 2007; Chiles, Vultee, et al. 2010; Foss and Klein 2012; Shane and Venkataraman 2000) work. As a school of economic thought to which many have contributed over a century and a half, Austrian economics is not a monolithic bloc; rather, it comprises a number of distinct strands or perspectives (McMullen and Shepherd 2006)—each with a unique ability to help scholars understand certain phenomena. Many organizational entrepreneurship scholars, however, appear to be unaware of this intellectual heterogeneity, leading some to unwittingly commingle concepts from different perspectives, unknowingly shoehorn ideas from one perspective into another, or simply ignore other perspectives altogether (Chiles, Bluedorn, and Gupta 2007). Consequently, the organizational entrepreneurship literature that draws from the Austrian tradition often contains inconsistencies and gaps.
This article takes a step toward addressing these problems by developing a typology that builds on Chiles, Vultee, et al. (2010) to make sense of the numerous strands of Austrian and Austrian-related economics, with a particular focus not on how the Austrian literature itself has developed, but on how it has inspired organizational research. Consistent with the wider organization studies literature, this article takes a broad view of Austrian economics to include not only its core thinkers (F. A. Hayek, Israel M. Kirzner, Ludwig M. Lachmann, Carl Menger, Ludwig von Mises, Murray N. Rothbard), but also closely related scholars such as Joseph A. SchumpeterAlthough few (perhaps no) Austrian economists would count Schumpeter among their ranks, most organizational scholars would. Indeed, organizational scholars tend to see Schumpeter as “the preeminent Austrian economist” (see Chiles, Bluedorn, and Gupta 2007, 488). This view of Schumpeter as an Austrian economist probably obtains from his close ties to the Austrian school (e.g., Böhm-Bawerk supervised his dissertation, Wieser had a significant intellectual influence on him and vice versa; see Powell, Rahman, and Starbuck 2010) and his pursuit of Austrian themes (Vaughn 1994). For more on Schumpeter and his relationship to Austrian economics, see Ekelund and Hébert (2014), who cover Schumpeter in their chapter on “Austrian Economics.” and G.L.S. Shackle.Shackle studied Austrian economics under Hayek and completed his dissertation under his supervision (Harcourt 1981, 139–40), albeit on a Keynesian topic. Consequently, some consider Shackle a post-Keynesian with Austrian school influences. Shackle later explored issues raised by Mises about the fundamentally indeterminate nature of a social science of human action, developed innovative subjectivist theory that engaged Austrian ideas and laid the groundwork for further Austrian research, and served as an ally to Austrian economists interested in radical subjectivism (Vaughn 1994, 75, 104, 118). In a 1978 interview, Lachmann was asked what relationship he saw between Shackle’s work and that of the Austrian school. His response: “I can think of no one more distinguished or important to the fundamental Austrian ideas than Shackle … I regard Shackle as, in fact, an Austrian” (Lachmann 1978). So too have organizational entrepreneurship scholars who draw on Austrian radical subjectivism (Chiles et al. 2013; Chiles, Tuggle, et al., 2010; Chiles, Vultee, et al. 2010; McMullen 2010). Based on the Austrian school’s emphasis on the entrepreneurial organizing of production in service of the consumer, and the relationship between production and the core Austrian concepts of knowledge and change, the typology elaborated here yields four distinct perspectives: two firmly rooted in states of equilibrium (equilibration and punctuated equilibrium)The concept(s) of equilibrium in the Austrian tradition differs substantially from what is commonly seen in mainstream economics—and is usually taken for granted by organizational scholars—either in the general or the partial equilibrium tradition. Unless otherwise noted, the word equilibrium in this paper refers to the Austrian concept of the Wicksteedian state of rest (WSR), which, along with other Austrian ideas, is explained below in the section entitled “Core Concepts in Austrian Economics.” and two that break sharply with the first perspective (disequilibration and punctuated disequilibrium). The goal is to help scholars pursue Austrian-inspired organizational entrepreneurship research in a more mindful and informed manner by providing not only an organizing scheme to make sense of the various strands of Austrian economics, but also a nuanced understanding of how each of those strands maps onto different ontological, epistemological, and methodological assumptions.
This is important because different strands of Austrian economics are undergirded by different philosophical assumptions, which play a powerful role in how we see and study entrepreneurial phenomena (Chiles, Vultee, et al. 2010; McMullen and Shepherd 2006). Indeed, different paradigms are appropriate for understanding particular phenomena and pursuing certain lines of inquiry—and not others (Burrell and Morgan 1979). Thus, the aim is to sensitize organizational entrepreneurship scholars wishing to ground their work in Austrian thought to the importance of the different ontological, epistemological, and methodological assumptions within this school as used in organizational research.
This article goes beyond previous efforts by organizational entrepreneurship scholars to make sense of Austrian ideas. For example, Pittaway (2005) summarized the philosophical assumptions of a wide range of economic approaches to organizational entrepreneurship, including Austrian economics, but treated the Austrian school as a monolith. Jeffery S. McMullen and Dean A. Shepherd (2006) focused on the philosophical assumptions of Frank H. Knight, Kirzner, and Schumpeter but did not develop an overarching typology. Chiles, Vultee, et al. (2010) explored the philosophical and methodological assumptions of neoclassical and Austrian economics approaches to organizational entrepreneurship. Although they distinguished different strands of Austrian thought, they used a single, generic objective-subjective dimension to structure their arguments, an approach criticized by some scholars (Cunliffe 2011). Although drawing inspiration from Chiles, Vultee, et al. (2010), for example, in how the typology’s perspectives were titled, this work, by contrast, builds upon the fundamental Austrian idea of production as guided by the entrepreneur (Lachmann 1976; Mises [1949] 1998; Rothbard [1962, 1970] 2009) and its relationship with the core concepts of knowledge (convergent/divergent) and change (continuous/discontinuous). Further, this work explores different Austrian constructs of equilibrium to understand markets as dynamic, real-world processes, thus providing a more comprehensive view; it does so in order to develop a typology that links each type to the broader philosophical and methodological assumptions of organizational research commonly conducted using that perspective. This typology contributes to the field of organizational entrepreneurship by not only allowing scholars to make sense of a wide range of entrepreneurial phenomena, but also guiding them to the best approach in studying the particular phenomena of interest to them.
In sum, the aim of this work is to provide guidance to organizational entrepreneurship scholars wishing to ground their research in Austrian thought. It does so by first reviewing the core concepts of equilibrium, knowledge, and change within the Austrian school of economics and explaining how these concepts have been used to develop a typology that makes sense of the numerous perspectives within this school. Next, it is shown how the typology’s perspectives are all rooted in different sets of philosophical and methodological assumptions, and why this matters to Austrian-inspired organizational entrepreneurship research. In addition, the typology is illustrated using selected empirical examples drawn from the organization studies literature—all comprising an industry level of analysis—in order to spotlight the types of questions that entrepreneurship scholars can appropriately ask and answer from each perspective. The nature of the entrepreneur and of opportunities is also discussed in relation to each perspective, with the aim of helping organizational entrepreneurship scholars locate and choose the most appropriate perspective for their research efforts. Finally, organizational entrepreneurship researchers are provided with potential research questions that are illustrative of the types of phenomena with which each Austrian perspective is concerned.
A TYPOLOGY FOR CLASSIFYING AUSTRIAN IDEAS IN ORGANIZATIONAL ENTREPRENEURSHIP RESEARCH Typologies allow scholars to order and make sense of phenomena by arranging information into distinct and somewhat homogeneous groups. The categorization of information and patterns is essential to advance social theory and research, because classifying knowledge into homogeneous categories allows us to find differences between phenomena and to, ultimately, understand existing commonalities (Meyer, Tsui, and Hinings 1993). Each of the four quadrants of the typology presented here is rooted in specific philosophical assumptions that correspond to particular insights and ideas in which one can base future research in entrepreneurship. As such, each quadrant provides a focused way for organizational scholars to use an Austrian economics lens to make sense of entrepreneurship phenomena. These four quadrants correspond to three different paradigms, which denote different views of reality (Morgan 1980). Following Robert K. Merton (2004, 267), the term paradigm is used “to refer to exemplars of codified basic and often tacit assumptions, problem sets, key concepts, logic or procedure, and selectively accumulated knowledge that guide inquiry in all scientific fields.” In other words, paradigms are viewed as worldviews rooted in basic sets of beliefs that guide action (Creswell 2007). As Thomas Kuhn (1970) argued, paradigms have both intellectual and social purposes. First, they guide researchers to new definitions and questions about phenomena and, second, they “form structures within which their members can share a sense of purpose and engage in day-to-day practices of collaboration, collegiality, and ‘progress’” (Lindlof and Taylor 2011, 33).
In research, paradigms allow scholars to develop high-quality research designs by providing them with a set of philosophical assumptions regarding “the nature of reality (ontology), how the researcher knows what she or he knows (epistemology), the role of values in the research (axiology), the language of research (rhetoric), and the methods used in the process (methodology)” (Creswell 2007, 16). These philosophical stances shape the phenomena studied, the types of problems and questions posed, the particular approaches to data collection/generation and analysis, as well as the type of language used to describe and disseminate information (Creswell 2007). In this paper, the ontology, epistemology, and methodology of each paradigm are explored as a means to improve clarity regarding—and ultimately provide guidance on—how Austrian economics can be used as a lens to understand entrepreneurship phenomena.
CORE CONCEPTS IN AUSTRIAN ECONOMICS At the essence of the Austrian school of economics is praxeology, a term developed by Mises ([1949] 1998). Praxeology refers to the science of human action, i.e., the conscious actions taken by individuals toward a chosen goal. As such, it “rests on the fundamental axiom that individual human beings act” (Rothbard 1997, 58), with action consisting of the processes by which one selects a particular alternative over another by using specific means to pursue desired ends (Vaughn 1994). Fundamental to an understanding of human action is the notion that an individual’s actions take place over time (Mises [1949] 1998) and that his/her choices are rooted in knowledge that is only known to that individual (Hayek 1945). In the realm of entrepreneurship, Austrian economics treats the individual (i.e., the entrepreneur) as an organizer of production processes (Bylund 2016; Lachmann 1976; see also Mises [1949] 1998; Rothbard [1962, 1970] 2009). It is in production processes subject to unexpected change—which by their nature require individuals to combine and continually recombine resources— that “we find the real function of the entrepreneur” (Lachmann 1956, 13). Consistent with Austrian precepts, such processes take time to play out and are bounded by the entrepreneur’s limited knowledge (or ignorance).
Because Austrian economics places entrepreneurs at the very core of the market process, it is commonly referred to as the economics of time and ignorance (Vaughn 1994, 134)—a term that derives from John Maynard Keynes’s (1964, 155) “dark forces of time and ignorance,” which point out “the importance of the basic problems with which real time confronts individual actors” (O’Driscoll and Rizzo 1996, xiv). Although Keynes was quite far from being an Austrian, as a neoclassical economist he did use subjectivist elements in his economic analyses. The Austrian school of economics is rooted in dynamic subjectivism, as opposed to the static subjectivism of neoclassical economics. Unlike static subjectivism, dynamic subjectivism recognizes creativity and the uncertain nature of human action that unfolds through processes of change (Vaughn 1994). To study this dynamism, Austrian scholars have developed different ways of thinking about equilibrium.
Equilibrium
The Austrian school recognizes the market as a dynamic process that is always in disequilibrium. Thus, contrary to mainstream views, it does not use a single theoretical idea of static equilibrium; rather, it uses different dynamic equilibrium-like constructs to understand and deal with market dynamism. Recent work by Per Bylund (2019) recognizes this flawed use of static equilibrium in Austrian theorizing while problematizing Kirzner. Three of these Austrian equilibrium-like constructs are purely theoretical: (1) The evenly rotating economy, or ERE (Rothbard [1962, 1970] 2009), an imaginary construction where changes in preference and satisfaction are held constant while human action persists but merely as repetitive routine (Packard 2019, 6). (2) The final state of rest, or FSR, toward which all action is “pulled” and where there would be no action because all dissatisfaction would disappear; this state, however, “is constantly changing, as preferences, knowledge, technology, and expectations shift over time” and is thus never reached (Mises [1949] 1998; Packard 2019, 5). (3) The “Nirvana state of rest,” or NSR, in which all action becomes unnecessary because “no future knowledge, technology, or resources can attain a higher state of well-being; all possible improvements (forevermore) have been exploited, and we are at a true optimal state” (Packard 2019, 9). These equilibrium constructs, which are hypothetical, are theoretically similar to the mainstream concept of equilibrium (i.e., absence of new production and lack of change in the subjective valuations of market participants), which is, by definition, static. Austrian ideas about equilibrium, which are rooted in very different underlying assumptions, are fundamentally based on a market process that constantly reaches some kind of temporary equilibrium but that is dynamic in nature. Being hypothetical, these constructs serve only for economic reasoning and thus are not helpful to this discussion.
Two additional equilibrium constructs that appear in Austrian theorizing and that are more closely related to this discussion because they are grounded in the real world are: (1) the plain state of rest, or PSR, and (2) the fully arbitraged state of rest, or Wicksteedian state of rest, WSR (Packard 2019; Salerno 1994). The first state, the PSR, is reached every single time an exchange takes place, when all parties in a transaction momentarily exhaust the possible gains from trade. It is a momentary equilibrium that persists so long as “the prevailing state of valuations of the marginal pairs in each market remain constant” (Salerno 1994, 97–98). It is reached in a given market, at a given time, when all trades have been temporarily satisfied. At that particular time, all buyers and sellers have carried out the transactions that they deemed satisfactory at the current prices, to the point when everyone in the market is satisfied with the current situation and sees no reason to pursue further exchanges (Mises [1949] 1998, 245–251).In some specific empirical cases, there may be a theoretical difference between initial price paid or agreed upon by parties and the actual PSR (two-party market-clearing) price. However, this analysis falls outside the scope of this paper and thus does not affect our argument. The second state, the WSR, is more general; it is based on Wicksteed’s idea of the fruit market, in which the stocks of perishable goods and consumer valuations remain fixed for a given, foreseeable duration. It was reintroduced in Austrian circles by Joseph T. Salerno (1994) as a state between the FSR and the PSR. A WSR is reached “when preferences, supplies, and available parties to trade remain constant over some period of time” (Packard 2019, 6). This state lasts for as long as the prices for all goods in a given market remain stable; “[f]or the rest of the market day, each successive set of transactions takes place at equilibrium prices and thus generates a momentary WSR until the arrival of the next group of buyers on the scene” (Salerno 1994, 100).
Unlike in a PSR, where prices may change moment after moment, in a WSR, the different market criteria are stable enough to keep an equilibrated price and to get rid of arbitrage opportunities for a given period of time in a given place. An example of a situation close to a WSR is supermarket prices, which remain stable even after numerous transactions and end up facilitating exchanges because of price stability. This price stability is the basic idea behind general equilibrium. Figure 1 shows different understandings of equilibrium in terms of Austrian equilibrium constructs, real-world market equilibria, and mainstream equilibrium constructs.
Figure 1. Different Understandings of Equilibrium: Comparisons and Rough Equivalences
Significantly, the equivalences in figure 1 between Austrian and mainstream equilibrium constructs are neither perfect nor possible. The reason for this is that, for example, neoclassical economics does not aim to explain market prices, but rather hypothetical prices (as in full information, Nash equilibrium, perfect competition, etc.). As has been seen, the Austrian approach differs substantially from the neoclassical one in that it seeks to explain real-world prices (Klein 2008; Manish 2014). The aim with figure 1 is simply to facilitate understanding of Austrian ideas by comparing them to real-world market equilibria and mainstream equilibrium constructs.
In short, in discussions of entrepreneurship and production, Austrian economics recognizes two variants of real-world equilibrium—the PSR and WSR. The typology presented here is grounded in the latter, because entrepreneurial action starts at a point close to the WSR, eventually moving markets either closer or farther away from equilibrium. Furthermore, according to proponents of the Austrian school, “economics should be about how humans pursue their projects and plans over time, and with limited knowledge of present conditions and with pervasive uncertainty about the future” (Vaughn 1994, 4; see also Lachmann 1976 and Rothbard [1962, 1970] 2009). Thus, Austrians also recognize that equilibrium situations occur based on two important concepts: ignorance (or limited knowledge of the parts involved) and time (or the passage of time required for production to yield consumer goods—a process that relates to change). Discussed in the next two subsections are the typology’s dimensions—two core concepts that are central to the entrepreneurial organizing of production: knowledge (as convergent or divergent) and change (as continuous or discontinuous).
Knowledge
While neoclassical economists tend to assume perfect and homogeneous knowledge in the processes of decision-making and acting, Austrian economists view knowledge as imperfect, heterogeneous, complex, disaggregated, and dispersed (Vaughn 1994), as well as tacit and local (Hayek 1945). This conception of knowledge lets us understand why for Austrians human action will always result in unintended and uncertain outcomes. Uncertainty is one of the basic tenets of Austrian economics and is also a corollary of ignorance (O’Driscoll and Rizzo 1996). Thus, an understanding of ignorance, or limitation of knowledge, is crucial in Austrian thought.
Hayek, in his seminal paper “The Use of Knowledge in Society,” developed an understanding of knowledge not in terms of general laws, but rather “the particular circumstances of time and place” (Hayek 1945, 521). Later he further broadened understanding of knowledge in economic analyses by characterizing knowledge as “private, empirical, often tacit, not all gained through price signals, and often the source of surprise” (O’Driscoll and Rizzo 1996, 102). Hayek’s characterization of knowledge as tacit was based on Michael Polanyi’s ideas (Gourlay 2006). For Polanyi, knowledge has a fundamental and indispensable tacit component, even so-called scientific knowledge. Indeed, he suggests “that into every act of knowing there enters a passionate contribution of the person knowing what is being known, and that this coefficient is no mere imperfection but a vital component of his knowledge” (Polanyi 1958, viii). Despite Hayek’s attempts to expand our understanding of knowledge, the definition of this concept remains rather vague. For instance, although Hayek (1945) argued that knowledge is a function of the “man on the spot” and that fragmented and tacit knowledge is coordinated through the market process (Gloria-Palermo 1999), he did not make explicit what knowledge actually is. This has provided scholars within the Austrian school with the freedom to develop their interpretations of the concept, as can be seen in the knowledge arguments made by Kirzner, Schumpeter, and Lachmann.
More specifically, Kirzner (2005) distinguishes action knowledge from information knowledge. While action knowledge refers to the knowledge that shapes actions, information knowledge is what allows entrepreneurs to grasp opportunities. As Kirzner (2005, 80) notes, “The one who grasped the opportunity was, presumably through his alertness.” For Kirzner (2005), it is alertness that transfers information knowledge into action knowledge and, given the economic role of advertising and learning, information knowledge tends to be convergent. For Schumpeter, unique and idiosyncratic knowledge arises from technological breakthroughs (Sarkar et al. 2006). Innovation entails new knowledge, which is imitated or modified by the swarm of new market entrants who are incentivized by the monopolistic profits generated by innovators. This eventually results in knowledge, manifested as innovation, moving toward convergence (see Packard and Bylund 2018). Finally, Lachmann’s interpretation of knowledge contrasts starkly with Kirzner’s and Schumpeter’s. Lachmann considers knowledge as both interpretations of past experience and expectations of future action (Gloria-Palermo 1999). As such, knowledge is continually changing because of the “continual interpretation and re-interpretation of experience” and the “continual forming and re-forming of expectations,” which “makes accurate prediction of the future not merely difficult but largely impossible” (Chiles, Bluedorn, and Gupta 2007, 483). Thus, for Lachmann, knowledge is divergent given that the idiosyncratic knowledge possessed by individuals is not easily reconciled and that these individuals have the ability to create, in their minds, divergent expectations of the future.
In short, for some Austrians, such as Hayek and Kirzner, the market process allows for the coordination of fragmented and tacit knowledge (Gloria-Palermo 1999). For others, such as Lachmann, when one incorporates past knowledge and future expectations, which are subjective, the result is knowledge divergence that prevents plan coordination (Chiles, Bluedorn, and Gupta 2007). This shows that within the broad tradition of the Austrian school of economics there are two opposing views of knowledge and how it changes over time. Based on these two opposing views, this article breaks the knowledge dimension down into a convergence-divergence dichotomy, represented horizontally in the typology.
Change
When Austrians acknowledge the temporal dimension of market processes, they implicitly accept the existence of change. Indeed, as shown above, change and knowledge are natural bedfellows in the market process: change can either lead to a convergence or divergence of knowledge. Thus, knowledge is not a static concept, but one that changes over time. Such changes in knowledge are the result of the human experience of time and, ultimately, of learning (Hayek 1945; Vaughn 1994). Change, which is a constant in a world composed of humans acting upon their plans, has been described as either a continuous or discontinuous process. Continuous change, or first-order change, occurs in stable systems that do not suffer abrupt modification. This type of change, as Haridimos Tsoukas and Robert Chia (2002, 567) have argued, is “the reweaving of actors’ webs of beliefs and habits of action to accommodate new experiences obtained through interactions.” Using the metaphor of the acrobat on a high wire, they explain that stability is maintained by continuously correcting one’s imbalance (Tsoukas and Chia 2002). In Austrian economics, this relates to Kirzner’s (1973) view of a world in continuous change directed to a FSR, always coming to different PSRs and moving toward a WSR.
On the other hand, discontinuous change, or second-order change, entails abrupt shifts in the state of the existing system, resulting in the inexistence of equilibrium on the horizon. For instance, Shackle suggests that market processes go through abrupt and unexpected change in what he calls a kaleidic society—one “in which sooner or later unexpected change is bound to upset existing patterns” (Lachmann 1976, 54); this is a society “interspersing its moments or intervals of order, assurance and beauty with sudden disintegration and a cascade into a new pattern” (Shackle 1972, 76). Further, Schumpeter views change as a process of creative destruction in which entrepreneurs create new resource combinations in a discontinuous manner (Schumpeter 1934) and in response to changes in technical knowledge (Schumpeter 1942; Shane 1996). Thus, for authors such as Schumpeter and Shackle, change takes place in a discontinuous manner rather than in a continuous way, as argued by Mises and Kirzner (see D’Andrea and Mazzoni 2019). Based on these two differing views, the change dimension can be broken down into a continuous-discontinuous dichotomy, represented vertically in the typology.
A TYPOLOGY BASED ON KNOWLEDGE AND CHANGE The typology presented in this article illustrates four different perspectives within the Austrian school of economics broadly understood. Although four different perspectives are proposed, only three different paradigms—each with its specific ontological, epistemological, and methodological assumptions—underlie these perspectives. As explained above, ontology refers to the nature of reality, epistemology asks how the researcher knows what s/ he knows, and methodology describes the methods used in the research process (Creswell 2007). The assumptions stemming from each one of the perspectives presented in this typology are based on a combination of insights relating to alternative paradigms guiding research, as suggested by Guba and Lincoln (2005) and Chiles, Vultee, et al. (2010). The names of the perspectives represented in this typology are based on the forces that propel the market process: equilibration, disequilibration, punctuated equilibrium, and punctuated disequilibrium. For example, the convergence of knowledge will tend to generate a convergence of action from both entrepreneurs and consumers and, consequently, a tendency toward equilibrium; conversely, when knowledge is divergent, there will be a tendency toward disequilibrium. Figure 2 depicts the typology, with its two dimensions of knowledge and change and its four perspectives. It includes the major Austrian economists who are associated with— and inspire organizational work within—each perspective, as well as information regarding the type of paradigm, ontology, epistemology, methodology, research exemplar, and entrepreneurship authors specific to each different perspective. Below the typology’s four perspectives are explained in greater depth.
Figure 2. A Typology of Four Austrian Perspectives for Entrepreneurship Research: Key Austrian Economists, Paradigm, Ontology, Epistemology, Methodology, Empirical Examples, and Entrepreneurship Authors
Equilibration
In this perspective, the entrepreneur is described as an equilibrator who drives the market process “towards the hypothetical state of equilibrium” (Kirzner 2009, 145), the FSR or the ERE, as explained above. In fact, entrepreneurs and their decisions and actions are viewed as playing a critical role in equilibrating market movements. As such, entrepreneurship is about how entrepreneurs’ decisions disturb the existing market order—a process that emerges from entrepreneurs’ alertness (Kirzner 2009)—and drive the market closer and closer to the ERE. Thus, driving the market process are alert entrepreneurs who continually discover preexisting opportunities according to “their subjective interpretation of past experience” (Chiles, Vultee, et al. 2010, 140)—opportunities that exist “out there” and that are merely “waiting to be noticed” (Kirzner 1973, 74). As a result of the exploitation of these opportunities and the forces of equilibration (Kirzner 1997), markets have a general and natural tendency to gravitate toward a state of equilibrium (Chiles, Bluedorn, and Gupta 2007). However, this state is never reached, as this would entail the unrealistic case of having no opportunities and no competition (Kirzner 1973 1997). Instead, the WSR keeps changing moment after moment for the various economic goods in the different geographical markets. Thus, in the equilibration perspective, entrepreneurs continually discover preexisting opportunities that they then exploit, allowing them to “correct market inefficiencies” and “coordinate dispersed knowledge” (Chiles, Vultee, et al. 2010, 142), driving markets closer and closer to the WSR. This perspective is characterized by continuous change and convergent knowledge. Key Austrian economists taking an equilibration perspective include Böhm-Bawerk, Hayek, Kirzner, Menger, Mises, Rothbard and Wieser.
The equilibration perspective is rooted in a postpositivist paradigm. Significantly, although Austrian economics uses axioms and logical deduction, it does not embrace postpositivism to generate theoretical insights. Yet organizational work that draws from equilibration’s key Austrian thinkers is generally grounded in this paradigm, thus taking a scientific approach to research; as such, it tends to be reductionist, logical, deterministically based on a priori theories, with an emphasis on data collection and cause-effect oriented (see Creswell 2007). In practice, postpositivist scholars pursue research in a series of logically related steps by using rigorous methods of data collection and analysis while allowing for multiple levels of data analysis and using validation approaches. Additionally, they do not believe in a single reality; rather, they are on the lookout for participants’ multiple perspectives (Creswell 2007). Specifically, entrepreneurship research based on a postpositivist paradigm is characterized by a realist ontology, relating to fairly objectivist philosophical assumptions (Chiles, Vultee, et al. 2010); a modified dualist/objectivist epistemology, in which findings are considered to be probably true (Guba and Lincoln 2005); and a mostly quantitative/statistical/variance methodology, although it may include some qualitative methods (Chiles, Vultee, et al. 2010; Guba and Lincoln 2005).
An example of an empirical study taking an equilibration perspective is Asaba and Lieberman (1999). In their study of the Japanese soft drink industry, the authors explore the underlying causes and mechanisms relating to increased behavior similarity among competing firms. In the Japanese soft drink industry, new products are quickly followed by imitations from competitors. This mimicking behavior leads to increased behavior similarity and to markets gravitating toward a state of equilibrium. Another example consistent with the equilibration perspective is Meyer, Brooks, and Goes (1990, 98) during the period of “The 1960s: Evolution Via Institutional Isomorphism.” In their historical analysis of the San Francisco Bay area hospital industry, the authors found that during the 1960s this industry was characterized by incremental, or continuous, change resulting in the homogenization of the industry. Other works that fall within the equilibration perspective include Shane (Shane 2000, 2012), Shane and Venkataraman (2000), Dew, Velamuri, and Venkataraman (2004), McMullen and Shepherd (2006), Kor, Mahoney, and Michael (2007), Loasby (2007), Harper and Endres (2010), and Valliere (2013).
Punctuated Equilibrium
Schumpeter, with his notion of creative destruction, is the key economist taking a punctuated equilibrium perspective. Creative destruction refers to a dynamic process in which new entrants introduce superior new technologies to the market, making existing technologies obsolete and forcing incumbents to exit the market (Pe’er and Vertinsky 2008). The monopolistic profits that new entrants may realize serve as an incentive for innovation, attracting more players to the market; in turn, this results in economic rents eventually being competed away and in the market returning to equilibrium until another innovation occurs (Packard and Bylund 2018; Schumpeter 1934). This process comprises two distinctive features. First, innovation results in markets shifting through brief and violent upheavals from one equilibrium state to another (Chiles, Vultee, et al. 2010), suggesting the occurrence of discontinuous change. Second, a new wave of entrepreneurs is able to enter the market and compete rents away, implying that innovative technology and knowledge are ultimately shared and coordinated through the market process (McMullen and Shepherd 2006). For these reasons, the punctuated equilibrium perspective is characterized by discontinuous change and convergent knowledge. Importantly, this is a theoretical construction; in practice, Schumpeterian shocks spread to the market through the production process and could take a relatively long time to do so. Before the shock, the market tends toward equilibrium and is approaching a WSR; when the shock arrives, it profoundly modifies the capital structure (i.e., capital and prices will be reallocated and readjusted as in Lachmann 1976; Rothbard [1962, 1970] 2009) and the formerly existing foreseeable WSR gives way to a completely different WSR. As such, the shock diverts the WSR somewhere very different from where it was thought to be going before. Although not using the terms equilibration and punctuated equilibrium, previous work has demonstrated that in real-world markets both perspectives are necessary to economic development and that they tend to coexist (e.g., D’Andrea and Mazzoni 2019; Packard and Bylund 2018). This helps explain why in this typology some entrepreneurship work appears in both the equilibration and punctuated equilibrium perspectives.
Organizational research conducted within this perspective is often rooted in a critical realist paradigm. Critical realists believe that there is a world that exists independently of human consciousness, with knowledge about this world of events being socially constructed (Denzin and Lincoln 2005). Furthermore, critical realists are interested in not only explaining but also changing the world. To that end, they seek to identify, reflect on, and change the structures underlying human action (Alvesson and Sköldberg 2009). In regard to entrepreneurship, this means that the entrepreneur can actively respond to and shape the world (Chiles, Vultee, et al. 2010)—a perspective that is characterized by a realist ontology grounded in a “real” reality that one can only apprehend in an imperfect and probabilistic manner (Chiles, Vultee, et al. 2010; Guba and Lincoln 2005). Additionally, this paradigm is typified by a modified dualist/objectivist epistemology in which findings are considered to be probably true (Guba and Lincoln 2005) and by a mostly quantitative/statistical/variance methodology, although it may include some qualitative methods (Chiles, Vultee, et al. 2010; Guba and Lincoln 2005). Although the critical realist paradigm appears to be similar to the postpositivist paradigm, it is important to note that the latter is characterized as more objectivist than the former (Chiles, Vultee, et al. 2010).
Anderson and Tushman’s (1990) longitudinal study of the U.S. cement, glass, and minicomputer industries is consistent with the perspective of punctuated equilibrium. Not only do the authors mention Schumpeter in their opening paragraph, they also frame their study in a way that is consistent with Schumpeter’s view of change. Particularly, the authors “empirically explore when and how dominant designs emerge from technological discontinuities” (Anderson and Tushman 1990, 604) to illustrate that technological discontinuities, or disrupting innovations, trigger periods of upheaval that are followed by a period of order, which in turn is disrupted by a new technological discontinuity. Another empirical example is Meyer, Brooks, and Goes’s (1990, 101) discussion of the period of “The 1980s: Industry Revolution.” In their historical analysis of the San Francisco Bay area hospital industry, the authors found that, during the 1980s, this industry was characterized by discontinuous changes leading to restructuration, reconstitution, and adaptation. Lastly, other entrepreneurship works that fall within the punctuated equilibrium perspective include Guth and Ginsberg (1990), Shane (1996, 2012), Shane and Venkataraman (2000), Dew, Velamuri, and Venkataraman (2004), Venkataraman (2004), McMullen and Shepherd (2006), Kor, Mahoney, and Michael (2007), Loasby (2007), and Valliere (2013).
Disequilibration and Punctuated Disequilibrium
Lachmann and Shackle are the key economists of disequilibration and punctuated disequilibrium, respectively. Their assumptions are similar in that their view of the world is rooted in the same paradigm. For this reason, they are often grouped under the “Lachmann-Shackle position.” As Walter E. Grinder (1977, 20) explains,
The Lachmann-Shackle position that forces of divergence tend to outweigh forces of convergence makes a general market equilibrium unlikely. According to Lachmann, the strength of the forces of convergence depends almost entirely on the activities of entrepreneurs. If entrepreneurs take advantage of the price-cost discrepancies attending changing circumstances, the entrepreneurial function of using resources in search of profit (the process of innovation and imitation) will, as most Austrian economists agree, lead to a convergence of the plans of individuals in markets. However, because change is ever present and unpredictable, individuals have different expectations about the character and extent of change. It is this factor more than any other that precludes anything approaching a macroeconomic general equilibrium in the uncertain world of market activity.
The Lachmann-Shackle position is rooted in radical subjectivism—an approach that recognizes entrepreneurs’ divergent interpretations of complex phenomena and, thus, their divergent knowledge. In this disequilibrium-based approach, divergent knowledge eventually results in increasingly heterogeneous markets as entrepreneurs’ plans and actions collide, forcing them to revise and change their subjective future expectations and knowledge (Chiles, Vultee, et al. 2010). Although Lachmann and Shackle have a similar take on knowledge divergence, they do differ in their approach to change. In disequilibration, change in the market process has a continuous nature. For instance, Lachmann is known for advocating disequilibrium processes in a world of continuous change and reorganization (Harper and Endres 2010; Lachmann 1956).Lachmann acknowledged the operation of both equilibrating and disequilibrating forces in market processes (see, e.g., Lachmann 1986). His early work in capital theory gave the distinct impression that equilibrating forces dominated (Barbieri 2017; Lewin 1997), while his later work, which was more radically subjective, emphasized or at least logically implied the dominance of disequilibrating forces Barbieri (2017) dubs this evolution of Lachmann’s thought Lachmann I and Lachmann II, respectively. Our placement of, and emphasis on, Lachmann in the disequilibration quadrant of the proposed typology accords with Lachmann II. Although organizational entrepreneurship scholars pursuing Austrian radical subjectivism have embraced this Lachmann II interpretation (Chiles, Vultee, et al., 2010), they have also observed in Lachmann’s later work “a two-stage process, in which early market equilibration, attributable to close imitation of innovators’ products, eventually yields to market disequilibration, attributable to secondary innovations that differentiate rivals’ products” (Chiles, Vultee, et al., 2010, 159).(Barbieri 2017; Boehm et al. 2000; Chiles, Vultee, et al., 2010; Lewin 2001, 2007). In punctuated disequilibrium, market processes change in a kaleidic manner; that is, markets shift, or change, abruptly from one disequilibrium phase to another (Chiles, Vultee, et al. 2010; Shackle 1967). Thus, while the disequilibration perspective involves continuous change and divergent knowledge, the punctuated disequilibrium perspective entails discontinuous change and divergent knowledge. Furthermore, in both disequilibration and punctuated disequilibrium entrepreneurial actions drive the market away from the WSR; however, in punctuated disequilibrium this process occurs in abrupt punctuations. Reminiscent of Schumpeterian shocks, an action or event, or a set of actions and events, abruptly punctuates the disequilibrium market, kaleidically shifting it from one disequilibrium phase to another.
Organizational research conducted within the disequilibration and punctuated disequilibrium perspectives is often grounded in a social constructivist/interpretivist view of the world—i.e., they are both rooted in the same paradigm. In this paradigm, researchers search for an understanding of the world surrounding them by gathering subjective and intersubjective meanings of experience (Creswell 2007; Morgan 1980). Such meanings are thus complex, multiple, and varied (Creswell 2007). Indeed, researchers may even find that different individuals will have different perspectives of phenomena, leading to evidence of multiple realities (Creswell 2007; Morgan 1980). The term social constructivism refers to the idea that meanings are formed by interacting with others (Creswell 2007). In practice, social constructivist/interpretivist researchers ask general and broad questions that lead participants to build the meaning of phenomena through discussions or interactions with others. This allows researchers to address ongoing and dynamic processes of social interaction while focusing on context to understand the cultural and historical settings of participants and phenomena (Creswell 2007). Additionally, social constructivists/ interpretivists recognize that their own historical, personal, and cultural experiences shape their interpretations. Thus, the goal of these researchers is to make sense of, or interpret, the meanings the world has to different individuals based on their own backgrounds (Creswell 2007; Morgan 1980). This is why social constructivism and interpretivism are often combined (Creswell 2007).
Entrepreneurship research based on a social constructivist/interpretivist paradigm is characterized by a relativist ontology (Chiles, Vultee, et al. 2010), referring to “local and specific co-constructed realities” (Guba and Lincoln 2005, 195); a transactional/subjectivist epistemology, meaning that findings are co-created; and a process/ hermeneutical/dialectical methodology (Chiles, Vultee, et al. 2010; Guba and Lincoln 2005). Scholars taking a social constructivist/ interpretivist approach attempt to preserve the interpretations of those under study as well as their own, even if they are different or contradictory. This may lead to different perspectives, or multiple realities, which paves the way for a holistic understanding of the phenomenon under study (Stake 1995).
A research example that is consistent with the disequilibration perspective of Austrian economics is Hambrick et al. (2005). In their empirical study of the U.S. steel industry, the authors challenge the traditional view of institutional theory as argued by DiMaggio and Powell (1983) by suggesting that organizations do not become increasingly similar over time due to isomorphic pressures. Rather, they become less similar due to several macrosocial trends that the original authors did not anticipate (Hambrick et al. 2005). The way these authors frame their study is consistent with a disequilibration perspective, in which continuous change throughout time results in knowledge divergence and, consequently, a movement away from the WSR. Moreover, diversity is an indicator of disequilibrium (e.g., Kirzner 1973); thus, increasing diversity is an indicator of disequilibration. Another empirical example taking a disequilibration perspective is Meyer, Brooks, and Goes’s (1990, 100) discussion of the period of “The 1970s: Organizational Adaptation.” In their historical analysis of the San Francisco Bay area hospital industry, the authors found that during that period this industry was primarily characterized by incremental change and adaptation in different directions, leading to increasing interorganizational diversity. Lastly, other work in entrepreneurship that falls within the disequilibration perspective of the typology includes Dew, Velamuri, and Venkataraman (2004), Greenwood and Suddaby (2006), Chiles, Bluedorn, and Gupta (2007), Loasby (2007), Foss and Ishikawa (2007), Kor, Mahoney, and Michael (2007), Chiles, Tuggle, et al. (2010), Harper and Endres (2010), Mathews (2010), and Dolmans et al. (2014).
Chiles, Meyer, and Hench (2004) is an example of research that is consistent with the punctuated disequilibrium perspective. Their study of the musical theaters of Branson, Missouri, found that new organizational collectives evolve in a perpetual state of disequilibrium through an extended series of punctuation events, each of which ushers in a new disequilibrium phase qualitatively different from the one before. Such findings, the authors argued, “support a ‘punctuated disequilibrium’ view of change” (514, emphasis in original). Another empirical example of the same perspective is Chiles, Vultee, et al. (2010). Analyzing the Japanese beer industry, the authors concluded that this industry is characterized by disequilibrium market processes, continual disruption, and increasing heterogeneity. The authors’ analysis also provides an illustration of one methodological approach (hermeneutics; see Lachmann 1991) that can be used to study entrepreneurial phenomena from a radical subjectivist perspective. Lastly, other work in entrepreneurship that falls within the punctuated disequilibrium perspective of the typology include Chiles, Tuggle, et al. (2010) and Chiles et al. (2013).
FUTURE RESEARCH USING THE TYPOLOGY Keeping in mind the broad philosophical assumptions relating to each of the typology’s perspectives, let us now take a closer look at the different accounts of the nature of the entrepreneur and the nature of opportunities by the major Austrian economists within each perspective (see figure 3 for a summary). An overview of these is provided next as a basis for developing possible research questions (shown in figure 4) that scholars may find of interest in future research and that are appropriate for each perspective. Because this work is building on the work of Chiles, Vultee, et al. (2010), some of the research questions developed by these authors have been included intentionally, appropriately placed and organized within the typology’s four perspectives.
Figure 3. A Typology of Four Austrian Perspectives for Entrepreneurship Research: The Nature of the Entrepreneur and Opportunities
Figure 4. A Typology of Four Austrian Perspectives for Entrepreneurship Research: Potential Research Questions
Equilibration
Scholars taking an equilibration perspective view the entrepreneur as an imaginative and bold individual who is alert to opportunities (Kirzner 1997). By discovering and taking advantage of opportunities, the entrepreneur drives the market toward equilibrium, reducing Hayekian problems of dispersed knowledge through the coordination of diverse plans (Jakee and Spong 2003). In this perspective, as time passes, the WSR nears and nears in the various markets. Scholars using an equilibration perspective view the entrepreneur as an arbitrageur/middleman who buys or sells hoping to make a profit; thus s/he is someone who need not be a producer or an innovator, or even own capital (Foss and Klein 2010; Rothbard [1962, 1970] 2009). Lastly, the entrepreneur is an agent of change who profits by taking advantage of opportunities while acting in the interest of the consumer (Mises [1949] 1998). Austrian economists within the equilibration perspective view opportunities as preexistent in the market and as waiting to be discovered. Entrepreneurs discover such opportunities based on their own interpretations of past experiences (see Chiles, Vultee, et al. 2010).
Taking into consideration the aforementioned assumptions and information regarding the nature of change, knowledge, opportunities, and the entrepreneur, scholars wishing to pursue research using an equilibration perspective may consider asking questions such as (1) How do entrepreneurs continually discover existing opportunities?, (2) How do entrepreneurs continually correct market errors (due to market ignorance and dispersed knowledge)?, and (3) How do entrepreneurs ultimately drive markets from a disequilibrium state toward the WSR?
Punctuated Equilibrium
Proponents of this perspective view the entrepreneur as an innovator who disrupts business routines and market equilibria through opportunity exploitation (Jakee and Spong 2003). As such, the entrepreneur is not passive—s/he creates a world that is different from the one s/he finds—meaning that the entrepreneur is, in fact, a “creator” (Foss and Klein 2020; Kirzner 2009). However, it is important to note that although the entrepreneur is a creator and an innovator, s/he does not necessarily need to be an inventor or a capitalist (Schumpeter 1934). Additionally, the entrepreneur is different from a manager in that while managers perform routine activities, entrepreneurs rely less on tradition. In fact, entrepreneurs break with the old to create something new—a process known as creative destruction (Schumpeter 1934). Entrepreneurs exploit preexisting opportunities that are widely known and that are a result of scientists’ inventions (Chiles, Vultee, et al. 2010). In order to exploit such opportunities, entrepreneurs periodically carry out new resource combinations through their will and action (Bylund 2016; Foss and Klein 2012; Schumpeter 1934). This results in markets evolving “from one long period of equilibrium through brief upheaval to another such equilibrium” (Chiles, Vultee, et al. 2010, 140). From an Austrian equilibrium perspective, such entrepreneurial actions interrupt the path toward a WSR, thus suggesting a different, much more distant WSR toward which markets will tend once the rearrangement of production processes starts.
Taking into consideration the aforementioned assumptions and information regarding the nature of change, knowledge, opportunities, and the entrepreneur, scholars wishing to pursue research using a punctuated equilibrium perspective may consider asking questions such as (1) How do entrepreneurs disrupt markets, driving them from one equilibrium state to another?, (2) How do entrepreneurs combine existing resources in novel ways that allow them to exploit new opportunities resulting from technological change?, and (3) How do entrepreneurs take advantage of the inexistence of direct competition that follows the introduction of disruptive innovations?
Disequilibration
Scholars taking a disequilibration perspective view entrepreneurs as capable of reducing chaos to order through their creative intelligence (Harper and Endres 2010). In a world of continuous change, entrepreneurs act because they “prefer to anticipate tomorrow’s changes today rather than adjust themselves to those recorded in the latest message received” (Lachmann 1956, 22). They do so by forming combinations of heterogeneous capital resources in their plans and regrouping resources when their plans are revised, a process that ultimately has a disequilibrating effect on the market. Overall, the function of the entrepreneur is to address a world of unexpected change, as well as “to turn failure into success and to benefit from the discomfiture of others” (Lachmann 1956, 18). Opportunities are created and continually recreated through entrepreneurs’ creative imaginations, and they are realized through the combination and continuous recombination of capital resources (Chiles et al. 2013). Entrepreneurs’ actions cause markets to move away from the previously seen WSR step by step, thus reducing market order.
Taking into consideration all of the aforementioned assumptions and information regarding the nature of change, knowledge, opportunities, and the entrepreneur, scholars wishing to pursue research using a disequilibration perspective may consider asking questions such as (1) How do entrepreneurs continually create new opportunities?, (2) How do competitors in a market react to entrepreneurs’ disequilibrating actions?, and (3) How do entrepreneurs’ combinations of heterogeneous capital resources and regroupings of resources have a disequilibrating effect on the market?
Punctuated Disequilibrium
Under a punctuated disequilibrium perspective, the entrepreneur spots, creates, and exploits new opportunities. S/he is a decision-maker and a risk bearer under conditions of uncertainty (Batstone and Pheby 1996). And although the entrepreneur is ignorant of the future (Hill 2004), s/he possesses an imaginative capacity to ponder future possibilities (Ripsas 1998). Based on subjective expectations of imagined future possibilities, entrepreneurs make decisions that allow them to continually create and recreate opportunities (Chiles, Vultee, et al. 2010). Thus, opportunities are neither preexisting nor waiting to be discovered—they are created by the forward-looking mental acts of entrepreneurs (Chiles, Vultee, et al. 2010; Shackle 1979). Envisioning different courses of action leads to a divergence of expectations and, thus, to a kaleidic society—a notion that is vastly different from Hayek’s self-adjusting spontaneous order (Hill 2004). Ultimately, this results in a punctuated disequilibrium in which markets occasionally experience dramatic shifts from one disequilibrium phase to another as a natural part of an ongoing disequilibrium process (Chiles, Vultee, et al. 2010). In this perspective, such dramatic punctuations drive the market away from the WSR, kaleidically shifting it from one disequilibrium phase to another and allowing the entrepreneur responsible for that shift to collect quasi-monopolistic profits for as long as the situation remains.
Taking into consideration the aforementioned assumptions and information regarding the nature of change, knowledge, opportunities, and the entrepreneur, scholars wishing to pursue research using a punctuated disequilibrium perspective may consider asking questions such as (1) How do entrepreneurs proactively reshuffle resources to introduce new solutions in the market?, (2) How do entrepreneurs decide what imagined future(s) to pursue as part of a process that allows them to kaleidically create new opportunities?, and (3) How do entrepreneurs’ actions result in dramatic shifts from one disequilibrium phase to another, driving markets farther from equilibrium?
CONCLUDING THOUGHTS Austrian economists bring an important perspective on the history of economic thought, one that views the world as inherently cognitive and fundamentally dynamic; that is, about knowledge and change—knowledge that is both convergent and divergent, and change that is both continuous and discontinuous. By placing these concepts at the core of their enterprise, these economists have shed considerable light on the “dark forces of time and ignorance.” In acknowledging the concept of equilibrium in the Austrian tradition and building a typology based on the aforementioned two concepts, which are intricately connected to the Austrian concept of entrepreneurial production, the hope is to offer organizational entrepreneurship scholars a useful framework for organizing their thinking and guiding their research—not only into the more familiar equilibrium-based entrepreneurial phenomena, but also the less familiar disequilibrium ones.
As has been argued, Austrian economics comprises a number of distinct strands or perspectives, each with a unique ability to shed light on specific entrepreneurial phenomena. This work seeks to sensitize organizational scholars pursuing Austrian-inspired entrepreneurship research to the intellectual heterogeneity within this school of economic thought and to clarify the nuances of different perspectives within it, providing scholars with a solid foundation from which to build their research efforts. To do so, ideas from existing typologies in the organization studies literature were integrated and reworked to develop a new typology yielding four distinct perspectives: (1) equilibration, (2) punctuated equilibrium, (3) disequilibration, and (4) punctuated disequilibrium. The equilibration and punctuated equilibrium perspectives, which have garnered the lion’s share of scholarly attention, are firmly anchored in a perceived tendency for market actions to be directed toward some equilibrium, represented in Austrian theorizing by the WSR and the tendency toward the ERE. These perspectives have been valuable in moving the organizational entrepreneurship field forward for the last several decades. However, scholars have leaned on them heavily, and this overreliance has blocked progress into a range of disequilibrium phenomena, from entrepreneurs’ forward-looking imaginative acts to their ex nihilo creation and continual recreation of resource combinations to the relatively unstable interactions these acts and actions engender in markets characterized by radical uncertainty, pervasive heterogeneity, and constant disruption. The disequilibration perspective, in which entrepreneurial action drives the market process away from equilibration, has recently started to receive greater attention, opening inquiry into some of these neglected entrepreneurial phenomena. Its place in this typology further legitimates it as an important perspective in entrepreneurship research. The punctuated disequilibrium perspective is just beginning to appear on scholars’ radars and it is hoped that its place in this typology will compel others to explore some of the current “outer reaches” of the entrepreneurship field, helping us understand, for example, how creative entrepreneurial processes kaleidically shift from one disequilibrium phase to another.
More generally, organizational entrepreneurship scholars can use this typology to better understand how different Austrian perspectives are rooted in distinct sets of philosophical and methodological assumptions. Using this typology, scholars can also locate key differences over the nature of the entrepreneur, the nature of opportunities, potential research questions, and selected empirical examples that illustrate the types of phenomena with which each perspective is concerned. Additionally, for each of its four perspectives this typology lists authors whose work can serve as a reference point. This typology is useful and important because it provides organizational entrepreneurship scholars with a foundation to advance inquiry in at least two ways: (1) it helps scholars organize and sharpen their thinking about a particular entrepreneurial phenomenon, and (2) it guides researchers through the research process, allowing them to identify and make sense of the nuances and subtleties of the phenomenon under study, to ask appropriate questions, and to use suitable methodologies.
Scholars pursuing Austrian-based organizational entrepreneurship research might use this typology in the following manner. First, it is recommended that scholars start by reflecting on the nature of the phenomena they wish to study, specifically seeking an understanding of the nature of knowledge, change, opportunities, and of the entrepreneur (see figures 2 and 3). This will allow them to locate the phenomenon at hand within a particular Austrian perspective. As soon as researchers identify the appropriate perspective, they should examine and reflect upon the broader philosophical assumptions relating to the particular perspective (see figure 2). After that, they can develop research questions that are consistent with the perspective and its underlying philosophical assumptions (see figure 4 for examples). Finally, researchers can choose the appropriate methodology, which should also be consistent with the philosophical assumptions of the perspective being used (see figure 2). In the case that the researcher would like to consult previous work using a specific perspective, figure 2 offers lists of works that fall within each perspective.
Although helpful for sharpening our thinking about the numerous strands of Austrian and Austrian-related economics, this typology is not without limitations. First, some scholars criticize typologies for not being a true depiction of reality—that is, for being oversimplistic and for failing to portray the complexity of organizational life (Meyer, Tsui, and Hinings 1993). It is important to keep in mind, however, that the purpose of typologies is not to perfectly replicate reality but rather to provide a foundation from which to advance inquiry. As Gibson Burrell and Gareth Morgan (1979) have argued, typologies are useful in providing us with a heuristic device, rather than with a set of rigid definitions and classifications. In other words, typologies are designed to help sharpen our conceptions and thoughts about the dynamism of reality without getting lost in an absolutism that is not real. Thus, typologies provide scholars with constructs that help organize their thinking, from which they can then identify the nuances and subtleties that differentiate real phenomena from the ideal types. Given the process orientation of the Austrian school, this typology might be of particular interest to those interested in exploring entrepreneurship from a process perspective. It is recommended that future process-oriented scholars use this typology alongside other work exploring distinct worldviews in entrepreneurship scholarship—see, for example, the work of Chiles, Sara R. S. T. A. Elias, and Qian Li (2017)—to carefully consider the philosophical assumptions that undergird their research efforts.
Second, in developing this typology, and as is typical of this type of work, the two dimensions of knowledge and change were classified dichotomously, even though these are complex and nonbinary concepts. This approach thus prioritized parsimony, glossing over the complexity and nuances of these concepts (Doty and Glick 1994; Weick 1979). As Peer C. Fiss (2007, 1193) has argued, many concepts in the field are complex and multidimensional in nature, “requiring more continuous coding.” Future researchers are thus encouraged to explore alternative approaches, for example, by using qualitative comparative analysis (QCA) to develop an “ideal type” (e.g., Fiss 2011) for each key Austrian economist and their impact on organization and entrepreneurship studies.
Third, the two dimensions of knowledge and change provide one way to make sense of the various strands of Austrian and Austrian-related economics. Future scholars might build different typologies by choosing dimensions that may be rooted not only in other Austrian core concepts, but also in key differences between the Austrian school and mainstream economic thought (e.g., methodological individualism, subjectivism, praxeology). Developing new typologies would inherently allow future scholars to shed different light on—and further make sense of—the complexities of Austrian thought more specifically and economic thought more generally, and how the former may inspire organizational research.
Fourth, it is recognized that there are a number of important debates within the Austrian school that were not included in this discussion, such as Mises versus Hayek on the economic problem arising from power centralization (Salerno 1993), Mises versus Schumpeter on the theoretical grounds of economics (Schulak and Unterköfler 2011), and Kirzner versus Rothbard on the nature of the entrepreneur (Rothbard 1974). This typology represents a first step in helping guide the research efforts of organizational entrepreneurship scholars wishing to more firmly ground their research in Austrian thought. As such, it is a basic conceptual tool for holistically making sense of Austrian economics, allowing organizational entrepreneurship scholars to go beyond mere lists of go-to Austrian figures such as Hayek, Schumpeter, and Kirzner. The aforementioned debates provide theoretical detail and nuance that go beyond the initial efforts in this article. Future scholars are encouraged to flesh out this typology by adding the relevant insights from these debates to the appropriate perspective or, conversely, to explore how this typology might inform these debates.
In closing, the hope is that this typology, along with these concluding suggestions, will help organizational scholars pursue Austrian-based entrepreneurship research in a more mindful and informed manner. Doing so will improve our understanding of entrepreneurship.
The Austrian school of economics has been all but left by the wayside in economics (e.g., Backhouse 2000). This fate, shared with all “heterodox” approaches that do not fully comply with mainstream dogma, means Austrian theory is at best discounted by other economists. More often, and typically, it is forgotten and a relic of the past.
At the same time, Austrian economics is the only school of economic thought that is well represented in the study of entrepreneurship (e.g., Dahlqvist and Wiklund 2012; Korsgaard, et al. 2016; Packard and Bylund 2018).A similar argument can be made for related fields such as theory of the firm and strategy (e.g., Ioannides 2002; Jacobson 1992; Roberts and Eisenhardt 2003; Young, Smith, and Grimm 1996). Austrian theories, concepts, and perspectives on entrepreneurship make up an important part of what is modern entrepreneurship theory (Klein and Bylund 2014).
Although the former is as unfortunate as the latter is exciting, it is not impossible that they have the same cause. Austrian theory, focusing on understanding (not predicting) the dynamics of and emergent phenomena in the market process, conceived as an entrepreneurially driven (Mises [1949] 1998), production-based (Böhm-Bawerk [1889] 1959) discovery procedure (Hayek 1978), is undoubtedly well suited as a framework for studying all aspects of entrepreneurship as uncertainty-bearing value creation (Hastings, D’Andrea, and Bylund 2019). Mainstream economics, seeking to mimic the reliability of empirical physics, has taken great pains in attempting to exclude the dynamism of the market process from its theoretical models (e.g., Baumol 1968). As a result, modern economics is barren and generally lacks insight into what gives life to what older generations of economists sometimes referred to as the “economic organism” (Bylund and Bylund, forthcoming).
Economics without entrepreneurship is a twentieth-century idea. Joseph A. Schumpeter, schooled in the Austrian tradition but later enamored by the promise of formalized (if not mathematized) Walrasian analysis, early recognized this core flaw of the modern economic approach. In Capitalism, Socialism and Democracy, Schumpeter identified the free enterprise system’s constant regeneration through “industrial mutation…that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one” (1947, 83). This creative destruction, he noted, is capitalism’s essence, which modern economics has all but expunged—yet is impotent without. Writes Schumpeter:
a theoretical construction which neglects this essential element of the case [entrepreneurship] neglects all that is most typically capitalist about it; even if correct in logic as well as in fact, it is like Hamlet without the Danish prince. (Schumpeter 1947, 86) In contrast, entrepreneurship scholarship focuses on the prince along with the royal family but tends to neglect the remainder of the play and its characters. It should therefore be unsurprising that Austrian economic theory, in which the entrepreneur is the main character in the full play, is a valuable framework and inspiration. Indeed, the entrepreneurial opportunity, a core concept in modern entrepreneurship theory (Venkataraman 1997; Shane and Venkataraman 2000; Shane 2003; see also Dempster’s article in this issue), was originally formulated based on the entrepreneurship theories of Schumpeter ([1911] 1934) and Kirzner (1973). More recently, as the opportunity construct has become increasingly questioned (e.g., Foss and Klein 2020), the judgment-based approach (Klein 2008; McMullen 2015; Foss, Klein and Bjørnskov 2019), based in part on the entrepreneurship discussions of Mises ([1949] 1998) and Lachmann ([1956] 1978), has emerged as an important alternative.
It is safe to say, then, that Austrian economics remains an important perspective in the modern study of entrepreneurship. Yet while entrepreneurship scholars often take inspiration or even borrow from Austrian economics, the reverse is scarcely true. Even so, there is reason to believe both sides would benefit from more interaction and collaboration (for a recent but limited example, see Elert and Henrekson 2019). Austrian theory was largely developed prior to and beyond the reach of, and has therefore been unaffected by developments in, the entrepreneurship literature. This means that new findings and theoretical advances, as well as novel approaches and questions, that could contribute to the further development of the Austrian corpus may remain undiscovered. Similarly, entrepreneurship theory, which to date includes a number of interesting perspectives but lacks a firm core set of assumptions or theories, could benefit from considering, incorporating, or even adopting Austrian theorizing more broadly—as a framework, structure, or theoretical basis.
The aim of this special issue is to facilitate a synergistic discussion between Austrian economists with an interest in entrepreneurship theory and entrepreneurship scholars with an interest in the Austrian approach. Although we could perhaps go much further, the goal here is merely to begin building a bridge between the fields by creating an initial exchange of ideas, perspectives, and approaches to benefit both “sides.” The articles published in this special double issue contribute to this interdisciplinary exchange of ideas. Although they have different starting points, different aims, and utilize different perspectives and methods, they all address research questions and use methods that make them of interest both for scholars in the Austrian tradition and in the academic study of entrepreneurship.
The first article, “Turning the Word Upside Down,” by Mark Thornton, addresses the historical origins of the term entrepreneur. Going back to the early eighteenth-century, Thornton argues that an entrepreneur was traditionally understood as a government contractor, or someone operating with a known, predetermined revenue but unknown future costs. As one would expect, these entrepreneurs were known for cutting corners and underdelivering, as they themselves would benefit from keeping costs down. But the meaning of the word was turned on its head thanks, largely, to the writings of one man: Richard Cantillon ([1755] 2010). With Cantillon’s masterful treatise, the entrepreneur was given the very opposite meaning, similar to how we would today view entrepreneurs: as someone who deals with known costs but unknown future revenue. Thornton traces the influence of Cantillon and how the term changed meaning in dictionaries, among leading econ- omists, and then in common usage.
Randall Westgren’s article, “Carl Menger’s Grundsätze as a Foundation for Contemporary Entrepreneurship Research,” revisits insights from the Austrian school’s founding with Carl Menger’s groundbreaking Principles of Economics ([1871] 2007). Westgren finds in Menger’s observation that value is subjective an important yet missing piece of the puzzle in entrepreneurship theory. Thus, by formalizing Menger’s hierarchy of needs, he creates a model of strategic entrepreneurship that fills this important gap and ties together insights from consumer behavior, marketing, and organizational psychology.
In “Austrian Economics and Organizational Entrepreneurship: A Typology,” Sara Elias with coauthors Todd Chiles, Qian Li, and Fernando D’Andrea develop a typology to assist organizational scholars in applying core Austrian insights. They develop four distinct perspectives—equilibration, punctuated equilibrium, disequilibration, and punctuated disequilibrium—that distinguish different strands of Austrian economics in relation to entrepreneurial production and change. The article provides useful background on how these perspectives differ with respect to ontological, epistemological, and methodological assumptions, and illustrates their applications in organizational research.
In the fourth article, “Finding the Entrepreneur-Promoter: A Praxeological Inquiry,” Per Bylund addresses the Misesian conception of the entrepreneur-promoter and offers a means to define this distinct type of entrepreneur praxeologically. Applying the imaginary construction developed in Problem of Production (Bylund 2016)—the “specialization deadlock”—he provides a theoretical distinction between entrepreneurship in general (the uncertainty-bearing function; Mises [1949] 1998) and the promoter as the driving force of the market. The promoter is then defined theoretically as the function of establishing specialized production beyond what the market’s existing division of labor supports. In other words, promoters implement productive innovations beyond the extent of the market.
Mark Packard’s “Autarkic Entrepreneurship” addresses a different dimension of Austrian entrepreneurship theory and attempts to break new ground in a different direction. He argues provocatively that the entrepreneurial function is not limited to the catallactic (exchange) economy but is also an important part in, and necessary to understand, the autarkic or do-it-yourself economy. Arguing that catallaxy and autarky, as alternative courses of action, are substitutes, complements, and even competitors, Packard extends Austrian economic theory into the realm of the personal economy.
In “Why (a Theory of) Opportunity Matters: Refining the Austrian View of Entrepreneurial Discovery,” Gregory Dempster adds to existing entrepreneurship theory by producing an argument in defense of the entrepreneurial opportunity concept. Retaining essential elements of Kirzner’s (1973) original theory, Dempster reinterprets opportunity as an intersubjective phenomenon that emerges from entrepreneurial discovery and judgment. The paper thereby, in the words of the author, “places opportunity back in the limelight as a central concept for understanding the causes and effects of entrepreneurship” (p. 429).
“Entrepreneurial Empowerment: You Are Only as Good as Your Employees,” by Desmond Ng, develops the concept of entrepreneurial empowerment to explain how entrepreneurs can overcome their venture’s internal Hayekian knowledge problem. Ng argues that entrepreneurial success can be explained not only by the entrepreneur’s original ideas but also (and, perhaps, more importantly) by their ability to inspire others within the organization. Specifically, by empowering employees to make use of their local and tacit knowledge, the entrepreneur can establish a discovery process within the firm in which employees’ unique knowledge can contribute to the vision and goals of the organization.
In the eighth article, “A Dynamic Model of Entrepreneurial Opportunity: Integrating Kirzner’s and Mises’s Approaches to Entrepreneurial Action,” Alexander McKelvie with coauthors Johan Wiklund, Jeffrey McMullen, and Almantas Palubinskas present two longitudinal case studies to inductively drive the argument that time is important in entrepreneurship. The authors argue that the passing of (objective or clock) time increases the likelihood of market data change, thus requiring entrepreneurs (and entrepreneurship theories) to adopt a dynamic temporal perspective in which opportunity beliefs are updated. With this important identification, they seek an integration of Kirzner’s alertness to opportunity and Mises’s focus on entrepreneurial action.
Daniel Leunbach and coauthors Ekaterina Bjørnåli and Truls Erikson present an empirical analysis of subjectivism on the interpersonal or group level. “A Subjectivist Approach to Team Entrepreneurship” studies the team dynamics in 124 high-tech start-ups and finds that positive internal and external team dynamics, as subjectively assessed by the entrepreneurs, contribute to the effectiveness of the team. Their study presents a first attempt to measure the effects predicted by the subjectivist approach to team entrepreneurship.
Finally, “Institutions and Entrepreneurship: Pushing the Boundaries,” by Scott Burns and Caleb Fuller, recognizes the central role that institutions play in both new institutional economics (NIE) and Austrian economics and suggests how the approaches complement each other. Focusing specifically on Austrian insights regarding subjectivism, entrepreneurship, and capital, the authors argue that there are gains from theoretical trade between the disciplines. Specifically, they find that the Austrian perspective can improve the NIE understanding of institutional evolution as well as contribute to explaining observable within-country variation in entrepreneurship and production.
Combined, these ten articles cover a broad set of issues and adopt a multitude of perspectives on both how Austrian economics can be used in entrepreneurship scholarship, how entrepreneurship scholarship can lean on Austrian economic theory for further refinements, and how entrepreneurship scholarship provides direction for further theorizing in Austrian economics. There are many reasons to be optimistic about research within this gap, which is perhaps better understood as a phenomenal, conceptual, and theoretical overlap, between the fields. But there are also differences that should be acknowledged. For example, Austrian economics is a deductive, theory-first framework that seeks truth rather than testable hypotheses. Although empirical research is important, it is not used as a means for theorizing but rather to illustrate and apply theory. Meanwhile, entrepreneurship research typically follows the standard model of research in which theory is used to generate testable hypotheses that, if supported, may eventually be incorporated into the larger corpus of scientific explanation. This suggests that entrepreneurship may be more open to borrowing from Austrian economics than the other way around, as history has already shown (Klein and Bylund 2014). But Austrian economics would still benefit greatly from seeing its concepts applied and subjected to empirical analysis (even though Austrians would refer to this task as history or thymology, not theory development [Mises (1957) 2007]).
The articles in this special issue attempt all of the aforementioned tasks. They thereby indicate directions for future research within Austrian economics, in entrepreneurship, and where the fields overlap. They also address directions for further expansion beyond the present boundaries of Austrian economics and entrepreneurship theory. This double issue includes articles that open new lines of thinking for Austrian economists with an interest in entrepreneurship as well as for entrepreneurship scholars with an interest in Austrian economics. These articles, each in its own way, are the building blocks needed to give shape to a bridge that facilitates new collaborations and exchanges—perhaps even friendships. Regardless of what may come of this special issue, scholars on both sides should find the bridge well worth traveling.
Abstract: The socalled autistic economy (here autarkic)—the economy of one—has been employed by Austrian theorists as a useful analytic baseline on which to build catallactic (market process) theory, which has included a theory of entrepreneurship. But so far, the autarkic economy has been examined almost exclusively in this way. In this article it is argued that the autarkic economy must brought forward in our theorizing to be understood not as a mere analytic tool, but as a real and significant aspect of praxeology. It is proposed that catallaxy and autarky be understood as substitutes, complements, and even competitors. Extending Austrian theorizing of the autarkic economy, the entrepreneurial function within autarkic economies is examined and elaborated. It is shown that, far from only a catallactic role, the entrepreneurial function is prominent within the autarkic economy also, in which the entrepreneur plays a significant role in augmenting individual lifestyles and, thus, total economic development.
JEL Classification: B53, L26, D10, D13
Mark Packard (mpackard@unr.edu) is Assistant Professor of Management at the University of Nevada, Reno. The author thanks Professor Per Bylund and the anonymous reviewers for their thoughtful guidance and feedback on an earlier draft.
INTRODUCTION In the 2000 film Cast Away, character Chuck Noland (Tom Hanks) found himself stranded alone on an uninhabited island with an extremely limited number of resources and tools for his survival. A systems engineer for a shipping corporation, Noland also possessed limited knowledge and experience relevant to his newfound circumstances. With the familiar knowledge that rubbing sticks together could produce fire, he set himself to the task to little avail. In near desperation, Noland accidentally split one of the pieces of wood. Giving the split piece of wood another try, the kindling began to smoke. Realizing that the split piece of wood afforded the kindling additional access to air, he innovatively increased that access by sweeping an air canal in the sand beneath the kindling and by inserting a small object into the split wood to keep it open. Putting himself again to the task, he finally ignited the kindling and produced a fire. Elated, he exclaimed, “Look what I have created!”
The question this article seeks to answer is this: Was Noland an entrepreneur?
Austrian school economists, beginning with Carl Menger, have started their economic theorizing from the perspective of the “autistic” or “autarkic”Mises (1998) uses both terms—autistic and autarkic—in similar fashion but formally adopts autistic to reference the economy of one and autarky to reference political self-governance. However, modern idiom has laden the term autistic with the burden of a human development disorder. To avoid potential confusion (see, e.g., Devine 2006), I have elected to employ autarkic in the place of autistic. economy (Mises 1998, 244), the singleperson “isolated household economy” (Menger 2007, 75),I should here clarify that whether an “isolated household economy” (Menger 2007, 75) is autarkic or catallactic hinges on whether there is interpersonal exchange of produced goods. Thus, if there is a single producer in the household, there is no market and the household is “at the disposal of a single economizing individual,” i.e., autarkic. If there are multiple producers in the household, however, interpersonal exchange and a division of labor between producers can emerge, whether prices of some form are used or not, in which case it is catallactic. the “Crusoe economy” (Rothbard 2009, 319), the economy of one. It seems strange to the modern economist to suppose a single person to be an “economy”; but it is, in fact, the mainstream economist’s difficulty in grasping this fundamental reality that has impeded a much deeper analysis and understanding of economic processes. After all, a single actor produces and consumes, demands and supplies, values, innovates, and economizes. If economics cannot explain a single actor’s economizing of their own scarce resources within the bounded scope of their own life and property, it cannot succeed in explaining human action more broadly.
Of course, microeconomies, such as households, are not an insignificant aspect of current economic theorizing. Family and household economics have been developed by, e.g., Gary S. Becker (1965, 1991), Robert A. Pollak (1985), Theodore W. Schultz (1975), Kelvin Lancaster (1975), and many others since. But at this microscopic level, although the supply side is admitted as an input into the market’s circular flow, attention has been arrested almost wholly on the demand side, exploring the economics of how individuals and households determine what to demand (e.g., Michael and Becker 1973), which can then be aggregated into utility functions for macroeconomists. Thus, microeconomics has come to be dominated by behavioral economics and its consumer behavior theories, while “Crusoe economics” has come to be largely dismissed and ridiculed.
Even within the Austrian school autarkic praxeology has remained vastly underdeveloped, so far employed primarily as a building block toward understanding catallactic processes. Thus, even Austrian theory has neglected (but not altogether ignored) a vast and vital aspect of the overall economy—the extensive autarkic or do-it-yourself (DIY) economies that we each embody.
This research has two main functions. First, it advances an argument that autarkic economies are not at all inconsequential, but ought to be brought to the fore of Austrian theorizing. This piece of the praxeological puzzle places the autarkic economy as a real and direct competitor, or sometimes complementor, of the catallactic economy. In short, DIY is a real and common substitute for satisfactions purchased in catallactic markets. By focusing myopically on catallactic exchange, we overlook a critical option within a vast majority of consumer choice sets.
Its second function is to advance Austrian theorizing on autarkic economics by introducing and elaborating the concept of autarkic entrepreneurship. Although Austrian theorists have, again, focused almost exclusively on the catallactic function of the entrepreneur (e.g. Kirzner 1973; Lachmann 1986; Mises 1998), there is nothing about the entrepreneurial function per se that conscribes it to catallaxy alone. Instead, it is shown that the entrepreneurial function is very much alive and well within the autarkic economy also. To make a compelling case, it is necessary to first carefully examine and elaborate the essence of entrepreneurship, as this essence has been the source of some disagreement among Austrian theorists (and others).
AUTARKIC ECONOMICS So-called Crusoe economics—“that much maligned but highly useful analysis that sets individual man starkly against Nature and analyzes his resulting actions” (Rothbard 2009, lvi)—is the backbone of Austrian theorizing. As Ludwig von Mises (1998, 244) put it, “economics cannot do without it.” Both Mises and Murray N. Rothbard in their seminal treatises precede their analysis of interpersonal or catallactic exchange with a baseline theory of the “autistic economy,” a foundational foil in which interpersonal or catallactic exchange is absent, without which we could not see what catallactics would add, specifically, to the analysis. That is, to see why we voluntarily form and interact in a market, it is first necessary to understand how one economizes without one. However, this largely neglected aspect of economic theory is far more interesting and important than we have so far admitted.
Autarkic Exchange
Economic action is comprised of two types of exchanges: catallactic and autarkic. Catallactic exchange references the traditional market exchange, which is the centerpiece of modern economic theory. However, it is not the only type of economic exchange. “Autistic [or autarkic] exchange consists of any exchange that does not involve some form of interpersonal exchange of services” (Rothbard 2009, 84). But how can one exchange except with another?
A satisfactory answer to this is found in the deeper analysis of economic action that Mises evokes: “Action always is essentially the exchange of one state of affairs for another state of affairs. If the action is performed by an individual without any reference to cooperation with other individuals, we may call it autistic [or autarkic] exchange” (Mises 1998, 195). In other words, life, even in social isolation, is comprised of endless tradeoffs, which, in a strict economic sense, can and, perhaps, should be theoretically described as an exchange. By cooking one’s dinner, one exchanges time, labor, and raw foodstuffs for a warm meal—one no longer has those resources available, which could have plausibly been used for other productive ends. However, the hot, homecooked meal is valued over whatever alternative uses one might find for that time, labor, and those foodstuffs and, thus, one choses to make the exchange.
But with whom is one trading in such an exchange? There is no clear answer to this. We might say that one is trading with oneself, or with no one, or perhaps “with nature” (Kirzner 1973, 37). Nothing is being given to anyone—yet there is an exchange made, scarce resources for consumable goods and services. Thus, the principle of “opportunity cost” extends to the autarkic economy, for there is an opportunity cost that is sold in exchange for any chosen action.
The implication of this is that much of the economy is autarkic, individuals acting for themselves. If you were to break down your day into autarkic and catallactic actions (exchanges), it should be little surprise that a significant part of each day is comprised of autarkic exchanges, which can include rest and sleep, personal hygiene, eating, certain entertainment options, and so forth. The autarkic economy is not just a useful analytical foil but is a real and significant part of the human experience.
The Autarkic Economy
When you are ready for a meal, does your mind instantly wander to those restaurants available to you that might provide you with a prepared meal? When your teeth feel dirty, do you call your hygienist? Do you employ a housecleaning service to pick up after you and make your bed each day?
A significant amount of economic value we facilitate for ourselves rather than satisfying those unmet needs and the sense of “uneasiness” through catallactic market exchange. It is true that sometimes we like to dine out, to get our teeth professionally cleaned, or to our have our homes tidied up by hired hands. But far more often we perform these tasks for ourselves.
This raises a question: If we do such tasks ourselves, what happens to the economic value that the professionals did not capture from us? Is such value lost because we were unwilling to pony up our savings in support of the local economy? The answer is, of course, that we capture such economic value ourselves—the benefit of the service, i.e., the economic value, is obtained while the cost of obtaining it is retained, largely, by the do-it-yourselfer, leaving those costs available for the pursuit of other ends. In other words, the do-it-yourselfer participates not in catallactic exchange, but in autarkic exchange. In terms of a simple utility function, the expected utility, all costs and benefits accounted for, is in many cases greater in the autarkic economy than in the catallactic economy. It is often better overall (e.g., cheaper, more rewarding) to do it yourself than to pay another to do it.
Contrast such cases with, for example, the value provided by a medical surgeon. While it is true that self-diagnosis has become easier than ever with the vast amount of medical information that we now have access to online, few of us would perform anything more than a minor toenail surgery on ourselves. Many market needs are too complex, involved, or require significant expert training that do-ityourself amateurs do not have and, thus, cannot do for themselves, at least not without some additional capital goods. One cannot massage one’s own back without the use of some additional capital goods that would allow me to reach those tight muscles. Leonard Read’s (1958) famous essay “I Pencil” illustrates the limitations of autarkic production well. The autarkic economy alone simply cannot provide economic goods even as simple as a pencil due to their complexity and the total knowledge, skill, and capital required.
Thus, at one end of the spectrum, we have certain services that, in fact, cannot be performed by catallactic markets. For example, the spiritual needs and values that many economic actors pursue through, e.g., churchgoing cannot be contracted out, the benefits pursued accruing only to those who go and do for themselves. Similarly, while we have, in recent decades, found new ways to socially connect people, such connections, including love, must always be made by those persons themselves, and cannot be purchased from or contracted out to others.
At the other end of the spectrum, we have some services that absolutely cannot be performed autarkically. At this extreme end we are talking about literal impossibilities. One cannot, for example, both perform a play and enjoy it live from the gallery at the same time. Close to that end of the spectrum would be those goods and services that, although not literally impossible to perform for one’s self, are far too complex for a single actor, such that it is effectively impossible (e.g., computer manufacturing).
Many economic goods and, especially, services, however, lie somewhere between these extremes, where the economic actor has a real choice whether to do it (or make it for) themself or else pay someone else to do it. In these circumstances, the value of doing it yourself (e.g., cost savings) is counterbalanced by other considerations, such as the quality of work. Although it seems silly to even think of a catallactic market for some services, such as showering or getting dressed in the morning, these services could be contracted out (if, for example, physical ailments made such activities impossible to do one’s self). However, these services we prefer to do ourselves (if we can), because the cost of doing so is low, whereas the cost of contracting on the market for such services would likely be quite high. You can hire a chauffeur, but such is a luxury for the very wealthy, whereas it is not excessively costly to drive yourself. Conversely, a great many goods and services could be done autarkically, but the costs of doing so are prohibitively high, while the cost of hiring them out is quite low—you can buy a pencil for under ten cents.
The most interesting examples, however, are far more moderate. If a homeowner decided to repaint a room, she would be faced with a decision of whether it is worth hiring professional painters, who would save her the time and likely do a higher-quality job, or else save hundreds of dollars doing the job herself. Such decisions, which most of us regularly face, illustrate a key insight: that the autarkic and catallactic economies are often competitors. A restaurant is in competition with other restaurants, certainly. But it is also competing against your kitchen and recipe book—the uneasiness (i.e., hunger pangs) that we look to satisfy by going to a restaurant can also be satisfied ourselves if we decide that our own efforts in doing so are worth the advantages. There are a great many goods and services that are comparable, in terms of cost and benefit, between the autarkic and the catallactic economies.
Not all autarkic activities are competing with catallactic markets, however. In many cases they are complements, together combining to augment total achieved value. For example, while we generally like to wash ourselves, we generally use market products (e.g., shampoo) to do so. In fact, it is interesting to observe that catallactic markets have arisen as supports to the autarkic or DIY economy, such as home improvement stores and DIY instructional platforms.
Economic analysis that fails to account for the very real and productive autarkic economy is incomplete. A business strategist that focuses myopically on industry competition may be severely unprepared when consumers turn away from that industry completely to perform the needed services themselves. For example, the tax accountancy industry has greatly suffered as online tax preparation software has enabled people to prepare and file taxes cheaply and easily themselves. Home kitchen technologies (such as bread makers, sous vide machines, and pressure cookers) have made preparing high-quality homecooked meals much easier and accessible to the culinarily untrained. Entertainment options not only include productions by entertainers but also autarkic options such as social gatherings, afternoon strolls, family game nights, and quiet evenings enjoying the starlight on the porch.
By theoretically elaborating the autarkic economy, we gain a much more complete picture of economic phenomena, including economic growth and change.
Fundamentals of the Autarkic Economy
Before advancing the question of entrepreneurship within the autarkic economy, let us first lay some additional groundwork. How are we to define and understand this DIY economy? The fundamentals here are essentially equivalent to those laid out by Menger (2007), Mises (1998), and Rothbard (2009). But let us be explicit.
The first and most fundamental construct is subjective value. “Value is…the importance that individual goods or quantities of goods attain for us because we are conscious of being dependent on command of them for the satisfaction of our needs” (Menger 2007, 115). In other words, subjective value is not something that a thing has but is something an individual actor does—things do not have value, rather we value things. Because of this, value is individual and can be very different for different persons. Subjective value is, in fact, a wholly autarkic construct and not a catallactic construct— there is no interpersonal value. Although individual values may shift when embedded within social groups, Austrian methodological individualism demands that we still understand such valuations individually, and not as the brainchild of some “real” collective.
We have already seen that exchange is both an autarkic and catallactic construct. Because of this, we can also integrate the concept of price in the Mengerian sense—“the quantities of goods actually exchanged” (Menger 2007, 191)—as well as the opportunity cost (i.e., “the next best alternative forgone” [Rothbard 2009, 266]) into the autarkic economy. These costs are what is sacrificed in order to attain the valued benefit. Autarkic exchange, however, has no need of a “medium of exchange” or a “money” (Mises 1912), which is confined to catallactic exchange.
Let us also define economy for the purpose of this discussion. While it is rarely, if ever, explicitly defined, it becomes clear in the classical Austrian works that ‘economy’ represents the productive pursuit of need satisfactions through purposeful action. Thus, the underlying driver of economy is unmet human needs:
An imperfect satisfaction of needs leads to the stunting of our nature. Failure to satisfy them brings about our destruction. But to satisfy our needs is to live and prosper. Thus the attempt to provide for the satisfaction of our needs is synonymous with the attempt to provide for our lives and well-being. It is the most important of all human endeavors, since it is the prerequisite and foundation of all others. (Menger 2007, 77)
The mechanism of economy, the response to unmet needs, is purposeful human action (Mises 1998; Rothbard 2009). In fact, all economic action is purposeful (Mises distinguishes action from animalistic instinct and impulse), being universally pointed at the satisfaction of unmet needs. Let us, thus, define economy here as the productive actions taken toward the satisfaction of human needs.
Economic profit, then, refers to “the increase in satisfaction (decrease in uneasiness) brought about” through exchange (autarkic or catallactic), “the difference between the higher value attached to the result attained and the lower value attached to the sacrifices made for its attainment” (Mises 1998, 286). An economic loss is, then, a “a decrease in satisfaction” (Mises 1998, 287), where that which is sacrificed surpasses that which is gained in return. Thus, both economic profit and loss are always “psychic phenomena” (Mises 1998, 287; emphasis added), wholly subjective.
Economic growth and decline, finally, refer to the overall satisfaction of human needs, in the aggregate, throughout the economy (as conscribed by the delimiters of the described economy, e.g., individual, household, local, national, global), whether it is increasing or decreasing, respectively, by average economic profits exceeding losses or vice versa. An autarkic economy grows, then, when an individual actor’s overall wellbeing is increased, when his needs are more fully met by those resources at his disposal.
Delineating the Autarkic and Catallactic Economies
Let us, now, draw clear theoretical boundaries between the autarkic and catallactic economies. The definitional boundary is clear—an economy is autarkic inasmuch as it involves no interpersonal exchange and is catallactic otherwise. But let us expound briefly on the theoretical underpinnings between autarkic versus catallactic action, i.e., when and why one might be preferable to the other. These mechanisms involve, as previously implied, the personal nature of the uneasiness needing satisfaction, the complexity of the satisfaction desired, and the costs of bringing the satisfaction about (see figure 1).
Figure 1. Catallactic versus Autarkic Economizing
First, some human needs are innately personal in nature and, thus, must be satisfied for one’s self. These generally comprise the psychological and spiritual needs—whatever they may be—of human existence. Per self-determination theory (Deci 1980; Deci and Ryan 2000), basic human psychological needs include autonomy, social relatedness, and competence. Satisfaction of each of these must be achieved for one’s self—they cannot be purchased from others, though catallactic services and solutions might help individuals to achieve them. What might be called spiritual needs, such as hope (O’Hara 2011), are similarly personal in nature. In contrast, physiological needs, such as food, water, shelter, medicines, etc., are comparatively universal and can easily be obtained via catallactic exchange. Also, some psychological and perhaps even spiritual needs, such as need for excitement (Scitovsky 1981), may be sufficiently generic to allow satisfaction to be purchased through catallactic exchange.
A second factor in determining whether satisfactions are pursued via autarkic or catallactic economy is the complexity of the satisfaction. As the pursuit of satisfaction evolves toward more complete and, thus, more complex solutions, the complexity of such satisfaction grows beyond the capacity of a single actor and requires the cooperative productive efforts of multiple actors. For example, most market services, such as housecleaning, car repair, and cooking are doable by knowledgeable consumers because they require only a moderate amount of human capital. In contrast, most manufacturing and production requires far more human capital than a single person can possess, requiring multiple actors to act cooperatively. It is this problem that underpins Bylund’s (2016) thesis that firms arise out of a need to overcome a specialization deadlock, which arises out of the fact that complex consumer satisfactions require a greater division of labor. Because such specialization is dissuaded by market pressures, entrepreneurs must contractually guarantee salary to market actors to overcome the propensity toward generic human capital and motivate their investment in the needed specialization for complex production. In other words, as solutions become more complex, catallactic markets and, specifically, firms are needed for their efficient production.
Relatedly, the boundary between the autarkic and catallactic economies lies in differences in their efficiencies due to the division of labor. In the evolution of the catallactic economy, some solutions have become so efficiently produced through specialization that it is simply much more economically efficient to purchase those solutions from specialists rather than to produce those satisfactions for one’s self. For example, although it is still possible for one to make one’s own clothing, soap, or quilt, the efforts to do so are now far costlier than to simply purchase those goods on the market. Although some still enjoy sewing, soapmaking, and quilting as hobbies, for most the catallactic economy clearly outperforms the autarkic economy for such production. In contrast, other satisfactions, such as meal preparation and various home improvement efforts, are still often cheaper to do for one’s self. Thus, inasmuch as a division of labor can decrease total costs, the preference between autarky and catallaxy shifts toward the catallactic side.
THE ENTREPRENEURIAL FUNCTION Before we can begin our exploration of the entrepreneur function within the autarkic economy, we first need to carefully define what this entrepreneurial function is. This question, of course, has been a source of some debate among economists, including Austrians. In fact, the modern academic discipline of entrepreneurship has been in active debate over the nature and foundations of entrepreneurship for over three decades now, to no imminent conclusion (see, e.g., Gartner 1988; Ramoglou, Gartner, and Tsang 2020).
Prevailing Definitions of Entrepreneurship
The nature of entrepreneurship has been examined from several angles already. Peter G. Klein (2008) classifies these various approaches to entrepreneurship into three distinct categories: occupational, structural, and functional. The first two, occupational and structural, pertain to economic realism or positivism as prevails in the economic mainstream, supposing entrepreneurship to be a thing that exists in the economy. The latter category, functional approaches, is characteristic of and to the Austrian school, depicting entrepreneurship as something that economic actors do within the economy.
Neoclassical Economics
Early entrepreneurship research in mainstream (primarily neoclassical) economics depicted entrepreneurship as either an occupational or structural phenomenon. “Occupational theories define entrepreneurship as self-employment and treat the individual as the unit of analysis, describing the characteristics of individuals who start their own businesses and explaining the choice between employment and self-employment” (Klein 2008, 176). Classic exemplars of such an approach include Kihlstrom and Laffont’s (1979) classic risk aversion model and Parker’s (2009) composite review of the self-employment research.
Alternatively, “structural approaches treat the firm or industry as the unit of analysis, defining the entrepreneurial firm as a new or small firm. The literatures on industry dynamics, firm growth, clusters, and networks have a structural concept of entrepreneurship in mind” (Klein 2008, 176). This approach to the study of entrepreneurship was empirically popular among early entrepreneurship scholars (e.g. Acs and Audretsch 1989, 1990; Oakley, Rothwell, and Cooper 1988).
Notably, both of these approaches are clear in their implication for the autarkic economy—entrepreneurship is a catallactic phenomenon only. This is, perhaps, not surprising given that the positivistic foundations of mainstream economics imply that entrepreneurship exists in the market economy (and, so, is not to be found out of it).
Austrian Economics
The Austrian school of economics has set itself apart from the economic mainstream, among many other ways, by characterizing entrepreneurship as an economic function. Entrepreneurship is not something that exists in an economy, but is something that certain economic actors do, a function that they perform. Austrian theory has examined the role of the entrepreneur—what his purpose is and what effects he has on the economy—whereas mainstream economics, both neoclassical and Keynesian, has simply assumed away this role, taking the small business as already given (Casson 1982; Hébert and Link 1988, 2009). In other words, positive economics takes the entrepreneurial firm as extant and real, and so offers no theory of its emergence in the first place. In this only the Austrian school has had anything meaningful to say. Here let us consider the different entrepreneurship theories of the Austrians, namely those of Joseph A. Schumpeter, Mises, Israel M. Kirzner, and Ludwig M. Lachmann (ordered chronologically).
Although some do not include Schumpeter as a member of the Austrian school, in this sense he belongs with the Austrians. Schumpeter (1934, 66) conceived the function of the entrepreneur to be innovation, i.e., “the carrying out of new combinations,” which he defined broadly to include the introduction of economic novelty to the market in five different categories:
(1) The introduction of a new good—that is one with which consumers are not yet familiar—or of a new quality of a good. (2) The introduction of [a] new method of production, that is one not yet tested by experience in the branch of manufacture concerned, which need by no means be founded upon a discovery scientifically new, and can also exist in a new way of handling a commodity commercially. (3) The opening of a new market, that is a market into which the particular branch of manufacture of the country in question has not previously entered, whether or not this market has existed before. (4) The conquest of a new source of supply of raw materials or half-manufactured goods, again irrespective of whether this source already exists or whether it has first to be created. (5) The carrying out of new organization of any industry, like the creation of a monopoly position (for example through trustification) or the breaking up of a monopoly position.
Thus, Schumpeter’s entrepreneur is the introducer of novelty into the production system, the disrupter of Walrasian equilibrium. Note that this entrepreneurial function is different from the “inventor” function, which merely devises the novelty. Although the inventor (who creates the novelty) and innovator (who brings it to market) are often the same person, they need not be. Although Schumpeter takes no interest in autarkic economics, one can infer from this that his entrepreneurship theory might include Noland or Crusoe whenever they innovated.
Mises’s work on entrepreneurship is somewhat limited and yet remarkably profound. However, because it is limited, the essential function of the entrepreneur in Mises’s treatment is somewhat unclear. The standard interpretation of the Misesean function of the entrepreneur is as speculator, the bearer of uncertainty and of riskWhereas Knight (1921) describes risk as a situation of known outcome probabilities in contrast to uncertainty, Mises depicts risk as what one stands to lose within uncertain endeavors. in the allocative investment of scarce resources. While the capitalist earns interest and the worker earns wages, the entrepreneur is the one who “earns profit or suffers loss” (Mises 1951; 1998, 255). However, Mises (1998, 288) also, quite explicitly, observed that “The specific entrepreneurial function consists in determining the employment of the factors of production.” Certainly, such resource allocation is speculation and necessarily bears uncertainty. But it is not clear whether the true essence of the entrepreneur is, for Mises, in the speculation or in the resource allocation. Rothbard and Kirzner assumed the former, Lachmann the latter. I will come back to this question shortly.
Mises (1998, 252–53) explicitly depicts the entrepreneurial function as a catallactic one. However, he seems to understand this characterization (“catallactic”) more generally as an economic function, for also included among these “catallactic” functions are consumer, landowner, capitalist, and worker, all of which are autarkic economic functions also, and not merely confined to interpersonal market activities.Although land ownership has little apparent meaning in a wholly isolated autarkic economy (à la Crusoe), in another sense property (e.g. land) ownership is what enables autarkic economy within the catallactic economy. Thus, although Mises formally discusses the entrepreneurial function as a “catallactic concept” only (Mises 1998, 253), it can certainly be extended to the autarkic economy also.
Although Kirzner’s work has centered on the entrepreneurial function, the essence of this function has been rather difficult to pin down. Most understand Kirzner’s entrepreneurial function to be the discovery of yet unexploited “opportunities,” for which he has been much criticized (e.g., Foss and Klein 2010; Rothbard 1985, 1997). Thus, the unique feature that characterizes the entrepreneur is his “alertness” to such opportunities where others have overlooked them. But Kirzner’s conception of an opportunity is rather unclear, especially as pertaining to autarkic versus catallactic processes. The standard definition of opportunity is as a “market imperfection” (Alvarez, Barney, and Anderson 2013), a situation in which the entrepreneur “buys where prices are ‘too low’ and sells where prices are ‘too high’” (Kirzner 1997, 70), plausibly obtaining for himself a pure profit with no cost or risk to himself (Kirzner 1973). One footnote of particular relevance, however, illustrates the difficulty in interpreting Kirzner on this point:
In a world of perfect knowledge the only scope for decision-making relates to opportunities for exchange—either with man or with nature— something one values relatively little for something one values more highly. In a world of imperfect knowledge, there may exist at any given time something selling at more than one price in the market. Once this price difference is noticed, once some knows it, a profit opportunity has been discovered. (Kirzner 1973, 37n4–38)
Observe here that Kirzner defines opportunity in two ways. In the first, it is a situation in which valued goods can be exchanged for something of higher value, thereby achieving a pure profit. In the second, he defines it as a situational price difference that can be exploited for a pure profit. Although these seem essentially equivalent, there is a critical difference, especially for the research at hand. Price differences, of course, necessarily imply a catallactic economy. However, according to his first definition of opportunity, such exchange—either with man or with nature—need not be catallactic, but apparently includes autarkic exchange “with nature” (such as exchanging valuable time and labor for the goods of nature acquired from those efforts). Thus, we can also ascribe to Kirzner an entrepreneurial function of new value discovery that fits both the autarkic and catallactic economy contexts.
Lachmann (1977, 1978), finally, sees entrepreneurs “as ‘problem-solving’ individuals who ‘change’ and ‘direct capital flows’” (Endres and Harper 2013, 306). In other words, the essential function of Lachmann’s entrepreneur is to reorganize capital more efficiently. In this sense, Lachmann’s entrepreneur overlaps significantly with Schumpeter’s and Mises’s, and only lightly with Kirzner’s. Lachmann expends some effort advancing the notion of capital, which is often, in traditional economics, understood to be given by its objective nature. Lachmann, however, rejects this objectivism—capital is only given by entrepreneurs, who create from the (objective) properties of things new and better (subjective) purposes or uses for those things, reconceptualizing them into new capital goods. For example, wood material is merely matter of a certain type until some entrepreneur imagines out of it the purpose of comfortably sitting and, thereby, creates out of that matter the capital good of “chair.” Once again, while Lachmann theorized this entrepreneurial function within the context of the catallactic economy, it appears equally valid in an autarkic economy.
Each of these entrepreneurship theories holds merit in depicting important economic functions that serve to explain economic change processes. However, each one seems to focus on a different economic mechanism, which prompts us to ask, again, what is the real entrepreneurial function?
The Entrepreneurial Function Reconceptualized
There is, perhaps, no “right” answer to the question of what the entrepreneurial function is. The question is definitional and, thus, analytic and tautological. Each of the functions outlined above is a real economic function, with specific and relevant economic effects. By what criteria might we determine which is the most apropos to economic theory?
It seems that the best and, in fact, only criterion that could direct such a judgment is the economic effect that one seeks to explain by the concept of entrepreneurship. To make this argument, let us follow the standard Austrian method of starting with the artificial foil to which we will add the entrepreneur—a society in which there are no entrepreneurs whatsoever. Let us start with Mises’s evenly rotating economy (ERE).
The Evenly Rotating Economy
The ERE is “a fictitious system in which the market prices of all goods and services coincide with the final prices. There are, in its frame, no price changes whatever; there is perfect price stability. The same market transactions are repeated again and again” (Mises 1998, 248).
What would occur if value scales, technological ideas, and the given resources remained constant? What would then happen to prices and production and their relations? Given values, technology, and resources, whatever their concrete form, remain constant. In that case, the economy tends toward a state of affairs in which it is evenly rotating, i.e., in which the same activities tend to be repeated in the same pattern over and over again. Rates of production of each good remain constant, all prices remain constant, total population remains constant, etc. (Rothbard 2009, 321)
The ERE allows us to “analyze the problems of change in the data and of unevenly and irregularly varying movement” (Mises 1998, 248). There is no uncertainty in the ERE whatever; all actions are perfectly predictable, and all actors are mere automatons, performing perfectly their prescribed duties. Thus, the ERE is a “state of final equilibrium” (Rothbard 2009, 321).
Adding the Entrepreneurial Function
Let us now add the entrepreneurial function to the ERE, where we have no economic change whatsoever. To understand what sort of change is introduced by the entrepreneur to the ERE, we have to first examine what the entrepreneur is trying to accomplish—i.e., what is the goal of the entrepreneur? The purpose that drives the entrepreneur is distinct from that of the “manager,” whose role is circumscribed to “a limited and precisely determined sphere of action” (Mises 1998, 301), namely the (re)production of goods according to established plans. The aim of the entrepreneur, and of the entrepreneurial function, is to generate and purvey such “entrepreneurial plans” (Lachmann, 1977, 1986; Mises, 1998, 300). These plans—distinct from the managerial function of carrying out existing plans for economic value facilitation through production— are pursuant of new and better ways to economize existing resources and activities. They seek to facilitate a higher economic state, to achieve economic growth. Such economic change is accomplished in several ways. We focus here on the effected changes, driven by the entrepreneurial function, on “values, technology, and resources” (Rothbard 2009, 321), which can no longer be held constant.
First and perhaps foremost, economic change can be accomplished by changing the technology by which resources are employed toward need satisfaction. By creating new knowledge about what resources can do, by reconfiguring resources into “New Combinations” (Schumpeter 1934) or new forms of capital (Lachmann 1978), new solutions are created whereby total need satisfaction might be augmented, thereby achieving a higher economic state. Or else the new solution might prove ineffective, and the resources taken away from their more productive uses are wasted in ineffective production, generating an economic loss.
Second, this economic change can be accomplished by reallocating resources more effectively. Under the ERE, present resource allocations are merely replicated, oblivious to any possible gains that might be achieved through optimization. The entrepreneurial function, however, may alter presently inefficient resource allocations toward more highly valued ends (Kirzner 1973), facilitating economic growth. Again, there is a chance that such reallocation results in economic loss, the previous resource allocation proving the more valuable or else the cost of reallocation proving too steep to warrant the change.
Third and, perhaps, least discussed, economic change can be accomplished by the shifting of subjective values. If, as some philosophies and religions teach, humankind were to learn greater contentment within their present world of scarcity, total economic value and satisfaction might increase with no changes to the productive structure whatsoever. That is, because satisfaction is a subjective state—a state of mind—such a state can be achieved by altering the mind rather than the exogenous effects on it. However, it is also possible that people instead learn to want more and more, to become increasingly or perpetually dissatisfied, as has become common in the modern age of consumerism and instant gratification. Thus, shifting subjective values can also either increase or decrease total aggregate well-being. Strictly, the entrepreneur has no direct access to such subjective values, which are the sole purview of individual consumers, to effect such change. However, it is within the entrepreneur’s purview to influence such change by “pushing and promoting” (Mises 1998, 255) their ideas.
In short, by introducing changes to an economy by shifting resource allocations, the entrepreneurial function introduces a profit and loss mechanism (Mises 1951, 1998). But let us be careful here. Although entrepreneurship is a primary source of economic profit and loss, it is not the only one in a real economy. Were we to relax the ERE to allow changes not instigated by entrepreneurs, it is possible that such changes, such as shifting demand, depleting supply, etc., would also cause economic shifts, up or down. If, instead of adding the entrepreneurial function to the ERE, we added only the ability for demand to change, such shifts in demand would also cause economic growth or decline. If, all else held constant, consumers suddenly changed their preferences from blue shirts toward orange shirts, the supply of blue shirts would suddenly become excessive and the supply of orange shirts would then be insufficient, producing an economic decline. Or, if supply were allowed to change, newly discovered supplies might increase total satisfaction outputs, while depleted supplies would cause markets that require the supply to evaporate, leaving consumers less satisfied.
Thus, the entrepreneurial function generates economic profits or losses, causing growth or decline. It is not the only source of such change, but it is the most consequential. And, perhaps more importantly, although other allowed economic changes might result in greater or lower economic value, entrepreneurship is intentional, pursuant always of greater individual well-being and, thus, economic value. While entrepreneurial failure is common, entrepreneurs generally accept the risks of such venturing only when economically feasible, the risks worth the rewards. Thus, the tendency of entrepreneurship-driven change is toward economic growth, which is why societies that promote greater entrepreneurial activity tend to see higher rates of economic growth (Bjørnskov and Foss 2013, 2016; Holcombe 1998; Packard and Bylund 2018). However, as Baumol (1990) reminds us, some entrepreneurs’ individual pursuit of economic value may come at the expense of others’ well-being and so may not be net productive. Furthermore, intending to generate new economic value does not imply success, and the efforts of doing so can result in resource maldistribution and loss. Thus, while entrepreneurship is the engine for economic growth, not all entrepreneurship will result in such growth.
But what is the ultimate source of this economic growth? Is it innovation (Schumpeter 1934)? Opportunity discovery and exploitation (Kirzner 1973; Shane 2003)? Perhaps opportunity creation (Alvarez and Barney 2007)? Or capital allocation/investment in uncertainty (Foss and Klein 2012; Lachmann 1978)? The answer to all of these seems to be yes. Each of these economic subprocesses contains the profit/loss function that characterizes entrepreneurship. Each of them bears uncertainty, generating profit when successful and losses when not.Kirzner (1973), of course, supposes that the pure entrepreneurial function can be employed without any capital investment and, thus, risk of loss whatsoever. But Kirzner errs here in failing to account for the autistic exchange (Mises 1998, 195–96) of the entrepreneurial endeavor. A “pure” entrepreneur still must expend time and effort, which might have been employed in other productive efforts, which can be lost in the case of failure. There can, in fact, be no entrepreneurship without uncertainty or risk of loss. The entrepreneurial function that we are seeking is, thus, broader than any of these specifically.
Let us step back from such specifics and proffer a more general and generalizable definition of entrepreneurship, then. The essential features of the entrepreneurial function, based on this analysis, include intentionality toward economic (psychic) profit and the commitment of resources (broadly defined) to do so.
Thus, we can define entrepreneurship as “the intentional pursuit of new economic value” (Packard 2017, 544) through resource investment. By “economic value” we again mean a general increase in individual, subjective well-being. Generally, then, such endeavors are the source of new economic growth, which is again understood as an overall increase in the quality of life. This definition captures the entrepreneurial function as a whole and all types of entrepreneurial activities, while excluding unintentional sources of economic change. If entrepreneurship entails all intentional pursuits of new economic value, such pursuits would entail pursuits of increases to and betterments of need satisfactions. They would include product and process innovations and improvements. They would include large and small changes. And they would include each and every previously defined entrepreneurial function reviewed above.
A REASSESSMENT OF THE MISESEAN ENTREPRENEUR Let us return here to the ambiguities in Mises’s defining of the entrepreneurial function. It is proposed that a more careful reading of Mises lands us on an understanding of the entrepreneurial function that is essentially equivalent to the one that we have just arrived at. However, it is rather different from the one widely supposed within modern Austrian academia.
The modern view of Mises’s entrepreneurial function is as speculator, the bearing of uncertainty. “Like every acting man, the entrepreneur is always a speculator” (Mises 1998, 288). Accordingly, it is supposed that entrepreneurship is inherent in all human action to some extent. Rothbard (2009, 64) explains:
This process of forecasting the future conditions that will occur during the course of his action is one that must be engaged in by every actor. This necessity of guessing the course of the relevant conditions and their possible change during the forthcoming action is called the act of entrepreneurship. Thus, to some extent at least, every man is an entrepreneur. Every actor makes his estimate of the uncertainty situation with regard to his forthcoming action.
I find this conclusion to be untenable for a few reasons. The first, and a common challenge made by those outside of the Austrian school, is that if all action is entrepreneurship, then none is. In other words, if we cannot separate “entrepreneurship” from “action” broadly, then the concept of entrepreneurship is redundant and useless. It provides no additional insight beyond our general understanding of human action, which also is always uncertain. Second, the prevailing interpretation implies that because all action is entrepreneurial, none is managerial. Clearly, Mises did not intend such a conclusion, as will be shown. Finally, the foregoing analysis of the entrepreneurial function—concluding that its essence is in the intentional pursuit of new economic value—implies that uncertainty bearing is a necessary consequence of entrepreneurship and not its essence. Read in that way, Mises’s theory comes into better focus, as will also be shown.
Is All Action Entrepreneurial?
Scholars who have adopted a definition of the entrepreneurial function as speculator have, it seems, misread Mises. Here we find the primary source of the confusion:
Like every acting man, the entrepreneur is always a speculator. He deals with the uncertain conditions of the future. His success or failure depends on the correctness of his anticipation of uncertain events. If he fails in his understanding of things to come, he is doomed. The only source from which an entrepreneur’s profits stem is his ability to anticipate better than other people the future demand of the consumers. If everybody is correct in anticipating the future state of the market of a certain commodity its price and the prices of the complementary factors of production concerned would already today be adjusted to this future state. Neither profit nor loss can emerge for those embarking upon this line of business.
The specific entrepreneurial function consists in determining the employment of the factors of production. The entrepreneur is the man who dedicates them to special purposes. In doing so he is driven solely by the selfish interest in making profits and in acquiring wealth. But he cannot evade the law of the market. He can succeed only by best serving the consumers. His profit depends on the approval of his conduct by the consumers. (Mises 1998, 288)
Mises points out here that all entrepreneurship, like all action, is speculative. But to read this, as Rothbard does, to imply that speculation or forecasting is entrepreneurship is not here justified. Instead, all entrepreneurship is a type of human action and, like all human action, is speculative. In fact, it is one of the most speculative types of human action.
However, while all entrepreneurship is action, the reverse is not true—not all action is entrepreneurship. In Rothbard’s interpretation, he does not go so far as to claim all action to be entrepreneurship, as such an interpretation intuitively seems false. Instead, he claims all action to be entrepreneurial to some extent, the extent being that to which the action bears uncertainty. Yet, of course, this leads to a recognition that all action is entrepreneurship, although some actions are more “entrepreneurial” than others.
One problem with this is that a lot of uncertainty bearing is not entrepreneurial whatsoever, at least not intuitively. Is a student an entrepreneur when guessing on an ungraded pop quiz? Is an art observer an entrepreneur when wondering who painted the lovely seascape? Is a historian an entrepreneur when uncertain as to the true underlying causes of World War I? These types of uncertainty bearing have no obvious economic effects, as they have no effects on the structure of production. At best, one could argue that such uncertainty bearing affects consumption outcomes, but such an argument is tenuous. One can be uncertain about a great many things that do not matter at all to that person.
Perhaps we could augment the speculative entrepreneurial function to include risk bearing, requiring some investment, which seems more plausible. But the essence of this risk is in the investment and not only in the uncertainty. Action without investment is not entrepreneurial.
The Managerial Function
It is clear in Mises’s writing that the “managerial function” (Mises 1998, 302) is a real function within the catallactic economy. Mises (1998, 301) describes the manager as “a junior partner of the entrepreneur” who attends “to the entrepreneurial functions which are assigned to him within a limited and precisely determined sphere of action.” In short, the entrepreneur delegates the responsibilities of carrying out his plans to the manager. It is not the function of the manager to devise the plans, which are provided by the entrepreneur. Instead, the managerial function “is to adjust—within the limited scope left to his discretion—the operation of his section to the state of the market” (Mises 1998, 302). The manager is, thus, given discretion to operate within a “limited scope” or “section” of market processes. Mises then quickly acknowledges that, often, the entrepreneurial, managerial, technician, and other market functions are performed by the same person.
Again, defining all action as entrepreneurial leaves no room for this managerial function, which must thus be circumscribed to some artificial world, such as the ERE, where action may be certain. Clearly, this was not Mises’s intention (see Mises 1998, 300–07), which again forces us to reconsider how he understood entrepreneurship.
The Essence of Entrepreneurship
It is my argument, then, that Lachmann, and not Rothbard, reads Mises most correctly here. The essence of entrepreneurship is, for Mises (1998, 288), in “determining the employment of the factors of production.” Assuming that, in particular, Mises is referring to the entrepreneur’s changing the allocation of these factors of production, which seems apparent from his elaboration that entrepreneurs dedicate these resources to “special purposes,” speculation and the bearing of uncertainty naturally follow from this function. Thus, “[l]ike every acting man, the entrepreneur is always a speculator” (ibid., 288). But these consequences are not the essential function itself, and not all speculators are necessarily entrepreneurs. Any speculation without resource (re)commitment is simply idle wondering, and not entrepreneurship. In contrast, “the function of the entrepreneur cannot be separated from the direction of the employment of factors of production for the accomplishment of definite tasks” (ibid., 302). Thus Mises, like Lachmann, sees the entrepreneurial function as the formulation of “entrepreneurial plans” (ibid., 300), the productive task to which invested resources are to be put, which plans are then carried out by managers (and “submanagers”), who implement the plans via the employment of technicians.
If we accept this reconception of Mises’s entrepreneurial function, then to what end are such essential plans directed? Mises makes it clear that entrepreneurs are “driven solely by the selfish interest in making profits and in acquiring wealth” (ibid., 288), which profits he again defines as an “increase in satisfaction (decrease in uneasiness) brought about” (ibid., 286). Entrepreneurship is always intentional, directed toward an increase in subjective value, i.e., subjective well-being. Thus, the entrepreneurial function—the formation of new entrepreneurial plans—can be restated in the very same language we arrived at previously: entrepreneurship is the intentional pursuit of new economic value through resource investment.
THE AUTARKIC ENTREPRENEUR Adopting this general definition of entrepreneurship here, let us circle back to the notion of an autarkic entrepreneur. Can Noland or Crusoe or a do-it-yourselfer intentionally pursue new economic value through resource investment? Clearly, the answer is yes. Thus, entrepreneurship is not a catallactic function only, but is a key function and aspect of all human existence, conjointly or alone. Autarkic economizers can perform the entrepreneurial function also.
But what does this autarkic entrepreneur look like? Let us take the standard fictitious Robinson Crusoe example as our starting point here before moving on to more practical and real applications of autarkic entrepreneurship.
Isolated Autarky
Let us begin our analysis with the case of isolated autarky or the “isolated household economy,” where there is but a single economic producer (whether it is a lone and isolated actor or, else, all other actors in the “household” are wholly unproductive and dependent). In this case, the entire economy is “at the disposal of a single economizing individual” (Menger 2007, 75). Consider Robinson Crusoe (pre-Friday) in the state of nature. What are the intentions that motivate his actions? Following the standard Misesean framework, Crusoe’s aim is universally directed at a higher state of well-being. This includes, firstly, survival—the bare necessities. Thereafter, increasing productivity and savings would allow him to incrementally allocate more of his time and action to the pursuit of more and better satisfactions of his various needs.
Thus, immediately, the autarkic entrepreneurial function rears its head. To begin, Crusoe must go from no production (other than, perhaps, getting his bearings) upon finding himself on the island—a state of affairs that would not do as a stationary economy—and increase production to a level above the survivability threshold. He must generate sufficient new economic value in order to meet the consumption demands of a properly functioning body—he must grow the economy to a level of basic sustainability. Given our definitions of economy and the entrepreneurial function within it, this means that survival, for Crusoe, requires entrepreneurship.
The autarkic entrepreneurial function, which Crusoe adopts, generates entrepreneurial plans to discover and allocate resources in a more productive way. One such plans are generated, the entrepreneurial Crusoe gives way to the managerial Crusoe, who then implements the plans purveyed by entrepreneurial Crusoe. At times, the entrepreneurial plan may go awry, and entrepreneurial Crusoe reemerges to reassess and revise the plan (see Packard, Clark, and Klein 2017). Additional revisions and new entrepreneurial plans may also arise as new information becomes available. In short, autarkic Crusoe bounces between distinct producer functions so that, in the end, consumer Crusoe can enjoy the spoils of those productive efforts.
It is the autarkic entrepreneurial function, however, that devises autarkic plans of action. Once those plans are devised, the role of the autarkic entrepreneur is completed and passes to the managerial function. In fact, once Crusoe’s economy has reached a level of sustainability, the entrepreneurial function is no longer strictly required, and Crusoe could plausibly maintain the same production plan for survival, merely replicating time and again the established level of subjective well-being until there is some change in supply or demand. However, it is unlikely that Crusoe would voluntarily stand pat at a minimum level of sustenance. As productivity increases (through, e.g., learning curves), Crusoe may find enough time and savings to invest in capital goods. This investment is another case of autarkic entrepreneurship to further increase future well-being by employing saved resources in developing useful tools that might increase overall productivity. Or, perhaps, the attained level of productivity may be such that he can turn to other productive activities aimed at better satisfying other, nonessential needs (e.g., building more comfortable furnishings) or otherwise improving the satisfaction of the essential needs (e.g., pursuing a wider variety of foods). All such activities are entrepreneurial, aimed at creating new economic plans for value attainment. While Crusoe may very well go through periods of managerial persistence, we would expect him to be always on the lookout—Kirzner’s ‘alertness’—for new ways to better address those still imperfectly satisfied needs.
Through repeated entrepreneurial endeavors, Crusoe’s one-man economy can plausibly attain a level of productivity that may be quite comfortable to him. In other words, Crusoe could, through entrepreneurial efforts, plausibly grow his economy of one to a quite high level of subjective well-being. However, he alone could never approach the levels of productivity, economic growth, and total satisfaction that could be achieved through catallactic economizing.
Normal Autarky
Although the isolated autarky illustration is apt and useful in illustrating the entrepreneurial function within the autarkic economy, it holds little obvious practical relevance to the typical economic actor. However, autarkic economics, including the entrepreneurial function within it, is in fact very relevant and important to economic theory and to the real world, as has already been argued. Thus, let us now expand our autarkic economy to the typical and everyday situation—the normal autarkic economy.
This normal autarkic economy is embedded within and interacts with the catallactic economy. However, “normal autarky” refers to those productive economic activities that are performed outside of the catallactic economy—those which individual actors (or households) perform for themselves. This normal autarkic economy includes, as previously indicated, home cooking, homemaking, pursuing hobbies, maintaining personal hygiene, rest and sleep, and other activities that are either not available in the catallactic economy or where the marginal benefits of the market options do not supersede the costs of DIY.
To motivate this theory, consider the following research by von Hippel, de Jong, and Flowers (2012, 1669):
INDENTOur study finds consumer innovation to be quite significant in both scale and scope. Via a survey of a representative sample of 1,173 consumers in the United Kingdom, we estimate that 6.1% of UK residents 18 years of age or older have created or modified consumer products they use during the prior three years. This represents nearly 29 million people. In aggregate, we find that UK consumer product users spend 97,800 person-years and an estimated £3.2 billion annually on their development efforts—more than 1.4 times the consumer product R&D expenditures of all firms in the United Kingdom combined. We also find that consumer product innovation spans a wide range of fields, from toys, to tools, to sporting equipment, to personal solutions for medical problems. We further discover that consumer-developed innovations appear to be complements rather than substitutes for producer innovations, and that consumer innovators very seldom protect their innovations via intellectual property; in fact, 17% diffuse to others.
This suggests that there is a vast array of autarkic economies booming under our noses, with frequent entrepreneurial endeavors by which new solutions are innovated and existing (catallactic) solutions are altered and augmented.
Most of these innovations are never taken to market, remaining the purview of autarkic economy and not of catallactic economy, even though many of them appear to solve a real market need. Some have ascribed this tendency for good entrepreneurial solutions to remain confined to the autarkic economy to a market failure (de Jong et al. 2015; de Jong, Gillert, and Stock 2018). However, in fact, catallactic entrepreneurship is quite different from autarkic entrepreneurship— it requires very different skillsets, vastly more time and effort, and the bearing of significantly more uncertainty and risk. That is, there are—or may be—very good reasons to confine entrepreneurial efforts only to autarky, even in the presence of a large and booming catallactic economy and significant market potential.
Thus, autarkic entrepreneurship is very different in scope and function from catallactic entrepreneurship. The former may lead, in some cases, to the latter, as in the case of so-called user entrepreneurship (Shah and Tripsas 2007). However, this is, as we have seen, not always the case, as vast amounts of autarkic entrepreneurship stay confined to their respective autarkic economies. Furthermore, there appear to be many cases of catallactic entrepreneurship that do not clearly start within an autarkic economy. In such cases, the entrepreneurial plans characteristic of the entrepreneurial function are, in the first place, devised for the satisfaction of others’ needs, whereby the catallactic entrepreneur might gain profit for themself through catallactic exchange.
The Boundary between Autarkic and Catallactic Entrepreneurship
The scope of this paper is not a full elaboration of a theory of autarkic entrepreneurship, which would require a much larger treatment. My aim has been only to make a compelling case that there is a real autarkic economy and that the entrepreneurial function operates within it. Furthermore, it is to assert that the autarkic entrepreneur is different from and performs a different function than the catallactic entrepreneur. This is, thus, a call for new theorizing on a prominent type and area of economic activity that has been neglected.
However, to perhaps get this ball rolling, let me lay down some initial legwork with regard to the normal operations of the autarkic economy in relation to the catallactic economy, specifically in regard to the entrepreneurial function of each. In other words, why are some entrepreneurial activities pursued in the autarkic economy and others in the catallactic economy? What are the boundary conditions that separate them? One answer is likely to be the amount of needed capital, including human capital, required for the innovation and production of certain solutions. Thus, Schultz’s (1975, 1979, 1980a, 1980b) human capital approach to entrepreneurship may be a good starting place for such explorations.
Another key factor must, of course, be the transaction costs of catallactic versus autarkic exchange. Transaction cost economics, which compares a firm’s internal versus external transaction costs to determine its proper scope (Grossman and Hart 1986; Holmstrom and Roberts 1998), might be adapted to compare autarkic and catallactic transaction costs and, thereby, help determine the “scope” of the autarkic economy vis-à-vis the catallactic economy. For example, while catallactic transaction costs involve costs of triangulation, transfer, and trust (Munger 2018), autarkic exchange largely skirts the bulk of these costs, its transaction costs involving primarily uncertainties. Similarly, the cost-benefit calculations themselves may also vary between catallactic and autarkic economies (see Piano and Rouanet 2020).
A third factor is the fact that catallactic markets can benefit from a division of labor, whereas autarkic exchange cannot.
These factors tie into another important area of future research, which would explore how these distinct economies, and their entrepreneurial functions, interact. For example, when are autarkic innovations taken to market or not (de Jong, Gillert, and Stock 2018; de Jong et al. 2015; von Hippel, de Jong, and Flowers 2012)? And how and when are catallactic solutions “internalized” by the autarkic economy—i.e., when do market solutions become DIY solutions?
Relatedly, how and when do these distinct economies support each other? For example, DIY services (e.g., home improvement retailers, medical self-diagnosis websites such as WebMD.com, and legal document creation aids such as LegalZoom.com) are quite large and profitable catallactic industries that serve as suppliers and support services for the autarkic economy. This is exemplified by The Home Depot’s marketing slogan: “You can do it. We can help.” Or, on the other hand, some retailers leverage consumer human capital (or just “consumer capital”), facilitating greater value for their customers by leveraging autarkic production in so-called (somewhat imprecisely) value co-creation (Ramírez 1999; Ratchford 2001; Vargo and Lusch 2004; Vargo, Maglio, and Akaka 2008). For example, IKEA gained an advantage over its competitors by offering high-quality furniture at a steeply discounted price by leveraging its customers’ willingness to assemble the furniture themselves. In other words, IKEA outsourced the last steps of the value chain to the autarkic economy.
In short, there are clear and obvious benefits to autarkic economic activities—including entrepreneurship—that may not obviously translate to the catallactic economy. One reason is the personal nature of the need and its solution, which, perhaps, makes the solution economically infeasible for catallactic production, having too narrow a market. Said differently, some activities may be pursued through autarkic entrepreneurship out of necessity due to a persistent absence of those activities in the catallactic economy. Other reasons include costs, convenience, and the mere enjoyment of producing (e.g., hobby gardening, crafting, or woodworking). These reasons and boundaries are the subject of much needed future research.
CONCLUSION The aim of this article has been to expand and legitimize the Austrian theory of autarkic (autistic) economy and, especially, the entrepreneurial function within it. Entrepreneurship is not merely a catallactic function but plays a far more prevalent role in economic life than has hitherto been proffered. In fact, we act as entrepreneurs quite regularly—even daily—as we look at our routines and decide to try new things instead: new recipes, new activities, new friendships, new furniture arrangements, etc. In other words, we act as entrepreneurs whenever we take our existing stock of capital and enact plans to shift them into new arrangements and combinations to produce, hopefully, better value outcomes (cf. Schultz 1975, 1980a).
Because life is an endless pursuit of ever higher value states (Packard 2019), because we continuously seek ever better satisfactions of our needs (Witt 2001), entrepreneurship plays a key and frequent role in our trying to grow our autarkic economy, to increase total well-being out of the resources possessed. This role is different from the oft-supposed function of uncertainty bearing that characterizes all human action. It is true that much of our day is employed in the management function, carrying out previously laid entrepreneurial plans and rotely replicating value states previously established by our entrepreneurial activities. We wake up at our routine time, ready ourselves routinely for the day, eat at routine times, and go through the day doing many of the same things by rote. But it is the entrepreneurial function—the autarkic entrepreneur—that breaks this routine, that tries something new.
The autarkic entrepreneur performs this function for the same reasons as the catallactic entrepreneur—in pursuit of new and superior economic value. Certainly, the catallactic entrepreneur is far more consequential, altering the value state of vast swaths of benefited economic actors through large-scale production and market interaction. For this reason, the catallactic entrepreneur has been rightly placed at the forefront of economic theorizing (at least in the Austrian tradition). However, this attention has caused the theoretical neglect of the autarkic entrepreneur, who is in fact a key economic actor also.
If I may be so bold, the neglect of the autarkic entrepreneur has been one of the most significant oversights of all of economics, including the Austrian school (which has, at least, somewhat recognized it). By bringing the autarkic, DIY economy into the theoretical frame, we observe a great number of insights into the boundaries of catallaxy and autarky. Without these, economics, including catallactics, is simply incomplete.
Consumer sovereignty is a principle of Austrian economics. Here’s how entrepreneurs apply the principle in business, as told by Martin Lünendonk, co-founder of FounderJar.com, as well as Finance Club and Cleverism.com.
How to Make the Customer your Boss Download our "How To Make The Customer Your Boss" graphic at Mises.org/E4E_95_PDF.
"There is only one boss. The customer. And he can fire everybody in the company, from the chairman on down, simply by spending his money somewhere else." —Sam Walton Though they are several decades old, these words by Walmart founder Sam Walton are still very relevant, especially in today’s highly competitive world.
This is particularly true for those trying to make money online. You are already in competition with hundreds, perhaps thousands of other businesses, and if you do not put your customers first, they can easily move to the competition. It’s as easy as tapping a few buttons on their smartphone.
Great business leaders understand that businesses exist for one sole purpose — to serve the needs of their customers. If you want your business to not only survive, but to thrive in this hyper-competitive world, it’s time you started treating your customers like the boss.
Below, let’s take a look at the steps you need to take to place your customers in their rightful seat — the boss’s seat.
- Identify the Key Problems Customers Want To Get Solved To effectively serve your customers, you need to first identify what key problems the customer is trying to solve.
Very often, entrepreneurs set out to solve problems they think the customer has, without trying to look at things from the customers’ point of view and confirm whether the customer has this problem, and whether it is a problem they are trying to solve.
For instance, Blackberry assumed that what its customers wanted was a laptop that could fit on the palm, so they focused on improving the physical keyboard.
Apple, on the other hand, realized that what customers actually wanted was a device that was amazingly easy to use, and when they introduced a device with a touch screen and no physical buttons, they took Blackberry out of business.
So, how do you identify the problems that customers are trying to solve? There are two ways to do this:
Listen To Your Customers The easiest way to identify the problems your customers are trying to solve is to actually listen to them. They know what they are struggling with and why they need this problem solved.
If you listen to your customers, you are unlikely to find yourself in a situation where you are solving a problem no one cares about.
There are two main approaches you can take to listen to your customers and identify the problems they are trying to solve. Here are a few…
Interview your customers: Your first option is to get proactive and ask the customers directly. You can do this using surveys on your website, by getting on the phone and talking to customers, through focus groups, and so on.Look at customer reviews: Your customer reviews present another great opportunity for you to learn about the problems your customers are trying to solve. Here, you should place more focus on the negative comments, since these are the ones that highlight customer needs that are not being met. However, even positive comments can give insights into customer problems that you’re solving effectively. Listen To Your Salespeople The second approach to identifying the problems customers are trying to solve is to listen to your salespeople.
Your salespeople are in direct contact with your customers, and they, therefore, have better insights into your customers’ thought processes.
They know the pain points that drive customers to purchase your products and services, they know the things that customers like or dislike about your products, they know the reasons that keep some customers from purchasing, and so on.
By administering surveys to your sales teams, you can gain insights that will help you figure out your customers’ key problems, which will in turn help you to serve them better.
When trying to gain insights about customer problems, either from the customers themselves or from your salespeople, it’s good to try to get to the root cause of the problem. Sometimes, what you think is the problem might not actually be the problem.
For instance, at one point, Disney was experiencing lots of criticism because visitors felt the queues for the rides were too long. At first glance, the problem seems obvious – visitors spending too much time waiting for their rides.
The solutions to this problem are obvious as well. To shorten the queues, Disney would either have to invest in more rides, or reduce the number of visitors getting into their parks. Both of these solutions would cost Disney millions.
Disney hired a group of designers to help them solve this problem. After interviews with Disney visitors, the designers realized that the problem wasn’t the long queues. The problem was that visitors were getting bored because they had nothing to do while waiting in the queue.
To solve the problem, they had Disney add themed music and videos that visitors could listen to and watch while waiting for their rides. By getting to the root cause of the problem, they were able to come up with an effective solution that saved Disney millions.
Similarly, do not take your customers' feedback at face value. Try to identify what the root problem is before you start developing a solution.
- Make Sure Your Offering Solves Those Customer Problems Now that you have identified the problems that your customers are trying to solve, it’s time to come up with solutions to solve those problems.
The best way to ensure that the solution you are developing solves the actual problems your customers are struggling with is to involve your customers in the development process.
One approach is to develop a minimum viable product (MVP) of your solution and show it to a group of customers with the problem you are trying to solve. You then collect their feedback, and use insights to improve your next iteration and ensure that your final solution solves the customer problem in the most effective way.
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For instance, when creating DropBox, founder Drew Houston didn’t want to spend months, perhaps years, working on a product that no one was interested in, so he started with an MVP.
Drew’s MVP was a simple 3-minute video demonstrating how his product was meant to work. He shared the video on Digg, an online community of technology early adopters.
After sharing his video, over 70,000 people joined the DropBox beta waiting list within a single night, which was enough validation that his product was solving the right problem.
Another way to involve customers in the development of your solution is to form a small community of beta testers and give them access to your solution during the development process.
This works even if you are developing a service-based product. For instance, if you are a digital marketing consultant, you could create a package — say a content marketing package — and test it among a small group of customers before you launch it in full scale.
The aim here is to have a group of actual customers continually testing the solution you are developing to make sure that it addresses their key concerns in the best possible manner for them.
This way, you don’t have to worry about spending months or years coming up with a solution to your customers’ problems, only to discover that it is not the kind of solution they were looking for.
Another way to ensure that what you are offering solves your customers’ actual problems is to conduct A/B tests. This basically involves creating two versions of your offering, giving two small groups of customers access to each version, and then tracking the results to identify the version that solves customers’ most effectively.
- Track Customer Satisfaction Ultimately, what matters is keeping your customers satisfied. If your boss is unsatisfied with your work, you can bet that you will be out of work soon.
Similarly, if your customers are unsatisfied with your business, they will fire you – by spending their money on your competitors.
Actually, while 96% of unhappy customers will not voice their dissatisfaction, 91% of them will never make another purchase from you. This is definitely something you don’t want.
To know whether your customers are happy, you need a way to track and measure customer satisfaction. Here are five of the most effective ways of measuring customer satisfaction:
Customer Satisfaction Surveys This is one of the easiest ways of tracking customer satisfaction. With this approach, you simply need to put up a survey asking your customers how satisfied they are with your services.
Depending on the medium you are using to administer the survey, you can add one to three open-ended questions to learn more about what they think of your services.
Customer satisfaction surveys can be served through email, through your website, or through your app.
Customer Satisfaction Score (CSAT) The CSAT is the standard metric for measuring customer satisfaction. Here, you ask customers to rate how satisfied they are with your products or services on a scale. The scale could be 1 – 3, 1 – 5, or 1 – 10.
After receiving responses from various customers, you then find the average rating to determine your customer satisfaction score. The higher the score, the more satisfied customers are with your services.
Net Promoter Score (NPS) This is another popular metric for measuring how happy customers are with your business and your services.
Unlike the other metrics covered here, however, NPS does not measure how satisfied customers are with your business. Instead, it measures how likely they are to refer someone to your business. This is especially useful for those in the freelance business, which depends heavily on referrals.
The NPS will ask a customer to rate on a scale of 1 – 10, how likely they are to recommend your business to their friends and acquaintances.
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The NPS categorizes your customers into 3 groups:
Promoters: These are customers who give you a rating of 9 – 10. They are willing to spread the word about your business and recommend your products and services. These customers are already satisfied with your business.Neutral/Passives: These are customers who give you a rating of 7 – 8. They are indifferent to your business. They aren’t disappointed with your business, but they aren’t satisfied either. They are unlikely to talk about your business to others.Detractors: These are customers who give your business a rating of 6 and below. They are unhappy with your business, and will spread negative word about your business in a bid to discourage others from doing business with you. The Net Promoter Score is a very useful metric. If someone is willing to recommend your business to others, then this means that your products or services are good enough that they would stake their reputation on them.
Customer Effort Score (CES) This metric measures customer experience, particularly how hard it is for your customers to get what they want from your business. Customers are typically asked to rate their effort from 1 (very little effort) to 7 (very high effort).
A high score means that customers have to work very hard to get what they need from your business, which translates to poor customer experience.
Social Media Mentions Keeping track of what people are saying about your business on social media can also help you figure out how satisfied your customers are with your business.
Satisfied customers will take to social media to praise your business, while unhappy customers will share their dissatisfaction with their social media followers.
Monitoring the conversations about your business happening on social media will allow you to step in and respond to comments in time and control your brand perception, especially when people are sharing negative comments.
Here are three tools that you can use to track social media mentions:
Google AlertsMentionSocialMention 4. Put Customer Value First, Profits Will Follow A lot of entrepreneurs believe that the core purpose of a business is to make profits.
Smart entrepreneurs, those with the right entrepreneurial mindset, on the other hand, know that the core purpose of a business is to serve its customers. Therefore, their core focus is on delivering customer value.
Of course, this does not mean that businesses that put customer value first don’t think about profits. They do. What differs is their approach.
These businesses understand that when you keep your customers happy (by delivering great value), these customers will bring more business, and spread positive word about your business, leading to more business, and ultimately, greater profits.
Actually, the findings of research by Deloitte and Touche show that companies that put customers first are 60% more profitable compared to those that don’t.
So, what exactly does it mean to put customer value first?
Putting customer value first means that every single business decision made within your organization should have a positive impact on customer experience.
For instance, when upgrading its systems, a customer-centric company will choose systems that allow it to deliver the best customer experience.
Similarly, when hiring, customer-centric companies go for employees who show a knack for putting customers first. Basically, every decision is evaluated based on its impact on customer experience.
Here are some tips on how to make your company customer-centric and put customer value first:
Understand your customers deeply. It is impossible to put customers first when you don’t even know who they are. To get a good understanding of who your customers are, you need to develop highly detailed buyer personas. Actually, gaining a good understanding of the customer segments you’re targeting is a key component of the business model canvas.Make sure that all your team members are engaged and have a good idea of the impact of their work on customer experience.Make it a habit to collect customer feedback, and then use this feedback to gain insights on how to improve the customer experience.Don’t just focus on getting customers to make the purchase. Focus on building relationships that will turn them into loyal customers and brand ambassadors.Be easily accessible. Make it easy for customers to get in touch with your business when they have an issue, or when they need any sort of help. Ready To Put Your Customers In The Boss’s Seat? As an entrepreneur, you are in business to serve your customers, which means that your customers are your boss. If you want your business to thrive, you need to start treating them as such, by putting their needs first.
In this article, we have gone over 4 key points on how to make the customer your boss. Here’s a recap:
Identify the key problems customers want to get solvedMake sure your offering solves those customer problemsTrack and measure customer satisfactionPut customer value first and profits will follow Additional Resource "How To Make The Customer Your Boss" (PDF): Mises.org/E4E_95_PDF
Abstract: This paper takes the subjective value theory, conception of economic goods, and the hierarchy of needs from Carl Menger’s Grundsätze der Volkswirtschaftslehre (1871) to elaborate a model of strategic entrepreneurship. Menger’s account of subjective valuation by buyers of goods in market exchange fills a gap in most conceptual approaches to entrepreneurship, which are based on a highly impermeable boundary around the entrepreneurial firm. We examine how this account “closes” an economic model of entry for an entrepreneurial firm in an existing rivalry network by making the assessment of value explicit with respect to buyer needs relative to goods sold by incumbent firms. A formal representation of Menger’s needs hierarchy in the face of qualitatively different market goods is the centerpiece of the strategic entrepreneurship model. This conceptual model is tied to methods of eliciting subjective valuations of product attributes and buyer needs fulfilment from the literatures of consumer behavior, marketing, and organizational psychology. This serves as a methodological basis for scholarship in entrepreneurship.
JEL Classification: B53, L26 Randall Westgren (westgrenr@missouri.edu) is professor of applied economics and the McQuinn Chair in Entrepreneurial Leadership at the University of Missouri-Columbia.
INTRODUCTION Scholars in the field of entrepreneurship flail about, seeking a theory that serves as a foundation for erecting boundaries to keep the field distinct from other territories in management and economics and to exploit as a basis for empirical analysis. In 2003, Scott Shane introduced a hubristic General Theory of Entrepreneurship, which attempted a link between the individualistic/personality-based accounts of David C. McClelland (1965, 1987) and a recently minted construct: the entrepreneurial opportunity. Since the publication of this tome, the field has maintained a vigorous discourse over the nature of the opportunity. It is beyond the scope of this paper to recount this history (readers interested in replowing the field can consult Short, Ketchen, Shook, and Ireland [2010]); however, for scholars of Austrian economics, it is interesting to note that one of the fault lines in the literature is the dichotomy between Kirznerian and Schumpeterian opportunities (Shane 2003, 21). Shane takes the idealtypus of Schumpeter’s innovative, disequilibrating entrepreneur and Kirzner’s metaphoric alert, equilibrating entrepreneur, reifies them into realtypus entrepreneurs, then rereifies them as social objects: opportunities. Thus, two Austrian accounts of market processes are bent into psychological types, thence into the creation opportunity and the discovery opportunity (Alvarez and Barney 2007, 2010). Schumpeter and Kirzner have lost their place on the marquee, but their accounts of market processes remain as misapplied social objects to which entrepreneurial action is directed.
Fortunately, some scholars in the entrepreneurship field have sought to apply the theories and constructs from Austrian economics in a more apropos manner. It must be understood that these current contributions to the field may overlap with the theory of the firm (Bylund 2015; Foss and Klein 2012), strategic management (Foss and Lyngsie 2014), and market processes (Bylund 2011). The boundary walls for entrepreneurship are not as important in the Austrian tradition as they are to the evolving field of entrepreneurship. These contributions draw from all the generations of the Austrian economics tradition (Salerno 2002) and take advantage of subjectivism, dynamics of market processes, and capital theory. Two recent reviews offer useful insights into both the breadth and depth of contributions to entrepreneurship from the Austrian tradition (Klein and Bylund 2014; Foss, Klein, and McCaffrey 2019). This paper takes these contributions as given and also seeks to add some specific insights by Carl Menger to theory-based entrepreneurship research.
This paper takes the subjective value theory, the conception of economic goods, and the hierarchy of needs from Carl Menger’s Grundsätze der Volkswirtschaftslehre (1871)I have endeavored to link the authoritative English translation by Dingwall and Hoselitz (Menger [1871] 2007) to the original German edition (Menger 1871). I use an electronic version of Grundsätze der Volkswirtschaftslehre that identifies the original pagination. For the translation, I use the 2007 version produced by the Ludwig von Mises Institute. Dingwall and Hoselitz moved some of Menger’s original footnotes to the translated text; these discrepancies are noted where important, as are translated passages that appear to misinterpret Menger. to elaborate a model of strategic entrepreneurship. Menger’s account of value and exchange in the economic system is much more complete than his explicit presentation of the entrepreneur. His careful model of the genetic-causal process that links the transformation of commodities and other economic goods (services of labor and capital, as well as transport and storage) from higher order goods to consumer goods with attendant time delays and uncertainty is as valid today to describe entrepreneurial value creation as it was in the middle of the nineteenth century. More importantly, Menger’s explicit insistence on subjective valuation by buyers of the final consumption goods as the basis for exchange fills a gap in most accounts of entrepreneurship, which are based on a highly impermeable boundary around the entrepreneurial firm. Pricing of the entrepreneur’s product is not generated within the opportunity or the firm, but is the result of a causal process of subjective assessment of the product’s capacity to satisfy one or more of the buyer’s wants.
The objective of this paper is to make this causal process explicit at the boundary of the entrepreneurial firm and the market (Bylund 2011). Following a brief review of Menger’s conception of entrepreneurial action, we examine the substantive elements of Menger’s ontology of economics that support valuation of entrepreneurial activity at the market divide between firms and buyers. To show the merits of Menger’s theory to strategic entrepreneurship, a recent formal model of entrepreneurial entry is reviewed. The singular deficiency of that model is that buyer needs are elided. The deficiency is rectified by a combination of Menger’s verbal representation of hierarchical needs and a formal model developed a century after his treatise was published. Together, these two representations of the genetic-causal process between entrepreneurial action and the market’s subjective assessment of the product and competing goods complete the account of new entry into a market. In the spirit of economic ecumenicalism, the appropriateness of verbal and mathematical representations of this causal process is addressed to support Menger’s contributions to entrepreneurial action 150 years on.
MENGER'S ENTREPRENEUR AND ECONOMIC ONTOLOGY In the Grundsätze, Menger spends only about four paragraphs describing the entrepreneur (Unternehmer) and, more importantly, entrepreneurial activity (Unternehmerthätigkeit). Given that Menger’s project is about human action, the functions performed by the entrepreneur are essential.
Entrepreneurial activity includes: (a) obtaining information about the economic situation; (b) economic calculation—all the various computations that must be made if a production process is to be efficient (provided that it is economic in other respects); (c) the act of will by which goods of higher order (or goods in general—under conditions of developed commerce, where any economic good can be exchanged for any other) are assigned to a particular production process; and finally (d) supervision of the execution of the production plan so that it may be carried through as economically as possible. (Menger [1871] 2007, 160)
Hébert and Link (2009) place Menger’s entrepreneurial role in their historical categories of manager/superintendent (with Say, Mill, and Marshall) and decision-maker (with Cantillon, Marshall, Wieser, Walker, Keynes, Mises, Shackle, Cole, and Schultz). Correctly, Hébert and Link do not include Menger’s entrepreneur in the roles of innovator, enterprise owner, capitalist, industrial leader, contractor, or arbitrageur. I quibble with the exclusion of “organizer and coordinator of economic resources” and of “employer of factors of production” for Menger’s entrepreneur. It is clear from chapter 3 of the Grundsätze, that Menger traces value creation from higher order goods, including labor services and other services (e.g. shipping, warehousing). This appears to be more about value creation through the (economizing) use of factors of production and purchased inputs than simply managing and making decisions.
One of Hébert and Link’s roles is highly problematic, both in general and in the specific case of Menger: “the person who assumes the risk associated with uncertainty (Cantillon, Thünen, Mangoldt, Mill, Hawley, Knight, Mises, Cole, Shackle)” (2009, 100). Muddying risk and uncertainty is a problem in general, especially when Knight takes such care to separate them. But in the case of Menger, it is more substantive. First consider this quote:
it will be evident that I cannot agree with Mangoldt, who designates “risk bearing” as the essential function of entrepreneurship in a production process, since this “risk” is only incidental and the chance of loss is counterbalanced by the chance of profit. (Menger [1871] 2007, 161).
Menger footnotes this disagreement based upon Mangoldt (1855). In the original, one finds “die ‘Gefahr’ doch nur etwas accidentielles ist” (Menger 1871, 138n). The risk is accidental, not incidental. Thus, it appears that Menger denies risk bearing, in the sense of aleatory probabilities of economic outcomes, as an entrepreneurial function. However, in section 4 of chapter 1, “Zeit—Irrthum” (“Time and Error”), Menger asserts that
The greater or less degree of certainty in predicting the quality and quantity of a product that men will have at their disposal due to their possession of the goods of higher order required for its production, depends upon the greater or less degree of completeness of their knowledge of the elements of the causal process of production, and upon the greater or less degree of control they can exercise over these elements. The degree of uncertainty in predicting both the quantity and quality of a product is determined by opposite relationships. Human uncertainty about the quantity and quality of the product (corresponding goods of first order) of the whole causal process is greater the larger the number of elements involved in any way in the production of consumption goods which we either do not understand or over which, even understanding them, we have no control—that is, the larger the number of elements that do not have goods-character.
This uncertainty is one of the most important factors in the economic uncertainty of men, and, as we shall see in what follows, is of the greatest practical significance in human economy. (Menger [1871] 2007, 71)
This characterization of uncertainty looks close to that of Knight (1921).
At the bottom of the uncertainty problem in economics is the forward-looking character of the economic process itself. Goods are produced to satisfy wants; the production of goods requires time, and two elements of uncertainty are introduced, corresponding to two different kinds of foresight which must be exercised. First, the end of productive operations must be estimated from the beginning. It is notoriously impossible to tell accurately when entering upon productive activity what will be its results in physical terms, what (a) quantities and (b) qualities of goods will result from the expenditure of given resources. Second, the wants which the goods are to satisfy are also, of course, in the future to the same extent, and their prediction involves uncertainty in the same way. The producer, then, must estimate (1) the future demand which he is striving to satisfy and (2) the future results of his operations in attempting to satisfy that demand. (Knight 1921, 237–39)
The foundation of Menger’s account is the time delay in transforming goods of higher order into goods “directed finally to the satisfaction of human needs” (Menger [1871] 2007, 67). This is his genetic-causal process, a series of time-stepped transformations of commodities (Waaren) into consumer goods (Gebrauchsgüter), in which the consumer values the economic character of the goods in the final exchange. Inside that valuation, there must be a payment for capital and for entrepreneurship.
The aggregate present value of all the complementary quantities of goods of higher order (that is, all the raw materials, labor services, services of land, machines, tools, etc.) necessary for the production of a good of lower or first order is equal to the prospective value of the product. But it is necessary to include in the sum not only the goods of higher order technically required for its production but also the services of capital and the activity of the entrepreneur. For these are as unavoidably necessary in every economic production of goods as the technical requisites already mentioned. Hence the present value of the technical factors of production by themselves is not equal to the full prospective value of the product, but always behaves in such a way that a margin for the value of the services of capital and entrepreneurial activity remains. (Menger [1871] 2007, 161)
Evidently, Menger dismisses aleatory risk as an element of entrepreneurship, as all economic agents face these accidental errors across time and space. But, if (a) the causal process that transforms higher order commodities into first order consumption goods is the essence of entrepreneurial activities and (b) those activities are fraught with epistemic uncertainty (a knowledge problem) and (c) valuation of consumption goods should include returns to entrepreneurial activity, then those returns must reflect returns to judgment in the face of uncertainty (Foss and Klein 2012). Thus, we can relate Menger’s conception of entrepreneurial activity to contemporary accounts of entrepreneurship, particularly where decision-making and exercising judgment under uncertainty are central. However, it is paramount to understand that the Unternehmerthätigkeit that brings the consumer good to the market affords no guarantee that the returns to entrepreneurial activity will be positive; the essence of entrepreneurship is the economizing behavior in the face of uncertainty.
But there are other pieces of Menger’s economic ontology that can contribute to the advancement of the economics of entrepreneurship. It seems that every economist that reads the Grundsätze finds something particularly insightful, but often lost from discourse in neoclassical economics (Hayek 1934; Stiglitz 1937; Georgescu-Roegen 1954; Schumpeter 1954). Both Hayek (1934) and Stiglitz (1937) point to a combination of the subjective valuation of consumer goods by buyers and the imputation of value backward through the higher orders of goods, including commodities and the services of human action—including labor and entrepreneurship, the critical departure from classical economics and conceptually superior to the contemporary accounts of Jevons and Walras. Menger is profoundly clear that he is concerned with all economic goods, including labor services and intangibles (Verhältnisse), as well as entrepreneurial action. These goods have goods-character (Güterqualität)Dingwall and Hoselitz (Menger [1871] 2007, 52n3) explain that Menger uses both quality (Qualität) and character (Charakter) to describe the attributes of goods that respond to buyer needs. We return to this in a later section of the current paper. that is determined by no intrinsic valuation (e.g. labor value or physical costs of production), but by how the buyer values the good in exchange. Stiglitz is unique in proposing that this chain of valuation from consumer goods through all higher order goods follows the same pattern of uncertainty bearing in the economizing process of production that the final market valuation does. That is, the goods-character at any point in the chain has economic value derived from the subsequent goods-character of the later goods in the transformation process. We return to this important feature when we disaggregate goods-character explicitly into attributes in the next two sections of the paper.
The second innovation of Menger’s ontology that affects the economics of entrepreneurship was masked by the characterization of utility in neoclassical economics. Georgescu-Rogen (1954) points to Menger’s insistence that buyer valuation is tied to a multiplicity of wants or needs that are held in the consumer’s mind in a hierarchy. Buyers seek to fulfill these wants by purchasing consumer goods such that higher-valued wants are met first and the marginal wants have been met at the same comparable degree when the budget for the period in question is exhausted by the marginal Gebrauchsgüter. Georgescu-Roegen makes the compelling case that neoclassical theory reduces the complex nature of individual wants, with varying intensities and inherent incommensurabilities, to a common want: utility. He argues that wants are irreducible. At the very least, “bread cannot save someone from dying of thirst,… living in a luxurious palace does not constitute a substitute for food, etc.” (Georgescu-Roegen 1954, 514). As one of the foremost mathematical economists of the twentieth century, Georgescu-Roegen does not stop with this verbal assault on the false reduction of wants to utility; he shows that a hierarchical set of wants permits preference relations to exist between goods for rational choice, but that indifference between market baskets cannot be supported. Choices cannot be ordinally measurable. We return to the implications of this in a later section of the paper. First, we consider a recent economic model of entrepreneurship that will serve as a foil for incorporating Menger’s insights.
THE (NEARLY) NEOCLASSICAL ECONOMICS OF ENTREPRENEURSHIP In a recent article, Randall Westgren and Robert Wuebker (2019) present a formalized economic model of entrepreneurial entry into an existing industry/market. Their intent is to identify the portion of rent streams above contractible and noncontractible costs that can be attributed to entrepreneurial activity. Their model and consequent analysis turns on value creation—to encompass payments to capital, labor, purchased inputs, and the agent or agents that fulfill Menger’s entrepreneurial role and other roles such as innovation and uncertainty-bearing—preceded by the creation of value for buyers in the marketplace. That is, Westgren and Wuebker follow Menger’s ontology (without knowing) for imputation of value from the market between entrepreneurs and potential buyers. That is, the entrepreneur designs the new entry product to be qualitatively different from incumbent products or to have a cost structure that is superior for a qualitatively similar product, a microlevel expression of Michael E. Porter’s (1980) differentiation and cost advantage strategies.
The Westgren and Wuebker (2019; hereafter WW) model makes differentiation and cost advantage explicit in the characteristics or attributes of the product, following Kelvin Lancaster’s (1966, 1971) model of his “new approach” to consumer demand. Following Lancaster (1966), each product is characterized by a vector of attributes of interest to buyers, which create value. This is, effectively, a model of goods-character (Güterqualität) for consumer goods (Gebrauchsgüter).
(1)
The quality bundles may differ by both which attributes zi appear in the product and how they are combined by the quality function. WW follow Lancaster’s convention that a product consists of a linear combination of the attributes. The attributes and products that exist in the industry at time t will be:
where the vector of product attributes [Z] is related to the vector of r goods [X] by a rectangular matrix of what are effectively inputoutput coefficients that “count up” the product attributes in each unit of each good produced by the r members of the industry. At the limit, [G] is of dimension r x n.
WW and Lancaster continue with the presumption that buyers assess attributes in characteristics space but express their preferences in goods space:
where the subscripts denote the attributes {1, 2, 3, …, n} and the superscripts denote the products {1, 2, 3, …, r}. The time period is suppressed for clarity, though it is imperative to remember that time figures greatly in analysis of innovation and new entry—which follows directly from the foregoing analysis of Menger’s production system.
The (time-suppressed) choice problem for each buyer is:
In this general form, the utility obtained from characteristic j may arise from it being solely available in a given good Xi or it may come from several goods that express that characteristic in varying amounts. And any good may have several characteristics from the n characteristics that appear in the utility function. This supports the analysis that WW present, whereby the combination of the relative amounts of each characteristic available from the r goods is evaluated with the prices of the goods to obtain their shadow prices. This may be easier to evaluate in a two-dimensional characteristics space with four alternative goods. Figure 1 is based on both WW (2019) and Lancaster (1971, 39).
In figure 1, each of the four goods comprises a unique ratio of z2 to z1 in each unit purchased. Good X1 has the highest z2 / z1 ratio per unit and good X4 has the lowest. The points labeled 1, 2, 3, 4 are the points on the goods rays that exhaust the given budget allocation. The quantities of each good purchased may vary, but these points are analogous to the standard consumption frontier in neoclassical representations of the budget line in goods space. WW note that there are four stylized consumption points on this efficient frontier—labeled A, B, C, D—associated with four consumers (or consumer segments) who are “in the market for” z1 and z2. In Lancaster’s terminology, consumer A and consumer C are vertex buyers: they exclusively buy, respectively, good 1 and good 3. Because the z2 / z1 ratios for the four goods do not maximize their respective utility functions, consumer B buys some X1 and some X2 and consumer D splits purchases ofX 3 and X4. Lancaster calls these edge buyers. In three or more dimensions, there will be buyers who optimize as facet buyers, consuming multiple goods in higher dimensions of z space.
Figure 1. Four-Good, Two-Characteristic Choice Model
What happens when [G] is large? WW state that in the context of product innovation and entry, the number of strategically important characteristics will be small, following the logic of the resource-based strategy for the limited strategically important set of resources or factors of production (Barney 1986, 1991). Lancaster (1972) admits that the usefulness of his model is limited to instances where the number of operationally relevant characteristics is less than the number of goods. He proposes two ways to limit the dimensionality of [G]. The first way is technical. In any class of goods there will be a number of redundant characteristics or, perhaps, invariant characteristics across the class of goods. The nonredundant and highly variant characteristics will be a (small) subset of the n possible arguments in U. Second, there will be human (goods-people) relations (Lancaster 1972). These include satiation (for one or more characteristics) and dominance, linked to the context of the purchase decision (e.g. hunger, low income). The technical algorithm is all about the structure of the [G] matrix. Nearly all classes of potential buyers will eliminate irrelevant or common characteristics from consideration. Consider this representation of five (competing) products in a class of goods with seven measurable characteristics.
Given the redundancy of characteristics z1–z4 (although the individual amounts of the characteristics may vary), a buyer will sort on characteristics z5–z7. And if a buyer finds no utility in characteristic 5, the subset of goods that will enter the consideration set (Mehta, Rajiv, and Srinivasan 2003; Shocker, Ben-Akiva, Boccara, and Nedungandi 1991) will be X2, X3, and X5. Depending on the utility weights for the six relevant characteristics, it is possiblethat X2 will be dominated by X3 or X5—depending on the buyer’s relative utility for z6 and z7 and the quantities of each of the five valued characteristics in the two goods.
Westgren and Wuebker (2019) complete their argument for using the Lancaster model as the core of the search process that an entrepreneur follows to find a profitable entry point into the strategy space inhabited by incumbent firms. The search process and the subsequent innovation in product space create one form of Schumpeterian competitive move: product innovation, where a new attribute bundle will disrupt the value assessment by buyers. If the new entry is tied to process innovation, then a Schumpeterian “new combinations” entry will be profitable if there is significant cost advantage in producing the relevant (even if redundant) product attributes. WW go so far as to illustrate that at the limit, the product or process innovation may lead to Schumpeter’s creative destruction.
IMPROVING ON THE LANCASTER MODEL WITH MENGER In the previous section of the paper, we proposed that the WW model elaborates Menger’s goods-character by using Lancaster’s characteristics space to make clear the source of utility in the buyer decision. We examine this in detail and tie this to Georgescu-Rogen’s (1954) argument against the reducibility of wants to utility—a fault of neoclassical consumer theory that Lancaster maintains in characteristics space.
To be sure, Menger considers the quality of goods in section C of part 2 of his third chapter, “Einfluss der verschiedenen Qualität der Güter auf ihren Werth,” (“Influence of the Different Quality of Goods on Their Value.”) But the salient point of this discussion is that we cannot assess the value of qualitatively or quantitatively different goods—i.e., goods of differing quality—objectively. Individual buyers satisfy different needs and wants by consuming goods of different quality and the decision of choosing one particular good of a given quality rests in part on the “importance of needs that would remain unsatisfied” by the choice (Menger [1871] 2007, 143). Moreover, this is a matter of
the particular satisfaction that depends on a particular concrete good when a whole group of needs stands opposite goods whose various units are capable of satisfying these needs in qualitatively different ways….If goods of one quality can be replaced by goods of another quality, though not with the same effectiveness, the value of a unit of the goods of superior quality is equal to the importance of the least important satisfaction that is provided for by the goods of superior quality minus a value measure that is greater (1) the smaller value of the goods of inferior quality by which the particular need can also be satisfied, and (2) the smaller difference to men between the importance of satisfying the particular need with the superior good and the importance of satisfying it with the inferior one. (Menger [1871] 2007, 144–45)
Thus, Menger anticipates the essence of Lancaster’s characteristics approach as the basis for qualitatively different goods, but requires that the choice function include the two central features of his approach to the valuation of goods: (1) the subjective evaluation of the quality of goods must be based on how they fulfill a hierarchy of needs/wants, and (2) the analysis requires identification of the marginal need not satisfied by the choice set. Lancaster’s human relations algorithm is a shallow simulacrum of Menger’s valuation system. Lancaster allows for satiation and dominance to limit the size of the choice set but does not incorporate either of these constructs formally into his maximand or as additional constraints beyond the budget set (Lancaster 1972). In fact, he describes Menger’s approach to hierarchy in the 1972 paper but dismisses it because “[h]ierarchy in goods does not necessarily represent an underlying hierarchy of wants” (Lancaster 1972). Effectively, he gets Menger’s logic backwards. Any hierarchy of goods choice is, in fact, driven by the hierarchy of wants. Moreover, Lancaster highlights the importance of satiation to Menger.
Closely associated with the idea of a hierarchy of wants is some kind of satiation effect. In the original arguments of Menger and other writers in the same vein, the hierarchy was relevant because the consumer satisfied his wants in order of importance. Obviously, unless the most important want was satiable, the next most important would be irrelevant. (Lancaster, 1972, 59)
Clearly, Menger would agree with the last sentence if the circumstances of the buyer were limited and she could not command the necessary resources to fulfill the highest need. But this is trivial. All accounts of consumer choice theory require sufficiency of the budget constraint to purchase a minimal market basket to sustain life.
Lancaster hints at the salience of wants but does not include them in his utility function. All characteristics are evaluated on some common measure of utility and the compensatory nature of this utility function permits direct tradeoffs between all characteristics and, hence, the goods that comprise them. Lancaster requires that the utility function U (z1,z2,…,zm) have the same properties of the neoclassical economics maximand for choice in goods space. It must be differentiable and the purchase of any good with low levels of any zi must able to be compensated by the choice of any other good that contributes more zi so as to maximize utility. That is, there are indifference curves in attribute space that behave the same way as indifference curves in goods space. As Georgescu-Roegen (1954) points out, is these qualities are incompatible with a hierarchy of wants and, moreover, reduces wants to a single-valued utility measure that effectively homogenizes them.
Can we improve on this by capturing more of Menger’s account of hierarchical wants? That is, can we improve the formal model of Lancasterian choice to make the entrepreneurial action of WW more explicit? Yes. There is a significant piece of conceptual modeling that closes the gap between Menger and Lancaster. In 1972, Duncan Ironmonger published a book entitled New Commodities and Consumer Behaviour based on his 1961 PhD dissertation completed at Cambridge University. Ironmonger was particularly interested in developing an approach to support empirical analysis of demand for new and qualitatively different goods.
Choice under Priorities among Wants
The Ironmonger model’s formal symbols are very close to those of Lancaster (1966), save for the fact that zi is no longer the level of characteristic i, but the quantity of satisfaction of want i (per unit of time). Furthermore, the system has the following variables (time suppressed):
Xj is the number of units of good j consumed per unit of time,zi is the quantity of satisfaction of want i per unit of time,wij is the quantity of satisfaction of want i per unit of good j consumed,Pj is the price per unit of good j, andY is the income per unit of time.
There are three objectively measurable variables: Xj, Pj, and Y. There are two subjectively valued variables: zi, and wij. In matrix form, [W] is the matrix showing how m wants are satisfied by n goods, p is a vector of length n for prices, and [X] is a vector of n goods.
If one were to define a compensatory utility function in the manner of neoclassical theory or in Lancaster’s model, it would appear as
Ironmonger wishes to represent want satisfaction as a hierarchical (lexicographic) utility function. For two specific wants, z1 and z2, where z1 has priority over z2, there is no longer a continuous single utility function.
This is a two-step utility function, where below a satiation point z1* for the higher priority want, utility is measured entirely by the satisfaction level for z1 even if the consumption set (not yet defined) yields some positive satisfaction of the second want. After satiation of the priority want, utility is only increasing for the satisfaction of the second want even if more z1 occurs. In a world of three or more wants, the level of utility increases only with the marginal increase in the utility of the lowest want that is not yet satisfied by satiation. This is perfectly coherent with chapter 3 of Menger (1871).
Ironmonger presents a mathematical treatment of a system with m wants and n goods. He also allows any good to satisfy more than one want and there can be more than one good that satisfies any particular want. This echoes Menger in his section on the original measure of value.
But in ordinary life the relationship between available goods and our needs is generally much more complicated. Usually not a single good but a quantity of goods stands opposite not a single concrete need but a complex of such needs. Sometimes a larger and sometimes a smaller number of satisfactions, of very different degrees of importance, depends on our command of a given quantity of goods, and each one of the goods has the ability to produce these satisfactions differing so greatly in importance. (Menger [1871] 2007, 129)
Both Menger and Ironmonger agree on what they call the economizing and maximizing behavior, respectively. The consumer chooses goods such that the largest number of wants can be satisfied, given that all the wants that are more important than the least important satisfied want are likewise satisfied (at the level of satiation). The hierarchy of wants matters. The failure to satiate any higher-level want cannot be compensated by satiation of any number of lower-level wants. Menger illustrates this with a verbal account of finding the marginal want (that is not satiated). Ironmonger formalizes this as a linear programming model where the ith want is not satiated; it is the marginal want.
We can effectively rewrite the WW model to commit to Menger’s theory by combining elements of Ironmonger’s model. Remember that zk is now the level of satisfaction of the kth want and WW’s [G] matrix of the yield of characteristic k by the consumption of one unit of good j is replaced by the Ironmonger [W] matrix, which depicts the satisfaction of want k by the consumption of one unit of good j. And the maximand (utility function) has to identify the marginal want that is satisfied and the marginal want that remains unsatisfied. We will use Ironmonger’s notation for the marginal unsatisfied want “i” and the last satisfied want “i-1.” Since Menger requires a strict hierarchical or lexicographic ordering between the highest level want z1 and the lowest level expressed want zn, there must exist a boundary between satiated wants and the highest (of remaining wants) that is not satisfied.
The equations (5’), (6), and (7’) represent Menger’s causal model for one consumer, given r known goods [X] and their market prices {P1, P2, …, Pr}. The [W] matrix is the subjective evaluations by that consumer for the satisfaction obtained for each unit of the known goods consumed. The vector [Z] is also subjectively known by that consumer—the rank order of her wants—as are the satiation levels zk*. It is helpful to think of the linked want-by-want utility function as a series of constraints on overall utility maximization that hold the wants as distinct, noncompensatory, and ranked—the essence of Menger’s account.
Implications for Entrepreneurship Theory
How, then, can this model be used prior to entry by an entrepreneurial firm? From the perspective of the incipient entrepreneur, the model explains how purchase decisions are made based on buyers’ assessments of how goods in the market will fulfill their needs hierarchies. And though the model is individualistic—and not as Lancaster intended his model—it allows the behavior of the representative buyer to be repeated across a number of individuals, if the number of goods in the market of interest is relatively small and the relevant wants are also few, to identify target markets for the new entry. The fact that individuals faced with this choice problem must identify a needs hierarchy implies much for the entrepreneur. The rankings and how they are distributed among buyers in the target market provide a great deal of product design information, even if the subjective valuations in the [W] matrix are not known. To the extent that data on purchases of incumbent goods imply how buyers perceive the mix of product attributes that satisfy needs, the entrepreneur can use his judgment to identify underserved needs and his ability to design a product to serve those needs at a cost that matches buyers’ willingness to pay (Rossi, McCollough, and Allenby 1996; Allenby, Arora, and Gunter 1998).
There is another connection between Menger and contemporary scholarship. There is a body of theoretical and empirical work on cognitive models of the interactions between firms and consumers across “the market divide” (Porac and Rosa 1996). Joseph Porac and José Antonio Rosa describe imperfect information exchange between sellers and buyers given that these are subjectively assessed, especially if the product category is new. The markets are “inherently equivocal” and the standard tools of analysis such as cross elasticities of demand do not exist (Porac and Rosa 1996, 367). Rosa, Porac, Jelena Runser-Spanjol, and Michael Saxon (1999) elaborate the not-quite-shared process at the point of entrepreneurial action—new product entry—and note that
attributes do not exist on their own either. They are derived inductively through observation and interaction with products. The use and observation of products are idiosyncratic and dependent on a person’s vantage point and observational goals….Consumers and producers bring their product conceptual systems to bear on market interactions. They use their conceptual systems to enact meaning for the physical artifacts they encounter and link the products to usage conditions and production or profit concerns. (Rosa et al. 1999, 67)
Eventually, the individuated product assessments become the basis for shared comprehension of the product attributes and how they satisfy buyer needs. This would correspond to the target market or market segments discussed above. But this market process is clearly consistent with Menger’s subjectivism and his insistence that the array of individual valuations is not translatable into a single, stable market price.
Noncompensatory Decision Theory and Marketing Research
We are at a juncture that permits the application of market research methods to assess subjective variables inherent in the model shown above. These techniques of eliciting and analyzing data will lead to useful judgments about needs hierarchies, patterns of subjective beliefs held by active and latent buyers, and buyers’ willingness to pay for attribute bundles that satisfy their needs, even for products that are still not on the market. Moreover, significant work was done from the 1980s through the 2000s on modeling consumer choice across product attributes using noncompensatory models (Johnson and Meyer 1984; Gilbride and Allenby 2004; Hauser 2009; Shin and Ferguson 2017). This research developed significant empirical evidence that consumers do not follow a decision process that implies a compensatory utility function. Many different noncompensatory choice models are supported by experimental results, including the hierarchical/lexicographic model embodied in equation (5’) above. Others include a conjunctive decision rule, where some minimal level of all relevant attributes (i.e., need-satisfying product characteristics) must be present for the product to remain in the consideration set, and the disjunctive rule, where only the attribute(s) that satisfies the highest need causes the product to be considered.
It is possible now to take pairwise discrete choice data from controlled experiments and impute the choice model used by the subject. Repeating the experiment permits the researcher (or entrepreneur!) to build a simulation of perceived need fulfilment that can be used to simulate new product entry under alternative attribute designs (Train 2009). The complexity implied by the utility function in (5’) is easily handled by these methods, which were unavailable to Ironmonger in his subsequent empirical analyses of new product introductions in English (Ironmonger 1972) and Australian (Ironmonger, Lloyd-Smith, and Soupourmas 2000) households.
It is also possible through surveys of purchase intentions and controlled choice experiments to “extract” the subjective assessments from active and latent buyers’ minds. These assessments include hierarchical preferences (or needs) and the strength of those preferences, willingness to pay for new product attribute bundles, and confidence in subjective assessments of alternative products. These are the data that permit the expression of Menger’s model of buyer choice in a manner that completes the analysis of entrepreneurial action in the face of subjective valuation in the market. Such data will provide an improvement in the assessment of entrepreneurial entry over the model of Westgren and Wuebker, since their model seeks data on product attributes, not on how these attributes fulfill buyer needs. This Mengerian insight solves part of the epistemic uncertainty facing the Knightian entrepreneur as she develops her conjectures about expected market outcomes after entry.
FORMAL MODELS AND ENTREPRENEURIAL ACTION: A DISCUSSION In an oft-cited article, William Baumol (1968) argues that entrepreneurial action has been necessarily left out of formal neoclassical economics models. “The theoretical firm is entrepreneurless—the Prince of Denmark has been expunged from the discussion of Hamlet.” (p. 66) This quote will elicit wry smiles from entrepreneurship scholars and economists that abjure formal models. Baumol, at least at this point in his writing, believes the neoclassical model cannot be augmented or altered in any meaningful way and that advances in modeling entrepreneurship lie in heterodox economics and psychology. He ignores prior economic analyses, notably from the Austrian school, that keep the Prince on stage save for two footnotes. One is a sop to Schumpeter (p. 70) and the other, surprisingly, to Veblen (Baumol 1968, 67).Baumol quotes Veblen’s 1898 “Why Is Economics Not an Evolutionary Science?” The quote also appears in later books and anthologies. Veblen’s polemic on (classical and neoclassical) economic man begins, “The hedonistic conception of man is that of a lightning calculator of pleasures and pains, who oscillates like a homogeneous globule of desire of happiness under the impulse of stimuli that shift him about the area, but leave him intact. He has neither antecedent nor consequent. He is an isolated, definitive human datum, in stable equilibrium except for the buffets of the impinging forces that displace him in one direction or another” (Veblen 1898, 389).
Veblen’s 1898 polemic deserves some attention in two respects. First, in the article he acknowledges positively Menger and the Austrians’ approach in developing subjectivism, but he is disappointed that they did not create an evolutionary account with cumulative causation. “[T]he later Austrian group struck out on a theory of process, but presently came to a full stop because the process about which they busied themselves was not, in their apprehension of it, a cumulative or unfolding sequence” (Veblen 1898, 386). This is clearly a failure by Veblen to understand Menger, Böhm-Bawerk, and Wieser. Perhaps he would have seen more clearly the genetic-causal tradition at the core of Austrian economics had he lived to see the term codified by Hans Mayer in the 1930s (Cowan and Rizzo 1996). In any case, Veblen’s appreciation of Menger’s subjective value theory and hierarchical needs is clear from his The Theory of the Leisure Class (1899).
The second point is that Veblen was speaking of the consumer and not the producing agent—entrepreneur or manager. Veblen’s quotation repudiates the mechanistic utility maximization of the Lausanne school and its implied capacity for calculating across large sets of market goods. Veblen’s socially stratified, socially embedded consumer behaves more akin to Menger’s need satisfier. Veblen’s cynicism aside, this is consistent with the model presented above that forms the basis for target markets (i.e., buyer segments) for the entrepreneur. But it is not about the missing Prince.
In this paper, we rely on formal models written with mathematical notation, rather than on verbal reasoning alone. In part, this serves to link the formal models of Westgren and Wuebker (2019), Lancaster (1966, 1971), and Ironmonger (1972) to the reasoning of Menger. I rely on the erudition of Salerno (2010) and his presentation of the praxeological method that links Menger to Rothbard (2009). Salerno notes the effective use of fictive or abstract constructs “that permit the economist to strip away all but the conditions of action that are essential to his analysis of cause and effect” (Salerno 2010, 8). The formal models exploited above do the same thing. Both the verbal account and the formal model are representations of economic phenomena (Hacking 1983). All representations of target (real) phenomena are false with respect to the target, regardless of whether they are verbal, graphical, or mathematical representations. Stripping away inessential elements of an economic phenomenon to core causal relationships gives us Menger’s (1871, ch. 3) farmer with more grain than his household consumption needs require, Böhm-Bawerk’s (1959) horse-wheat market, Lancaster’s utility function for product attributes, and the demand curve we depict for university freshmen.
The value of representations is the stuff of philosophy of science. Cowan and Rizzo (1996) bring this to the fore in discussing the genetic-causal tradition in Austrian economics. They cite Nancy Cartwright (1983) and Uskali Mäki (1990, 1993) as defenders of this tradition as realism, despite the use of representations rather than full-blown accounts of the target (real) phenomenon. Cartwright (1999, 2007) carries this idea forward by suggesting that a representation is useful if it allows inferences about the target phenomenon. Mäki (2009, 2011) makes the case for models as representations of target systems if the isolations produce credible surrogates for the causal structure(s) of interest. He goes so far as to support “false” models: “I accept the weaker idea that a model may be true despite false assumptions. I also accept—and argue for in this paper—the stronger idea that a model may help capture truths thanks to false assumptions” (Mäki 2011, 48, italics original). It is informative for economists that Mäki chooses a piece by Menger’s (near) contemporary, Johann Heinrich von Thünen, as a way to highlight the value of an isolated representation—the well-known Der isolierte Staat (The isolated state). Thünen double dips in isolation; he presumes that an isolated region exists in space and he isolates the economic functions of interest by assuming a flat, perfect, cultivatable plain and by assuming away topographic features that would confound transport costs. Mäki notes that this representation of economic geography has no resemblance to the target world but that the idealized model makes use of the fictions of which it is built to posit truths about economic behavior and its causal nature in the target world.
There is one additional distinction about models as representations that merits discussion. One can isolate the causal structure of interest by abstraction or by idealization. These two terms are not synonymous, but the boundaries between them may be fuzzy in practice. Levy (2018) drives a wedge between the terms by defining abstraction as omission of (true) elements of the target phenomenon in creating the representation—omission without misrepresentation—and idealization as deliberate misrepresentation of the target—an “anti-factive” or “fictive” model. One would certainly characterize the axioms of rationality that undergird neoclassical models of consumer choice as idealization without even a whiff of abstraction. So, too, is Menger’s analysis of consumption decisions based upon satisfying a known hierarchy of needs given a subjective evaluation of value of the goods-quality (Güterqualität). The causal nature of the representation derives from careful logical construction of the system of exchange across all manner of economic goods (Salerno, 1999). The “realist” half of the causal-realist approach of Menger is not based on abstraction, but on development of idealizations that hold across all of the transactions traced from higher-order goods to consumer goods. One may contrast this with an obvious abstraction process such as case studies or the German historical school, in which detail is omitted from the target world (context) to highlight some observed phenomenon.
There are two important implications of training the lens of philosophy of science on both the Mengerian verbal causal-realist method and the models of Lancaster and Ironmonger. First, it is not true that an abstract model is more generalizable to the target world than an idealized model just because the former has some observable (factive) elements (Mäki 2009, 2011; Levy 2018). How closely a model resembles a target at some point in time does not imply its value as a representation of the target. Mäki emphases that the truth of the model lies not in resemblance, i.e., the truth of models, but in the truth in models whose construction (however fictive) yields inferences about causal mechanisms in the world (Cartwright 2007). This is Menger’s design in the Grundsätze. The second implication is that there is no reason to prefer one representation over another unless it yields superior inferences about the phenomenon being modeled for a particular purpose for a specific audience (Mäki, 2011). That is, a mathematical representation may not be inferior to a verbal representation (e.g. Ironmonger vs. Menger) depending on the pragmatics of the purpose (e.g. building a computer model for empirical analyses vs. explication of the principles of economic behaviors) for two distinct audiences. To the extent that both Ironmonger and Menger capture the cause-effect relationships between need hierarchy and consumption choices among available goods, they are equivalent representations. To the extent that Ironmonger’s model incorporates the logic of Menger’s hierarchy of needs in a representation of consumption choice that is superior to Lancaster’s model for the purpose of analyzing new entrants into product categories for entrepreneurship scholars, it is superior for that purpose.
CONCLUSIONS The intent of this paper has been to illustrate that Menger’s need hierarchy can be incorporated into a formal model of strategic entrepreneurship, such as that of Westgren and Wuebker (2019) so as to improve the representation of the choice behavior of buyers in target markets. This improved representation implies that an idealized model of entrepreneurial entry into a market whose customers are served (however well) by existing products can be more explicit. Moreover, by maintaining the distinctiveness (irreducibility) of wants that is the centerpiece of Menger’s consumer theory, we have a clear theoretic foundation for value creation for the buyer that is missing from current conceptions of the economics of entrepreneurship. What then follows is a superior basis for imputing value to entrepreneurial action by new firms to take new products and/ or processes to the market. That is, we have a theoretical structure whereby the subjective valuation of the attributes of new products by buyers, according to their subjectively held wants, can be imputed to the combination of resources and inputs used by the entrepreneur.
Menger’s ontology provides further insights, as his foundational consideration of the economic value of goods must include “a margin for the value of the services of capital and entrepreneurial activity” (Menger [1871] 2007, 161). Thus, the value of Schumpeterian innovation and Knightian (and Mengerian!) uncertainty bearing as entrepreneurial functions can be calculated over and above the production and transaction costs incurred by the firm (cf. Westgren and Wuebker 2019). Moreover, Menger requires that the economic value of intangible goods of higher order, such as intellectual property (patents, copyrights, brand names, etc.)—his Verhältnisse—be included in the imputation. This means that the “teardown” cost estimates for consumer electronics are nonsense. They exclude the economic value of past entrepreneurial action in the creation of intangible resources that may create value in the buyers’ of these products. Finally, the entrepreneurial actions that may be included in the third of Westgren and Wuebker’s entrepreneurial functions—Coasean organization, which includes cost-saving business model innovations—can clearly be considered within the Verhältnisse. To the extent that these innovations create value for the buyer because of lower cost relative to subjective value, they fall under Menger’s conception of entrepreneurship, i.e., economizing.
Where does this account of the economics of entrepreneurship fit with regard to the literature on entrepreneurial opportunity? It is superior to the so-called Kirznerian (objective) discovery opportunity (Shane and Venkataraman 2000). A Mengerian model of entrepreneurship cannot be considered as some exploitation of an objective opportunity that exists in the business environment, the metaphorical twenty-dollar bill lying on the sidewalk. The connection between entrepreneurial judgment and individual buyers’ subjective evaluation of products is hardly exploitation of an objective social phenomenon. Ontologically objective opportunity has been debunked by McBride and Wuebker (2020), and the very essence of Austrian economics, which is reflected in this paper, supports subjectivism. Then, does this account add anything to the Schumpeterian creation opportunity (Alvarez and Barney 2007)? If the creative opportunity is conceived as wholly the result of cognitive processes and action interior to the firm, then it fails to link buyer valuation to value creation, at least explicitly. The creation opportunity, typically conceived as a social construction process by the entrepreneurial team, has nothing to support imputation of value in a meaningful way. This will lead inevitably to the problem of whether there are observable outcomes (i.e., profits) from this mind-dependent phenomenon (McBride and Wuebker 2020). The Austrian economic tradition requires human action in the sense of investments, market entry, and purchases by buyers which are, at best, only implied by a social constructionist account.
The economic model presented in this paper can be tested empirically by observing these human actions. Pragmatically, this will follow the marketing and organizational theory designs discussed above. Given the differences among need hierarchies in submarkets, how will putative target markets assess at the group level the subjective valuations of the attribute bundles? In one target market, a particular attribute will fulfill the highest-ranked need and in another target market, that need will be lower ranked. The market process allocates different attribute portfolios (i.e., goods) among buyers in the market. A necessarily concise list of needs and a necessarily limited set of product attributes will cause the emergence of submarkets with different, but commonly held need hierarchies which translate into market shares for the competing goods. These appear as the vertices and edges of the consumption space in Figure 1, as depicted in Westgren and Wuebker (2019). The hierarchy of needs is a missing element in the model that WW build from the Lancaster (1966, 1971) approach that permits compensatory utility assessments for buyers. When a noncompensatory utility function, such as a needs hierarchy, is imposed, the vertices (i.e., product loyalty) become more logical and better defined. This makes the entrepreneurial action of product design clear. It should improve WW’s analysis of (product) innovation rents; product design responds to the entrepreneur’s subjective assessment of the unmet needs in some target markets. Moreover, this is clearly the exercise of entrepreneurial judgment (Foss and Klein 2012) that is central to the value-generating activities of both Menger’s and Knight’s entrepreneur.
The connection between Menger and the work by Porac and Rosa on cognitive models of product and product category emergence admits the value of methodological individualism in a manner that is not widely echoed in the literatures of management, markets, and organizations. Methodological individualism has been a central tenet of Austrian economics from Menger onward. For clarity, one should devolve the term into two claims: ontological individualism and explanatory individualism (Epstein 2015). Ontological individualism is the claim that social facts are exhaustively determined by facts about individuals, their actions, and their interactions. Explanatory individualism is the claim that social facts are best explained by individuals’ facts, actions, and interactions. Epstein cautions that both claims need to be examined on the merits of the theory and methodology being addressed (as opposed to all social science).
All of the explanatory power of this Mengerian approach to entrepreneurship is based upon individual choice. To the extent that some individuals can be aggregated into target markets according to their needs, this requires no additional assumptions of group-level characteristics or shared intentionality. Eventually, there will be social interactions among sellers and among buyers across the market divide, but the resultant social facts are additive of the individual social facts. Thus, this approach satisfies both ontological individualism and explanatory individualism.
In sum, we can argue that much of Carl Menger’s unique ontology is preserved in our account of its value for entrepreneurship research. Although Menger’s successors in the Austrian tradition took his groundbreaking treatise beyond its original scope, there are important lessons for the scholarship of entrepreneurship in the Grundsätze. In fact, one can see that much of Fritz Machlup’s list of “the most typical requirements for a true adherent of the Austrian school” (Machlup 1981) are visible in our account: (1) methodological individualism, (2) methodological subjectivism, (3) tastes and preferences expressed as subjective evaluations of goods, (4) opportunity costs, and (5) marginalism.
Beyond adherence to the traditions of Austrian economics, one hopes that this approach to the economics of entrepreneurship serves to advance contemporary thinking about the methodology of entrepreneurship research. By bringing buyer wants front and center, the calculation of entrepreneurial rents becomes less ad hoc and the design school approach can then be tied explicitly to imputation of value. And value creation is no longer about firm owners; it is about success in market entry.
Professor Per Bylund of Oklahoma State University is the author of The Seen, The Unseen, and the Unrealized. 2020 is the year social scientists failed to show us the unseen, namely the staggering and still unfolding economic, social, medical, and human costs of Covid lockdowns. Dr. Bylund and Jeff Deist discuss Covid and government responses against the backdrop of ripple effects, Say's law, "market failure," and the inability of bureaucrats to make rational tradeoffs. They also discuss Dr. Bylund's upcoming project for the Mises Institute: an Austrian economics primer, under 100 pages, available as a very inexpensive paperback.
Find Dr. Bylunds book at mises.org/Unrealized
And follow him on Twitter @PerBylund
Six ways — selected from many — that businesspeople can derive more insightful knowledge and perspective from Austrian economics than from traditional Business School teaching.
Download our "A-school vs. B-school" summary PDF at Mises.org/E4E_94_PDF.
More Human Austrians believe in business as an uplifting human endeavor, focused on how people as producers can best help people as customers to do well, feel better, and thrive. To do so, entrepreneurs cultivate their power of empathy: to understand others, feel what they feel, and understand their hopes and dreams. Entrepreneurs utilize this understanding to cultivate new ideas, design new solutions, and present new value propositions for customers’ consideration. It’s the human project.
When business schools approach business building as an engineering problem, to design and run an assembly of operating machinery — whether physical or digital - at maximum levels of efficiency, and to manage via mathematical models embedded in spreadsheets and software, they occlude the human factor.
More Subjective Emotion and subjectivity are important elements of human decision-making, both for producers and customers. Data and so-called rationality are important, but how people feel, how they perceive, how they interact, and how they subjectively weigh up options are dominant in shaping decisions. Austrians understand this, especially in the subjective imagination entrepreneurs apply to future customers and their potential preferences. No data or predictive models can reproduce this capability.
More Individual Austrian economics always starts analysis at the individual level. Every economic phenomenon can be traced back to one buyer exchanging with one seller. What are the motivations and incentives and processes that promote the completion of the exchange? What are the barriers that might prevent it? Can the resulting knowledge be applied in more instances, and even at scale?
Austrians are not atomists. We understand — more deeply, perhaps, than the minds behind the business school disciplines — interconnection, community, and the interaction of individual beliefs, values, and preferences. It is the study of these interactions that lies at the core of the Austrian approach to business. Groups and segments are abstractions — only individuals decide, choose, and act.
And today, technology is moving in our direction, enabling more fine-grained action to reach individual customers with tailored value propositions.
More Imaginative Professor Peter Klein has been, and continues to be, a leader in unwrapping the role of entrepreneurial imagination in the dynamism of business. He emphasizes that humans are fundamentally creative actors, and that entrepreneurs apply imagination to create new possibilities, new solutions, and new combinations of resources the world has never before seen. Opportunities are not “out there” to be discovered. They’re imagined by the entrepreneur.
Yes, there can be planning, e.g. in the choices between alternative patterns of resource allocation. But even these are subjective, based on individual entrepreneurial assessments. There can be projection of trends, although empathy with future customers is a counterweight to projection. Overall, imagination dominates.
More Action-Oriented As Peter Klein also teaches, entrepreneurship is characterized by acting to reap the rewards inherent in imagined possibility. This action orientation makes the Austrian approach to business much more realistic and straightforward than the business schools’ insistence on the mysteries and opacity of strategy.
Austrian entrepreneurs form their own beliefs, act on them, and gather the results. The results are a feedback mechanism, energizing the entrepreneur to make adjustments and try again. Business is very straightforward. The Austrian action-orientation to business is empowering and inspiring.
A Role for Theory Professor Klein told the story of his first foray into executive education. He was nervous about presenting Austrian economic theory to experienced and successful business people. He quickly learned that theory is what business needs and what traditional business instruction lacks. Managers often know everything about their industry, but do not always have theoretical perspective, or frameworks to help them see the forest and not just the trees. Without a theory, all they have is a mess of data.
Theory provides a path to interpretation. That’s what’s so valuable about Austrian economics: it emphasizes theory. One example we discussed for business was pricing theory. Austrian economics provides a pathway for entrepreneurs to map out how pricing for specific goods and services emerges via the interplay of customer preferences and context with entrepreneurs’ value propositions. The price that is right for an exchange can be discovered by following this pathway.
But the entrepreneur still needs to combine the theory with action and experience: set the price for an offering, and test the customer’s willingness to pay in the context of all their alternatives and their previous experiences. Theory provides an invaluable generalized assistance with understanding of the customer’s ultimate decision, but can’t predict the contingencies of the moment and of the individual’s idiosyncratic personal situation. With Austrian theory, an entrepreneur is more likely to get pricing “right” (via theory) but not every time (that’s experience).
Additional Resource "Austrian School vs. Business School" (PDF): Mises.org/E4E_94_PDF
“Small business” is just a government classification. Entrepreneurial businesses serving well-defined communities via creative specialization exhibit enormous economic productivity, energy and dynamism.
Such businesses can not be defined quantitatively as small, medium or large. They’re defined by their qualitative impact on their customers’ lives.
Entrepreneurial businesses care differently, and care more. Big businesses must pay attention to size and scale, to their huge revenue and profit streams, to their many, many shareholders, to journalists and bureaucrats and financial analysts. They are, typically, managing to maintain progress or status on a well-established pathway, and have limited time and resources to devote to customer care.
The triple option of the entrepreneur. Small businesses are designed and constructed to care for customers and communities. As Ramon Ray puts it, small business entrepreneurs choose to:
Create what we want;Serve whom we want;Collaborate with whom we want. As a consequence, business owners care differently about their customers, their colleagues, and their collaborators and partners.
Small business entrepreneurs create communities of fans. Ramon sees small business owners serving their chosen communities as Celebrity CEOs (see Mises.org/E4E_93_PDF). This does not require millions of Twitter followers or a pack of paparazzi. It results from being known and trusted as the specialist supplier of a highly desired service personalized to a well-chosen, often local, customer base. It’s the deli owner with the best sandwiches, or the mechanic to whom to trust one’s 1958 Edsel.
Customers become fans, deeply emotionally bonded to the entrepreneur and the service. Business owners become more deeply intimate with customers-as-fans, and the synergy is complete and lasting. The entrepreneur and the firm come to fit the community perfectly, and become indispensable.
The well-served community is a qualitative measure of business success, not quantitative.
Ramon Ray aims to build a community of entrepreneurs along similar lines of helping and caring. Entrepreneurs can thrive by serving well-chosen communities, and they can also thrive by being part of a community. His vehicle is a B-corp formed by fellow-entrepreneur Seth Godin, to support small business entrepreneurs. Akimbo provides knowledge, tools, and courses to help entrepreneurs run and grow a business. Ramon’s latest contribution is a series called Small Business Essentials, a workshop in 12 modules. The modules cover essentials including pricing, cash flow, and hiring, as well as entrepreneurial refinements such as properly defining what problem you are solving and who are you solving it for.
A special feature of the workshop is that participants are joined online by fellow entrepreneurs, so that there is a group experience, group knowledge sharing, and group Q&A. The community helps itself by helping each other. It’s a place to learn and a place to ask questions.
Additional Resources "Celebrity CEO Mindset" (PDF): Mises.org/E4E_93_PDF
Ramon Ray's "Small Business Essentials" Workshop: Mises.org/E4E_93_Workshop
Ramon Ray’s book, The Celebrity CEO: How Entrepreneurs Can Thrive by Building a Community and a Strong Personal Brand: Mises.org/E4E_93_Book
Principles of Austrian economics have immediate applications in business. Clay Miller, a deeply experienced and highly successful global tech entrepreneur, makes the case via five principles drawn from five easily-accessible sources of Austrian economic theory, with many accompanying examples.
Principle 1: The distribution of knowledge requires disaggregated thinking. Source: "The Use Of Knowledge In Society," F.A. Hayek: Mises.org/E4E_92_Hayek
Hayek wrote this paper as part of a research program into the problem that economics tries to solve. He defined it as a knowledge problem. Knowledge “never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess”.
The implication he drew was for central planning by governments and their departments and committees that would attempt to plan production or set prices. Such central planning is impossible because dispersed knowledge can not be aggregated and so the planners never have enough knowledge on which to base a plan.
Quote “The statistics which such a central authority would have to use would have to be arrived at precisely by abstracting from minor differences between the things, by lumping together, as resources of one kind, items which differ as regards location, quality, and other particulars, in a way which may be very significant for the specific decision. It follows from this that central planning based on statistical information by its nature cannot take direct account of these circumstances of time and place…..”
Application In our Economics For Business project, we have the opportunity to help entrepreneurs apply the same principle to business knowledge, or data. Too much aggregation can obscure information that is really important and most useful for improving business performance.
Here’s an example. A frequently used KPI (Key Performance Indicator) is average revenue per customer. It’s calculated by aggregating all customer revenue into one number and dividing by the number of customers. For this to be actionable intelligence, it is necessary to assume that spending by each customer is very uniform. But consider the case where average revenue per customer is $190 for a customer base of 10 users, composed of 9 who spend $100 each and one who spends $1,000. The KPI does not suggest that each new customer you acquire will spend $190. In fact, it’s more likely they’ll spend $100. And, in fact, what you would really like to know is the profile of the $1000 customer and whether that profile, applied in recruiting new customers, would enable you to recruit more $1,000 spenders. You really want to choose metrics that can provide insight into individual customer behavior — like the nature and motivation of the one $1,000 spender.
Similar Austrian thinking would apply, for example, to Google analytics, which can profile the type of customer interacting with your website or app, and observable behavior such as conversion rate by page visited, or abandonment rate for specific pages. These are disaggregated statistics that can help you serve customers better.
Austrian thinking is rigorous in seeking to identify cause and effect, and to ensure that correlation is not mistaken for causation. A simple example is restaurant data that exhibits a 30% increase in customer traffic on Tuesdays. There’s a correlation between day-of-week and traffic increases — but it’s not causation. Tuesday does not cause the traffic increase. What does? It requires digging to find out, perhaps, that a local firm offers a perk to office workers to pay for them eating out on Tuesdays. As Hayek would say, this is specific knowledge of time and place, more likely to be qualitative than statistical, embracing the subjectivity that’s central to Austrian economics.
Principle 2: Consumer Sovereignty requires that entrepreneurs are directed by their customers. Source: Bureaucracy, Ludwig von Mises: Mises.org/E4E_92_Mises
This book focuses on the inefficiencies and ineffectiveness of bureaucratic organizational structures and processes. In a chapter titled Profit Management, Mises defines the Austrian concept of consumer sovereignty. Understanding and applying this concept is central to entrepreneurs’ capability to create effective value propositions for their offering, brand or business.
Quote “Thus the capitalist system of production is an economic democracy, in which every penny gives the right to vote. The consumers are the sovereign people. The capitalists, the entrepreneurs, and the farmers are the people’s mandatories. If they do not obey, if they fail to produce, at the lowest possible cost, what the consumers are asking for, they lose their office. Their task is service to the consumer. Profit and loss are the instruments by means of which the consumers keep a tight rein on all business activities.”
Application Consumers are the ones driving production. It’s up to business managers to make sure that every decision is towards bettering the value proposition offered to customers.
For example, the décor in a restaurant should be chosen not because the owner favors it or because an interior designer decrees it, but for the purpose of enhancing the value experience of those consumers the owner wants to attract and to serve. This requires empathy. Consumer sovereignty and entrepreneurial empathy go together.
Because consumers are the ones valuing what is produced, they are the ones ascribing value to the product or service the entrepreneur produces. The entrepreneur needs to anticipate what they value, and to do so requires ever-greater closeness to the customer. Clay described the value provided by simple but tasty barbecue restaurants in his home state of north Carolina, in a décor of plastic and paper and small booths. But that wouldn’t attract the customers who prefer fine dining in a five star restaurant. The customer decides what experience they value.
Startups can usefully anticipate consumer preferences by creating an imaginary perfect customer, and thinking through the value they want and the value the business can facilitate for them. Once in production, get as much feedback as possible on the actual value experience and the customer’s feeling about it. Every decision made inside the business needs to be for the purpose of and directed towards improving the customer value proposition and value experience.
Principle 3: Human value scales are complex and ever-changing and entrepreneurial empathy is required in order to reach an understanding of customers’ value dynamics. Source: Human Action, Ludwig von Mises: Mises.org/E4E_92_Mises2
Human Action is the magnum opus of Austrian economic theory. Every chapter will yield great insights for business. Clay selected value scales as a topic.
Quote “It is customary to say that acting man has a scale of wants or values in his mind when he arranges his actions. On the basis of such a scale he satisfies what is of higher value, i.e., his more urgent wants, and leaves unsatisfied what is of lower value, i.e., what is a less urgent want. There is no objection to such a presentation of the state of affairs. However, one must not forget that the scale of values or wants manifests itself only in the reality of action. These scales have no independent existence apart from the actual behavior of individuals. The only source from which our knowledge concerning these scales is derived is the observation of a man's actions.”
Application When a person makes a decision to purchase your product or service, they conduct a quite complex evaluation to integrate your offering into their scale of values. And the values and the scale is constantly changing. Consumers are not static robots. Their circumstances change, their preferences for saving or spending change, their time of life or even time of day demand rearranging of value scales.
A consumer may have a high preference for Krispy-Kreme donuts. But then they go on a diet. Their value scale changes. Losing weight and increasing fitness are now higher values than enjoying a donut. If you are the Krispy-Kreme donut franchisee, it’s important to be aware of the value scale change, and to empathize with the customer. Maybe you could develop a promotion called “Cheat Day” that rewards them with a donut treat after a week of exercise and donut restraint. As Wayne Gretzky used to say, skate to where the puck is going to be, not where it is now.
How can you understand value scales? One interview with a customer — what a researcher would call deep, rich qualitative information — can be worth much, much more than survey data. Mises said that we can only know an individual’s value scales by observing an individual’s actions. Having them answer a survey question such as “How highly do you value this item?” or “What price would you pay for this item?” does not indicate how they would fit the item into their value scale. They may say they would pay $250,000 for a Ferrari, but, when they weighted the experience of owning the Ferrari versus the opportunity cost of foregoing other experiences, would they actually make the purchase? The survey answers won’t tell you.
Entrepreneurs are rewarded for estimating correctly what the customer values and creating the appropriate value proposition.
Principle 4: The market is a discovery process, with uncertainty on both sides of market exchanges. All entrepreneurial actions are tests, with no certain outcomes. Source: Competition And Entrepreneurship, Israel Kirzner: Mises.org/E4E_92_Kirzner
This is a seminal work on entrepreneurship. One of the major themes is that markets are a process of discovery. That insight directs entrepreneurs to think in dynamic, process terms. The entrepreneur experiences uncertainty in what he or she is producing, because they are not sure of what customers will value in the future. The customer is uncertain, too, because they’re unsure of how they’ll value what the entrepreneur produces. Whenever we, as consumers, feel trepidation about “pulling the trigger” on a purchase, we are experiencing this uncertainty. Meanwhile, the producer is anxiously discovering the receptiveness to his or her value proposition.
Quote “The market process, then, is set in motion by the results of the initial market ignorance of the participants. The process itself consists of the systematic plan changes generated by the flow of market information released by market participation — that is, by the testing of the plans in the market.”
Application Kirzner points out that every plan an entrepreneur has, every value proposition, every offering made to prospective customers can only be a test, a trial. Nothing in the market can be certain. Entrepreneurs are trying to anticipate what customers are going to value, and they can never be sure in advance.
That’s why entrepreneurs use empathy, to imagine, if they were the customer, what type of experience the customer would be looking for. Entrepreneurs must imagine what customers might enjoy in the future. They must seek the customer’s agreement that, “Yes, your product or service delivered what you promised and made me feel better.”
One implication of Kirzner’s principle of “market ignorance” is for branding. If a brand has accrued a certain level of market reputation, consumers will feel less ignorant. They will feel they “know” a brand that’s been producing for 100 years, that is symbolized by the 3-point star that can be seen everywhere, and that is trusted and approved by many other consumers. A brand represents the stored experience and the stored reputation of many customers.
Principle 5: All entrepreneurship is for social good, and more social good is achieved by subjecting business to the marketplace test of profit and loss. Source: Austrian Perspectives on Entrepreneurship, Strategy and Organization, Peter G Klein, Nicolai Foss, and Matthew McCaffrey, "Austrian Perspectives On Entrepreneurship, Strategy and Organization": Mises.org/E4E_92_Perspectives
In Chapter 4 of this book, the authors discuss the concept of social entrepreneurship. This is an idea that seems to be gaining traction, especially among millennial business owners and millennial entrepreneurs. The idea is that business should be focused on something more than profit and loss. It should provide some “social value”, making the world better. Klein, Foss and McCaffrey provide some robust Austrian thinking with regard to social entrepreneurship.
Quote “However, these metaphors (“social value”, etc) often imply a false conflict with traditional entrepreneurship. For example, the contrast between conventional market entrepreneurship and social entrepreneurship implies that the former is somehow not social, or even anti-social. This is misleading, however; for example, Austrians would respond that Mises’s calculation argument demonstrates that the entrepreneurial market economy is profoundly social. Entrepreneurs, by bearing uncertainty in an effort to satisfy consumers, work ceaselessly to improve the welfare of all members of society, and their work in turn strengthens bonds of cooperation between individuals and communities, while at the same time disincentivizing conflict and exploitation. This is social behavior in its most fundamental form.”
Application Steve Jobs improved society greatly by inventing the iPhone. The impact on society was considerable — better communication and information sharing, and higher productivity for billions of people.
Every venture — including social ventures — must grapple with basic economic problems. Taking on a social mission does not relieve the firm of the pressures of the marketplace. Social enterprises are business organizations, and if they earn revenues through the sale of goods and services, they must apply judgement to allocate scarce resources in the face of uncertainty. Genuine participation in the marketplace requires them to be subject to the profit and loss test.
Klein, Foss and McCaffrey make the point that “social value” is incalculable. What’s good for one individual is not the same as for another. Individuals value things subjectively. When a business pleases one group, it may be adversely affecting another.
Profit is not evil. It’s impossible to make a profit without serving your fellow man. You are doing good for society by being an entrepreneur, by producing things that people want and value. You forego your own consumption by investing in your business, and so you are making a sacrifice to serve others. And if social entrepreneurs are not subjecting themselves to the profit and loss test — if they are supported by charity or grants — then they are not receiving the signals form consumers that they are allocating scarce resources in the way that consumers — i.e., society — prefers.
The ethic of entrepreneurship is to serve, and to make others’ lives better, and to receive the approval and reward of customers via the profit and loss mechanism of the market.
Downloads and Extras Mentioned in the Episode: "The Use Of Knowledge In Society," F.A. Hayek (American Economic Review, Vol. XXXV, No. 4, September 1945; pp. 519–30): Mises.org/E4E_92_Hayek
Bureaucracy, Ludwig von Mises (Yale University Press, 1944): Mises.org/E4E_92_Mises
Human Action, Ludwig von Mises (Mises Institute, 1999): Mises.org/E4E_92_Mises2
Competition and Entrepreneurship, Israel Kirzner (Liberty Fund, 1978): Mises.org/E4E_92_Kirzner
Austrian Perspectives on Entrepreneurship, Strategy and Organization, Peter G Klein, Nicolai Foss, and Matthew McCaffrey (Cambridge University Press, 2019): Mises.org/E4E_92_Perspectives
Key Takeaways and Actionable Insights Austrian economics sees an economy in motion, perpetually renewing itself. Economic agents (firms, customers, investors) constantly change their actions and strategies in response to outcome they mutually create. This further changes the outcome, which requires them to adjust afresh.
Entrepreneurs live in a world where their beliefs and strategies are constantly being “tested” for survival within an outcome these beliefs and strategies create. It’s complex.
One of the strategies required in this dynamic system is innovation: the enabling of new value propositions to customers, sustained by new resource combinations, new technologies, new go-to-market capabilities, new channels and new delivery mechanisms.
Innovation has often been characterized as presenting the entrepreneur with an unmanageable level of uncertainty. Curt Carlson challenges this idea and believes innovation can be predictable via the utilization of sound process, captured in his N-A-B-C method (see Mises.org/E4E_37_PDF), which we explained fully in E4EPod episode #37 (Mises.org/E4E_37).
In addition, Curt tells us in episode #91 that the right individuals can strengthen the process by acting as innovation champions. Here are their characteristics.
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Originate a value proposition. The route to value starts with a value proposition — accurately identifying a need and developing the appropriately differentiated approach with the right cost structure. Champions are those who can originate innovation projects with an energizing and inspiring proposition. They are customer advocates with creative capabilities. Champions can use Curt’s process map for guidance, or our own "Economics For Business Template" ().
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Collaborate with a complementary partner. Innovation is a team game, and it often starts with a partnership of two. Venture capital funds often look for a team of co-founders rather than on brilliant individual. A combination of an engineer and a marketer is a good one, but there are many more. The key is that the partner is complementary: different skills, different experience, same commitment and passion.
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Build a team over time. The benefit of complementary skills is not limited to co-founders or co-champions. As an innovation project evolves, the need for more skills and different experiences expands. A champion is able to add complementary skills via new team embers over time, while maintaining team cohesion and integrity.
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Learn necessary value-facilitation skills. Recruitment is not the only route to new skills for the team. The champion should be able to recognize skill gaps and fill them via their own learning. For example, mastering the interpretation of qualitative data from customer learning sessions is imperative but not intuitive. Champions work hard at gathering the data (listening and empathy skills) and processing the data (interpretation skills) to project possible future solutions (imagination skills). These new skills are learned over time.
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Iterate with the team and in larger forums. It is impossible to predict how an innovation process will proceed, and what twists and turns will be necessary. A champion is able to iterate the understanding of the need, the approach to solving it, the use of technology, and the management of costs. Change is constant not only in the world, but in the innovation project. Iteration can be conducted in the small team, but the champion should also seek larger — perhaps company-wide — forums for sharing and commentary. Everyone’s input counts. Champions don’t become too possessive of their ideas.
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Champions exhibit enviable human values. Project teams are often under stress. Deadlines loom, experiments fail, ideas clash. A champion demonstrates human value of trust and respect and integrity that bind teams and projects together. People want to work with champions.
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Champions take organizational responsibility. All innovation projects are fraught with risk and uncertainty. Some will fail. Others will take unexpected turns. When the unwanted or unexpected happens, a champion takes responsibility and does not try to deflect blame to exogenous factors. All decisions are subjective, and champions take ownership of their decisions.
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Champions persevere. Innovation project timelines can be long. Curt described some that took 10 years or more (like the development of Siri, which eventually became associated with the iPhone4). Despite barriers that might seem insurmountable, and setbacks that might feel humbling, champion s keep going no matter what. They are inspired, and inspirational to others.
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Champions succeed. Success is not a behavior or a characteristic, it is an outcome. Nevertheless, with the right process and a good team, champions succeed repeatedly.
In our hyper-competitive world, without a champion success is not possible. The only viable path is to aspire to be the best at what we do. That starts and ends with someone committed to success — a champion.
Additional Resources Check out Curt Carlson’s HBR article, "Innovation for Impact" (PDF): Mises.org/E4E_91_PDF
Curt’s website is PracticeOfInnovation.com. Click on "Innovative Indices" to see how to assess the innovative potential of your firm and projects.
"N-A-B-C Innovation Process" (PDF): Mises.org/E4E_37_PDF
"Curt Carlson: There is a Systematic, Repeatable Process to Generate Customer Value" (E4EPod episode #37) : Mises.org/E4E_37
Abstract: This paper expands Fuller’s (2013) analysis of the net present value and interest rate changes in the context of the Austrian business cycle theory. During the boom phase of the business cycle, the economy shifts to a more risky position as the result of entrepreneurs’ profit targeting. To quantify this risk the duration, defined as the number of periods that elapse before the average present value dollar is received from a stream of cash flows, can be used. The new risk-adjusted net present value is created after applying the duration to capital asset pricing model determining the discount rate that should be used to calculate the present value of the project.
JEL Classification: B53, E22, E40, E52, G31, G32 Joanna Kruk (jkruk67@gmail.com) is a recent graduate of the Cracow University of Economics and Jagiellonian University.
- INTRODUCTION The Austrian business cycle theory (ABCT) gained the interest and endorsement of non-Austrians as a valid theory shortly after the outbreak of the 2007/08 crisis. Then, major focus was placed on macrolevel aggregates such as the volume of loans, the threat of large scale bankruptcy or the supply of money. Little attention was paid to the analysis of corporate finance and the causes of companies’ erroneous decisions about initiating and carrying out unprofitable undertakings. One direct cause of the collapse was identified as cheap credit, which engenders a reallocation of resources between stages of production. That is inconsistent with the intertemporal preferences of consumers. In particular, lowering the interest rate below its natural level causes production to become more future-oriented. Artificially low interest rates are not only the cause of incurring new debts by companies, but are also the reason why less efficient companies enter the market. Due to the poor quality of their projects, these less efficient companies are more likely to mobilize necessary funds if funds are less limited, which is the result of expansionary monetary policy. Correspondingly, there are numerous entrepreneurs that will receive investment funds only when credit is “easy.” (Engelhardt, 2013) Moreover, erroneous decisions to engage more resources to projects which cannot be successfully completed are implemented, making the situation worse than it otherwise would be.
The aim of this paper is to analyze corporate finance from an ABCT perspective with a focus on the excessive risk-taking by companies. While the main literature about the business cycle focuses on the effects of certain policies on the aggregate and general shift of the economy to more risky positions, the motivation of financial decisions on a micro-level can shed new light on the foundations of the emergence of the business cycle. The vast difference between the profitability of an investment project relative to the interest rate change was previously discussed by Fuller (2013) using the net present value and the marginal efficiency of capital to show how interest rates affect the intertemporal allocation of capital and shift the resources to more roundabout projects. Enriching the analysis in risk assessment could lead to a further conclusion regarding the subject. One of the frequently used risk measures is duration, used in capital budgeting and precisely described by Blocher and Clyde (1979) and Johnson (2005).
In this paper, we plan to analyze previous work on the cycle effects on the microenvironment from the Austrian perspective, along with financial literature research on risk assessment, in order to try to capture the impact of interest rates changes based on financial decisions of firms with on numeric examples.
- THE CORPORATE APPROACH TO THE AUSTRIAN BUSINESS CYCLE THEORY The Austrian business cycle theory was developed in the first half of the 20th century, mostly by Ludwig von Mises and Friedrich von Hayek. The main focus of the theory was placed on the intertemporal coordination and allocation of resources. In the market economy, the role of price signals was emphasized, as it is the major indicator of entrepreneurs’ success in fulfilling their clients’ demands. Special attention was paid to interest rates since the core of the ABCT is how artificially low-interest rates, which are falling below their natural level, influence the economic activity of agents.
As formulated by Rothbard (1978), the unhampered market interest rate is determined only by the “time-preferences” of the agents. People choose money right now over a promise made in the present to receive the same amount of money in the future, which means that their time preference is positive. Time preference also indicates the distribution of people’s income between savings and consumption. When the interest rate falls as the result of government intervention, rather than as a change in people’s preferences, an artificial boom starts. Agents are deceived into thinking that there is a greater amount of savings available for their investment projects, so they begin to engage more capital, particularly in lengthy and time-consuming undertakings, which previously were unprofitable due to the higher cost of financing them.
The main focus of Austrian economists is placed on emphasizing the disruption of intertemporal resources allocated between stages of production, resulting in malinvestments. At the later stage, these projects turn out to be impossible to complete since there are not enough resources to finish all undertakings initiated during the boom episode. This argument was originally formulated by Ludwig von Mises: “Projects which would not have been thought profitable if the rate of interest had not been influenced by the manipulations of the banks, and which, therefore, would not have been undertaken, are nevertheless found profitable and can be initiated.” (Mises 1912, 26)
In the microscale during the expansionary phase of the business cycle, firms will prefer to expand production. Since the interest rate is regarded not only as a cost factor but also as a factor of capitalization, decreasing the interest rate creates an incentive for investments in fixed capital by way of capitalization of future yields (Machlup 1935). This is the effect of the increased present value of future return, which is capitalized at the new, lowest interest rate. This reasoning applies to both lowering interest rates directly by the central bank and to credit expansion. In the second scenario, the newly available funds push down the interest rate and create the impression that there are more resources available for investment in lengthy projects. At the same time, the decreased interest rate is the reason people are less willing to keep their income as savings, thus the further discrepancy between real and natural interest rate is created (Engelhardt 2012).
The main reason for keeping interest rates low is to boost the economic activity of agents. As a direct consequence, on a corporate finance level, it causes an increase in debt to capital ratio but also has an effect on capital budgeting decisions as described by Cwik (2008). Firms tend to not only increase the volume on investments but also replace investment in working capital with investment in fixed capital, widening the distance between real-time preference and the one imposed by the nominal interest rates. After the boom ends, these projects are abandoned as they are no longer able to generate positive cash flows. Some of the fixed capital used in undertaking can be moved to other projects, which was described by Wood (1984) as the illusion of depression: when companies decide to quit unprofitable undertakings, thus causing a decline in economic activity, but releasing the necessary resources for more effective projects. The resources which cannot be engaged in another project due to their specifics are considered sunk costs.Mises (1949) used the distinction for convertible and partially or nonconvertible capital: “It is expedient to substitute the notion of the convertibility of capital goods for the misleading distinction between fixed and free or circulating capital. The convertibility of capital goods is the opportunity offered to adjust their utilization to a change in the data of production.”
- INFLUENCE OF INTEREST RATE CHANGES ON THE NPV OF THE INVESTMENT PROJECT Net Present Value is an indicator used in order to compare projects realized in different periods of time and with different lengths. It uses the discounted cash flow generated by the activity. The present value of delayed payoff can be found by multiplying the payoff by a certain discount factor, which is less than 1. If the value of the discount factor was greater it would mean that the dollar tomorrow is worth more than a dollar today, which denies positive time preference. Net present value is defined as follows:
(1) [[{"fid":"93412","view_mode":"image_no_caption","fields":{"alt":"kruk01","class":"media-element file-default","data-delta":"1","format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"kruk01","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"1":{"alt":"kruk01","class":"media-element file-default","data-delta":"1","format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"kruk01","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"kruk01","class":"media-element file-image-no-caption","data-delta":"1"}}]]
where:
CFt = a cash flow to be received in a period of time t,
r = discount rate.
Ludwig von Mises and Irving Fisher suggest using the present value approach to economic calculation since the price of an investment project is moving towards the present value of the project’s expected cash flows.Both values are equal in equilibrium or in the Evenly Rotating Economy. Present value approach was also advocated by Rothbard (1962, 62–63):
It is clear that the higher the rate of discount, the lower the present value of the future good will be, and the greater the likelihood of abstaining from the investment. On the other hand, the lower the rate of discount, the higher the present value of future goods will be on the actor’s value scale, and the greater the likelihood of its being greater than the value of present goods forgone, and hence of his making the investment.
The consequences of interest rate changes and their effect on the valuation of projects were examined by Fuller (2013) and can be presented graphically:
Figure 1. Net Present Value Profile
[[{"fid":"93413","view_mode":"image_no_caption","fields":{"alt":"figure 1","class":"media-element file-default media-wysiwyg-align-center","data-delta":"2","format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"figure 1","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"2":{"alt":"figure 1","class":"media-element file-default media-wysiwyg-align-center","data-delta":"2","format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"figure 1","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"figure 1","class":"media-element file-image-no-caption media-wysiwyg-align-center","data-delta":"2"}}]]
Diagram from Fuller (2013).
There are three indications of the NPV profile shape: the NPV of the project increases as the interest rate falls, the chart is curved, so the NPV profile becomes flattened as the interest rate falls, meaning that the change in interest rates causes not proportional change in NPV and this dependence is explicit in long term investment projects in particular, since the longer stream of cash flows is discounted. Third, the NPV profile intersects the interest rate axis at the point where NPV is zero, indicating the positive NPV area on the right from the vertical axis (Fuller, 2013).
If the present value is used as an indicator of a project’s profitability, then the expected reinvestment rate should be used as a discount factor, since comparing two projects of a different outlays requires comparing in relative, rather than absolute terms. In that case, it is necessary to compare “present value per dollar of outlay” (Solomon, 1956). The valid comparison can be made not only with similar projects but also with two different courses of action, which can be brought to the same measure using NPV.
Wealth maximizing investors use NPV to rank their investment projects while competition in the market creates a tendency for the price of an investment project to equal the present value of expected cash flows. This is because investors will bid up the price when it is below the present value and bid it down when it is above, a simple arbitrage process. In the wooden and steel bridge example first described by Hansen (1953, 118) and later developed by Fuller (2013), there is presented the disproportionate effect of the change of the interest rate on the short-term and long-term projects. Since the lowering of interest rates favors longer projects, it is intuitive that these projects are usually associated with greater uncertainty, since they absorb resources for a longer period of time. The risk of the interest rate change may be one of the components that has an impact on how safe the particular investment is. For the purpose of expanding and quantifying this intuition, risk measures such as duration can be used.
- DURATION AS A RISK MEASURE One of the reasons for the 2007 crisis was aggressive profit targeting. As a result, agents tended to focus on the higher return from their investments, neglecting the difference in risk associated with their decisions. Since they were acting in the low rates environment, in the long term, more risky projects seemed more attractive as there was a possibility to achieve higher profits by engaging in these. That is the reason we cannot exclude risk from its role in the profitability of the investment projects, and this factor should be included in further analysis. It is not surprising that risk is positively correlated with higher potential profit. As a result of entrepreneurs being more likely to forecast consumers’ demand in the near future, they generate greater errors in forecasting longer periods. Therefore, on average, there is a higher probability of erroneously forecasting more distant cash flow than those forecasts of cash flows to be received in the relatively near future.
In the short run, if we examine the wealth generated by the project without adjusting the forecasted values for risk, the output of the economy appears better when it is associated with an incipient boom. Consequently, in the medium or long run, collapse starts when this risk taken by the entities materializes.Materialization of risk may be explained by an example: when a large number of companies engage in similar ventures, with a 70 percent probability of success each, it means that, on average, this will end up as a loss for about 30 percent of companies. In the beginning, the projects generate positive cash flows and investments pay off, but eventually at least part of the risky investments will not succeed and the bust phase of the business cycle begins. Generally, the lower the interest rate, the more profitable investments in more roundabout projects appear. At the same time, the risk grows. This implies shifting the economy to a more risky position with higher potential returns (Cowen, 1997).
To quantify this risk, the risk-adjusted NPV as a measure of profitability should be used. Since wealth maximizing investors are evaluating projects only using risk-free NPV they may underestimate the risk associated with their investment decisions. One of the risk measures for the purpose of adjusting NPV for risk can be the duration measure. It was discovered and developed by Frederic Macaulay (1938) for the purpose of measuring the average time an investor waits to retrieve his money from an investment. Hicks independently derived “average period,” an equivalent measure of elasticity, with respect to a discount ratio (Hicks 1939, 186). Although it has other applications, duration has been successfully used in problems regarding the reduction of basis risk, and even Macaulay himself was primarily focused on “the risk-proxying properties of his measure, despite the assigned name duration.” (Cox, Ingersoll, and Ross, 1979) Although it was originally designed for bonds, it was later developed to be used effectively in capital budgeting (Blocker and Stickney, 1979). The duration is represented as follows:
(2) [[{"fid":"93414","view_mode":"image_no_caption","fields":{"alt":"kruk02","class":"media-element file-default","data-delta":"3","format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"kruk02","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"3":{"alt":"kruk02","class":"media-element file-default","data-delta":"3","format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"kruk02","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"kruk02","class":"media-element file-image-no-caption","data-delta":"3"}}]]
where:
CFt = a cash flow to be received units of time from today, beginning with t=1 period from today,
r = an appropriate discount rate for determining the present value of the cash flow,
t = units of time.
The formula represents a weighted average of the stream payments, where the maturity of each payment is weighted by the proportion of the total value of an asset accounted for by the payment (Haugen 1990), so the duration, in a way, represents an average life of an asset.
For the purpose of capital budgeting, the duration can be measured as the duration of the net cash inflows and the duration of the net cash outflows (Durand 1974, 25). The properties of this measure, as Blocher and Stickney (1979) pointed out, are as follows:
The duration of a stream of cash flows is always less than the time of the last cash flow (unless the stream is single cash flow, in which case duration is equal to the number of periods which elapse until that last cash flow).The difference between a project’s life and its duration is relatively small for shorter-lived projects but increases as the life of the projects is increased.Duration varies inversely with the discount rate used. The higher the discount rate, the shorter will be the time until the average present value dollar is received.For a project with a zero or positive net present value at the certain discount rate used, duration increases at a decreasing rate as the foreseen life of the project is increased, but it is bounded.Duration is relatively insensitive to the discount rate used for shorter-lived projects but becomes more sensitive to the discount rate as life is increased. (pp. 3–4) When used in predicting bonds’ prices, duration assumes a linear relationship between price and changes in interest rates. In reality, however, prices rise more than proportionally as interest rates fall and decrease at an increasing rate as interest rates rise. As a result, the duration will underestimate the price increase, meaning that the risk can still be undervalued.
To illustrate the calculation of duration we will use the following example:
Table 1. Duration Calculation[[{"fid":"93415","view_mode":"image_no_caption","fields":{"alt":"table 1","class":"media-element file-default media-wysiwyg-align-center","data-delta":"4","format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"table 1","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"4":{"alt":"table 1","class":"media-element file-default media-wysiwyg-align-center","data-delta":"4","format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"table 1","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"table 1","class":"media-element file-image-no-caption media-wysiwyg-align-center","data-delta":"4"}}]]
For this project, the duration is 1.74 and this is the number we receive by dividing the sum of the column (5) by the sum of the column (4).
Duration is also used as a measure of expected changes in market prices of bonds after a change in interest rates. The relation between duration (D), price (P) and interest rate (r) is described by the equation:
(3) [[{"fid":"93416","view_mode":"image_no_caption","fields":{"alt":"kruk03","class":"media-element file-default","data-delta":"5","format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"kruk03","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"5":{"alt":"kruk03","class":"media-element file-default","data-delta":"5","format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"kruk03","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"kruk03","class":"media-element file-image-no-caption","data-delta":"5"}}]]
Meaning, ceteris paribus, the greater the duration, the more sensitive will be a bond’s price to changes in the interest rate. The elasticity aspect of duration ensures its usefulness in capital budgeting decisions for the purpose of a measurement of a loss in the net present value of a project suffered from a change in required rates of return. In two comparable projects the shorter the duration, the less net present value of the project is vulnerable for interest rate changes (Blocher and Stickney, 1979) and the safer the investment, since the investors are waiting for the return, on average, for a shorter period of time. There is, however, a side effect of this approach: when investors expect the interest rate to fall, the investment in projects with a longer duration will experience a larger increase in their value than others, meaning that investors may shift to those projects if NPV valuation is not supported by further risk analysis. It may be perceived as the proper investment decision as long as the low interest rate environment is controlling. The problem is that longer investment projects are considered more attractive. But it is probable that the interest rate will increase during the project’s life. That will change profitability drastically.
Since duration reflects the average length of time consumed waiting for receipt of the cash flow generated by the project, it also demonstrates the liquidity of the project. It competes in that area with a conventional payback method,Payback period is the amount of time it takes to recover the cost of an investment. but duration surpasses payback period in that function since only duration can be incorporated in the analysis of NPV, and not as a supporting indicator alone.
- DURATION EFFECTS ON NPV Since, as explained in the above analysis, investors after lowering interest rates are switching their preferences to more capital-intensive, longer-term investments, at the same time, on average, they turn to projects with a longer duration. This means that during the phase of the boom of the business cycle economy shifts to a more risky position. Since the agents are targeting profit, there is a little attention paid to the risk exposure, measured by duration, of their projects.
Taking into the examination the example presented by Fuller (2013) of the two alternative projects, the further analysis of two investment projects will be carried out: a wooden bridge requiring a lower financial expense of 2,000 units and providing a constant cash flow of 1,000 in the next 3 years, and a steel bridge requiring the expense of 5,000 units and providing 0 units cash flow for the next 2 years, and a constant 1,000 units for the following 8 years, which is presented in the following table:
Table 2. Cash Flows Schedule[[{"fid":"93417","view_mode":"image_no_caption","fields":{"alt":"table 2","class":"media-element file-default media-wysiwyg-align-center","data-delta":"6","format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"table 2","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"6":{"alt":"table 2","class":"media-element file-default media-wysiwyg-align-center","data-delta":"6","format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"table 2","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"table 2","class":"media-element file-image-no-caption media-wysiwyg-align-center","data-delta":"6"}}]]
The interest rate for which these projects generate the same net present value, meaning that they should be indifferent in the investors ranking, is approximately 5.48 percent. Discounted by this rate, the net present value of the projects is around 699.10 units. Calculating the duration for both provides more information about the expected returns. Since the duration for wooden bridge equals 1.96, and for the steel bridge it is 6.22, investors have to wait for returns from invested capital more than three times longer if they decide to invest in the steel bridge, which is associated with a higher risk for their income. But further assume that the investors demand a higher return and the interest rate increases from 5.48 percent to 7 percent. In this scenario, the net present value of the wooden bridge decreases only to 624.32 from 699.10, which is about an 11 percent decrease, while the steel bridge net present value decreases from 699.10 to just 215.56, which constitutes a 61 percent decrease, showing how sensitive projects with a large duration are to changes in interest rates.
This may explain why even a slight change in the interest rates may cause a dramatic change in the profitability of a project. Since in the present low rate environment, we expect that the average undertaken project has a longer duration, the expected vulnerability to the discount rate changes also increases.
Table 3. NPV and Duration Schedule[[{"fid":"93418","view_mode":"image_no_caption","fields":{"alt":"table 3","class":"media-element file-default media-wysiwyg-align-center","data-delta":"7","format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"table 3","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"7":{"alt":"table 3","class":"media-element file-default media-wysiwyg-align-center","data-delta":"7","format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"table 3","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"table 3","class":"media-element file-image-no-caption media-wysiwyg-align-center","data-delta":"7"}}]]
To fully understand the duration’s significance in NPV analysis we present selected values in the table. The first conclusion is that the greater the interest rate, the smaller the duration is. It is the result of the NPV profile. When we increase the discount factor used for future cash flows, the more advanced payments are getting a lower share in the total NPV sum compared to prior payments. As a result, using the duration interpretation, we do not wait as long for future cash generated by the project as we do when using the same payment with a lower interest rate, due to the fact that later payments are given less significance. It also must be noted that the duration changes associated with interest rate changes are not substantial and are even small for the shorter projects.
The second conclusion which we can derive from the values in the table is that the greater the duration, the greater NPV loss from the increase of the interest rate. It is worth noting that this is only true for nominal values.
Figure 2. Duration Profile[[{"fid":"93419","view_mode":"image_no_caption","fields":{"alt":"figure 2","class":"media-element file-default media-wysiwyg-align-center","data-delta":"8","format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"figure 2","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"8":{"alt":"figure 2","class":"media-element file-default media-wysiwyg-align-center","data-delta":"8","format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"figure 2","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"figure 2","class":"media-element file-image-no-caption media-wysiwyg-align-center","data-delta":"8"}}]]
In Figure 2, different duration values for different interest rates are presented. Although changes are not significant, it can be easily seen that the values for duration for the shorter project, the wooden bridge, are steady. Despite the fact that the NPV and the returns from investment are changing, the average waiting period for the investor to recover his money from the investment is not. In case of the longer, more deferred project, we see a steady drop in duration value as the interest rate increases. Although, as we mentioned, generally shorter projects are less risky, in this case the decline in duration is associated with decreasing share of later payments in overall value. That means that the greater weight is given to the less distant payments, which is decreasing the duration, but at the same time NPV values are decreasing on a larger scale.
If the interest rate is artificially reduced by a central bank, the duration gap between shorter-lived and longer projects increases. This causes a greater hazard for the second type of projects as their payment is not only subject to interest rate risk, which can be measured by duration, but is also subject to the uncertainty associated with changing economic conditions of business.
Longer-term projects are more information sensitive and are subject to profitability changes due to uncertainty. Even though this is unquantifiable, the entrepreneurs have to make a prediction about the forecasted cash flows generated by the company investment decisions. As described by Ludwig von Mises (1951, 27): “There is no certainty about the future state of the market and about the height of these earnings. They can only be determined by speculative anticipation on the part of the entrepreneur.”
The duration may prove useful to quantify at least some risks regarding the previously estimated profit not being realized. The duration may show that not every long term project is equally risky—e.g., risk may also depend on how flat the yield curve is for a particular project.The flat yield curve indicates that there is almost no difference between short-term and long-term rates for bonds and notes of similar quality.
- RISK-ADJUSTED THE NET PRESENT VALUE Since the net present value is sensitive to interest rate changes, especially long-term projects should not be discounted with a nominal interest rate. Expanding the analysis for the illiquidity risk-adjusted interest rate could further develop the analysis. For projects in which annual cash flows constitute an annuity, the algorithm for the duration is reduced to:
(4) [[{"fid":"93420","view_mode":"image_no_caption","fields":{"alt":"kruk04","class":"media-element file-default","data-delta":"9","format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"kruk04","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"9":{"alt":"kruk04","class":"media-element file-default","data-delta":"9","format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"kruk04","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"kruk04","class":"media-element file-image-no-caption","data-delta":"9"}}]]
Where r is the value which equates the present value of the inflows to the price of the investment. For project analysis it can be the yield rate, the cost of capital rate, a risk-adjusted rate, or any rate that an investor may use as a required rate of return (Brown and Kulkarni 1993).
To perform the NPV analysis, the company can estimate the discount rate for each project using the Capital Asset Pricing Model (CAPM) method.CAPM defines the relationship between systematic risk and expected return for assets. While it is not the method consistent with the Austrian theory, it is still one of the most popular tools used by large companies on the market, which is the reason we cannot neglect its importance. Graham and Harvey (2001) surveyed 392 CFOs about the cost of capital, capital budgeting, and capital structure. The results indicate that “the CAPM is by far the most popular method of estimating the cost of equity capital: 73.5% of respondents always or almost always use the CAPM. The second and third most popular methods are average stock returns and a multibeta CAPM, respectively” (Graham and Harvey 2001). CAPM is also popular among academics. Research conducted by Welch (2008) revealed that about 75 percent of finance professors still advocate using the CAPM to estimate the cost of capital. Furthermore, there is evidence that while the CAPM deliberately fails to predict asset prices, it is more useful for the purpose of estimating the cost of capital (Da, Guo, Jagannathan 2012). Even if we do not fully acknowledge the prediction made using the CAPM model including the duration in the equation may reduce the entrepreneurial mistakes caused by the non-risk-adjusted version of it, which is the reason the model is included in the paper.
The model determines the required rate of return for an investment as the sum of the risk-free rate (Rf) and a premium, which is the product of beta and the difference between the market rate of return (Rm) and the risk-free rate:
(5) [[{"fid":"93421","view_mode":"image_no_caption","fields":{"alt":"kruk05","class":"media-element file-default","data-delta":"10","format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"kruk05","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"10":{"alt":"kruk05","class":"media-element file-default","data-delta":"10","format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"kruk05","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"kruk05","class":"media-element file-image-no-caption","data-delta":"10"}}]]
In order to obtain beta coefficients for investments, the method requires regressing the returns of the projects against the market returns, if available. In the case of the wooden and steel bridges, the most reasonable assumption is the beta coefficient for both projects moving in exactly same direction and having the same impact of changes on required return as a market,Beta belonging to the interval (0,1) means that the investment is reacting slower than the market, and beta greater than 1 means that every time the market rate changes the required rate of return changes more than the market rate. meaning that beta equals 1 and using the market return of 5 percent (for which the steel bridge is a more attractive investment using net present value as an indicator). The risk-free rate is usually described as the government bonds’ rate since they are currently considered the safest investment. We further make a conservative assumption that the risk-free rate is at 2 percent, meaning that 3 percent is the risk premium.The greater the risk premium, the greater impact duration will have on the risk-adjusted net present value. Since private investments usually have a few times higher return than the risk free rate, the 3 percent risk premium is a safe assumption.
We will now try to adjust the net present value of the wooden and steel bridges from the example using the following equation presented by Brown and Kulkarni (1993):
(6) [[{"fid":"93422","view_mode":"image_no_caption","fields":{"alt":"kruk06","class":"media-element file-default","data-delta":"11","format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"kruk06","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"11":{"alt":"kruk06","class":"media-element file-default","data-delta":"11","format":"image_no_caption","alignment":"","field_file_image_alt_text[und][0][value]":"kruk06","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"kruk06","class":"media-element file-image-no-caption","data-delta":"11"}}]]
where:
i = the rate of return adjusted for duration and timing of the cash flows
r = the required rate of return on a project,
D(i,n)= duration of a project with periodic cash flow over n years discounted at the rate appropriate for the duration of that project
D(r,n)= the duration of a project with equal periodic returns over the project life of n years discounted at the r rate
The equation derives from the standard CAPM equation with inclusion of liquidity adjustment coefficient (Di,n/Dr,n). A justification for including this ratio in the equation is that the “the ratio of duration of any project of n years life to the duration of a uniform series project of the same life, when multiplied by the risk factor should produce a close approximation to what the rate should be to correct for duration” (Brown and Kulkarni 1993). Since Dr,n is the function of only the project’s life and rate and it assumes equal periodic returns over the life of the project, it can be calculated using equation (4) using r just as in the CAPM model.
The values of i and Di,n remain to be calculated. We know that for a project with a higher earlier duration, the risk is decreased, so adjusting for the duration of the projects also decreases the discount rate. This is analogous to the case of the projects with lower earlier cash flows. Therefore we know that if the duration of the project is less than Dr,n, then i will be less than r, and i will be greater than r if the duration of the project is greater than Dr,n, as in this case. We find values of i and Di,n in the following way: first, we assume i = r and compute Di,n using (2). Then we find the difference between the left and right sides of (6). Therefore, we know whether our i lies in the interval [0, r] or [r, ∞]. Finally, we may use any method for finding roots, such as the bisection method, to find the value of i that makes both sides of (6) equal, again using (2) for finding Di,n.
For a steel bridge the proper discount rate i equals 5.65 percent with duration Di,n 6.21. Since the wooden bridge generates stable cash flows every year Di,n=Dr,n for this project, this means that the discount rate for this project is the same as the initially used 5 percent.
Table 4. NPV and Risk-Adjusted NPV Comparison[[{"fid":"93423","view_mode":"image_no_caption","fields":{"alt":"table 4","class":"media-element file-default media-wysiwyg-align-center","data-delta":"12","format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"table 4","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""},"type":"media","field_deltas":{"12":{"alt":"table 4","class":"media-element file-default media-wysiwyg-align-center","data-delta":"12","format":"image_no_caption","alignment":"center","field_file_image_alt_text[und][0][value]":"table 4","field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":""}},"attributes":{"alt":"table 4","class":"media-element file-image-no-caption media-wysiwyg-align-center","data-delta":"12"}}]]
Even though the steel bridge seemed the more attractive investment at the 5 percent discount rate and was higher in the NPV ranking, after adjusting the discount rate for the risk, the new risk-adjusted NPV changed the valuation, and in the effect the safer investment: the wooden bridge project is preferred.
- CONCLUSION Since the net present value is a frequently used indicator of the profitability of projects, when we consider its disadvantages—volatility resulting from even subtle interest rate changes—enhancing this measure for quantification of this risk can provide further information for investors. Since the duration of a project captures the impact of both uncertainty of future income and sensitivity for interest range changes in low rate environments, it can be used as a measure for interest risk changes and as a factor in determining the risk-adjusted NPV value. As presented in this paper, adjusting for risk can produce a different order of profitability of projects, enriching the analysis and preventing more risk-averse investors from taking excessive risk, which inextricably linked with longer investment projects.
It is worth noting that using such models for the purpose of making future predictions may constitute a part of the entrepreneur’s verstehen. In order to forecast future conditions of economic activity, entrepreneurs must use qualitative forecasts that are supported by his judgment. This was also the view emphasized by Rothbard (1997): “Misesian Man knows a lot; but he does not know everything and he must try to estimate the future, given various quantitative and qualitative estimates of change.” Duration is definitely among important parameters which have to be taken under consideration by entrepreneurs.
Previous research on corporate finance was focused on the liquidation phase and depression (Cwik 2008) or the focus was placed on the roundaboutness of projects (Cachanosky, Lewin 2014). A deeper understanding of financial foundations of the business cycle can increase knowledge of the effects of an easy monetary policy along with a better understanding of causal relations between companies’ decisions and any emerging crisis. While there is a common agreement about the wrong valuation of risk by companies throughout the business cycle, there is little evidence about the foundations of this factor underestimation. One of the reasons may be using measures that are not risk-adjusted and which may create an illusion of profitability in a current low rate environment.
Key Takeaways and Actionable Insights What exactly do we mean by paradigm? In our project to make a useful link between Austrian economic theory and business practice, we earlier introduced the Austrian Business Model. This is a recipe to make a profit — a template adaptable to any individual firm.
A paradigm is precedent to a business model (see Mises.org/E4E_90_PDF). It’s the underlying way of thinking — a set of values, beliefs, concepts and practices that combine to constitute a distinctive entrepreneurial approach to business.
Per Bylund’s exposition of the principle of Facilitation of Value leads to a new — Austrian — paradigm for business. Here is the framework:
The Purpose of Business is to facilitate value for customers. In today’s interconnected, fast-changing world, businesses are formed and managed with the intention of ensuring value experiences for customers. This challenge is fraught with uncertainty, because value is an emergent — and therefore unpredictable — property of the interaction of people, artifacts and behaviors in complex systems.
Customers, whether consumers or businesses, operate in their own system. They must fit everything they consume into their existing system — their life or their business processes and organization.
Customers experience value in their own systemic context. If they own a car, for example, they experience ownership value within a system of taking kids to school, commuting to work, and shopping, as well as in an intersecting system of service, maintenance, fueling, accessorizing, and replacing worn parts.
Businesses interface with the customer’s systems from their own system of design, procurement, resource management, partnering, warehousing, distribution, payments, technological enablement, regulatory compliance, communications and many more elements. A business system facilitates value to realize the customer’s experience within their own system.
The value of any offering is positively perceived by customers when they fit into their system is felt to be a good one and the offering contributes to system improvement or enhancement in some dimension. Uncertainty is always present because the system improvement can not be predicted with certainty in advance.
Austrian economics provides the principles for entrepreneurs, managers, and strategists to establish a unique, sustainable, profitable, and scalable process to facilitate value for customers.
The end-user / consumer takes the primary role. A business can not be an assembly of resources or an expression of core competencies or the implementation of innovation in isolation. It can’t be the result of a strategy to penetrate a market or disrupt a competitive set without first understanding the hopes and dreams and aspirations of customers. It can’t be a simplistic choice from a set of business models on the business school shelf.
A business must stem from giving the customer the primary role. The very purpose of a business is to please customers by serving their needs, and so their perception and preferences must define the business design. Since the needs of customers are subjective, idiosyncratic, changeable, and context-dependent, methodological individualism — making the individual the unit of analysis, rather than groups or segments or markets or industries — is the indicated approach.
This approach is a lot different than ideas of shareholder value or stakeholder value. It is sometimes acknowledged in terms such as consumer-centricity or consumer-first. But those commitments tend to be tactical and implementational. Relentlessly and unfailingly taking the point of view of the customer is fundamental to the new business paradigm. It’s what make business purposeful and ethical, sustainable and responsible.
Value is determined by the end-user or consumer. What consumers seek from business is value. Value is hard to define and challenging to quantify because it is a subjective experience of the consumer, within that consumer’s own individual context. What’s perceived as valuable by one individual consumer will not be the same as another individual, and any individual can change their perceptions or their ranking of what’s more valuable at any time.
Value, therefore, can not be created by a firm or a brand, despite the traditional use of that language. Value is formed in the consumer domain, as an emergent property of the consumer’s choices, behaviors and context. Take a laptop PC for example. The value experience changes depending on whether the user is a gamer, an executive in the financial system, or a video editor. It varies based on the software the user installs, the usage advice he or she receives from peers and experts, the quality of the user’s network, their preferences for in-use performance, and many more variables. You can examine the same value experience thought experiment for any good or service of your choice, e.g. the value of an Audi A8 to a family of 6 living in rural South Dakota compared to a family of two in Manhattan with a one-bedroom apartment and a single parking space. Value emerges in lived experiences within these varied contexts.
For a business to business enterprise, it is sometimes expedient to limit the value analysis to the final purchaser / end user. There are sometimes some special value considerations in these contexts. For example, business customers tend to evaluate every economic choice in money terms - does it lower costs or contribute to higher revenues? But it is also the case that a business customer is often, in fact, multiple users (whether a procurement committee or a department all using the same item), and so a group rather than individual assessment of value is appropriate. Nevertheless, value remains a subjective, idiosyncratic, changeable phenomenon.
Empathy for customer dissatisfaction is the starting point for business development. Dissatisfaction with the status quo — Austrian economists sometimes call it unease — is the raw material for business development. The genius of consumers is to always sense that their experience could be better than it is.
Empathy is the diagnostic skill of observing and analyzing behavioral data and deducing emotional drivers for change and innovation. A customer searching online for more efficient home heating solutions may be dissatisfied with the ambient conditions in the home, or with the level of his or her gas bills. An individual interview can determine which of these — or other alternatives — applies and point the way to a desired solution. The entrepreneurial practice is to focus empathetic attention on the inner drivers which are manifested in observable behavior.
There is no shortage of customer dissatisfactions to be addressed by businesses. The skill of empathy is to advance beyond taking the point of view of the consumer and to feel the experience that the consumer feels, and to identify the feelings that really matter. This is counter-factual — it’s not actually possible to feel what another human being feels — and is therefore an act of imagination. Imagination provides the energy for consumers’ dissatisfaction (they imagine a better future) and for entrepreneurs’ creativity (they imagine what dissatisfaction feels like for the consumer, and they imagine solutions to that dissatisfaction).
Empathic design To advance from imagination to a business plan is an act of design. Design can be captured as a process in which an innovating business creates a blueprint for a good or service or technology or other artifact that presents a practical solution to a customer. There are many design process alternatives. The shared design principle is to start with an identifiable customer with a problem to be solved, and progress towards a solution with which the customer can interact and can evaluate. Early prototype solutions should be adequate to share a resonant imagination between entrepreneur and customer, and to stimulate realistic responses from customers regarding features and attributes they do or do not find valuable, and flexible enough to accommodate frequent iterative adjustments based on those responses.
Uncertainty exists as a barrier to be overcome in the delivery of new solutions to customer dissatisfaction. Adaptiveness is the entrepreneurial response to uncertainty.
Uncertainty is integral to the business paradigm. Uncertainty can be experienced as the impossibility of predicting the future because of the extreme complexity of the interactions of customers, entrepreneurial offerings and potential solutions, opportunity costs, transaction costs, environmental factors and other system elements. The response to uncertainty is adaptation: making a change in a business offering and monitoring the resulting change in customer acceptance, customer behavior, customer interactions or other consequential results. Favorable changes are preserved, unfavorable ones discarded.
Continuous dynamic change then becomes the norm for businesses in an adaptive system. There is no equilibrium, no stasis, no predictive planning, no stable combination of assets or resources. There are no system-imposed or structural boundaries to a firm’s activities, just the subjective entrepreneurial judgment about interaction with customers to facilitate customer value. In complexity theory terminology, customer value is the constraint to the system that can shape change and emergent outcomes (think of Steve Jobs constraining his designers to “no buttons” on Apple devices).
Businesses accumulate capital as a result of the flows of income from customers. The measure of business effectiveness is the flow of income from customers. Insofar as entrepreneurial actions set in motion a flow which is projectable into the future, a business is in a position to make capital investments both to expand its capacity to generate income flows and to create new innovations to stimulate new flows.
Current flows are subject to change at any time when customer preferences change, or their environment changes or there are shocks to the customer’s system. Entrepreneurs must develop accurate appraisals of which of their assets - in what specific combination - are most responsible for generating income flows, and establish them in such a way as to be flexible in rearranging them and recombining them in response to (or in anticipation of) market change.
Future flows from investments in innovation are uncertain and unpredictable. Entrepreneurial skill in identifying productive investments (foresight) differentiates more successful from less successful firms.
Additional Resource "The Austrian Business Paradigm" (PDF): Mises.org/E4E_90_PDF
What is technological deflation, and how can entrepreneurs take advantage of it? By combining already available and easily accessible technologies to facilitate the accelerated information flows that constitute value in the 21st Century: higher quality, faster speeds, lower costs. Jeff Booth explains.
FREE DOWNLOAD: "Value Then vs. Value Now" (PDF): Mises.org/E4E_89_PDF
Key Takeaways and Actionable Insights Technology reduces the labor factor, lowers costs, and frees up time. These are the components of deflation: less labor and effort for any unit of output, faster speed, lower material costs, and re-allocation of time from lower to higher productivity activities.
The speed at which this technological change is happening is “staggering” in Jeff Booth’s words, and will accelerate. More and more time will be freed up to allocate to higher uses.
The result is deflation: higher quality for lower cost at faster speeds.
The only reason price deflation is not pervasive throughout the economy is the status quo governmental system. Federal Reserve money printing, more and more debt, lower interest rates — these are actions designed to drive price inflation. This scheme defies the natural order of technological deflation. It is the great fight of our time, says Booth, to end the inflationary scheme.
But for entrepreneurs, the right action is to embrace and harness tech deflation.
There is tremendous leverage for entrepreneurs in the current economy of technological change. Jeff uses his “folding analogy”. If you could fold a piece of paper 50 times, it would reach the sun. Technological change is at the early folding stage today, but each new fold doubles the growth rate and the impact.
The way for entrepreneurs to put this folding analogy to work for them is by combining technologies. Several folds at once.
One of Jeff’s examples is Elon Musk. In Jeff Booth’s words, Musk forecast three exponentials: the exponential improvement in battery technology, the exponential increase in the role of software in automotive engineering, bringing information flow into the vehicle, and the exponential improvement in A.I. to bring self-driving features to automobiles. Taken together, these three widely available technologies made Tesla a revolutionary venture, surpassing GM in market capitalization.
The same “crazy opportunities” are available to all entrepreneurs. We don’t all have to be Elon Musk. The possibility to increase customer value and reduce costs at the same time are available to all entrepreneurs. One of the keys to success is to direct technology towards increasing data capture: more and more data signals to drive deep learning via algorithms, leading to better and better and faster and faster decision-making. Data collection platforms managed with A.I. algorithms can generate the exponential growth that Jeff refers to. Google and Amazon are the examples everyone talks about; but here on E4E, in episode #84 (Mises.org/E4E_84), Bob Luddy talked about sensor-based data collection in his CaptiveAire restaurant ventilation systems, feeding performance data back to the central platform for increased learning and improvement. The opportunity is available to all types of business.
Value looks different today than in the past, and it will look different again in the future. “What will value look like in the future?” is one of the questions Jeff Booth urges all entrepreneurs to ask for themselves and their business.
He cited one example from history: the Blockbuster video rental business. To Blockbuster’s owners and managers, value looked like the convenience for consumers of movie entertainment of 9000 stores across the country, each with a huge selection of videotapes to choose from. Their idea of adding value was to provide popcorn and candy in the checkout aisles. But when Netflix came along, value starts to look different. It’s the convenience of streaming movies directly to your digital TV or tablet in your home or on the go, with constant additions to the offering, both of original content and content from other channels. The 9000 Blockbuster stores no longer look so convenient. Information flow and digitization make value look different.
Another example Jeff cited is the university education business. Traditionally, its value is based on real estate — an exclusive set of physical buildings in one specific place to which students must travel (or rent a dorm room) in order to access an exclusive faculty of high-reputation teachers. Now, with technology and information flow, the core knowledge is accessible anywhere/anytime, and is tending towards free. Offline educational ventures can hire teachers to make video classes available to the world, and virtual reality will make the experience even more vivid and more enjoyable. The knowledge is the same. Students’ questions are probably the same. The cost structure is totally different.
Three principles for entrepreneurs to facilitate new value in the future. Given these examples, and given the trends of accelerating digitization, data flow, multiplicative combinations, and algorithmic analysis and intelligence, what are the principles for business to follow to be able to facilitate new value for customers?
1) Aim for 10X improvement in the customer experience. The rate of acceleration is so fast, and the exponential potential of new combinations of technology is so great, that innovators must aim for a 10X improvement in customer-perceived benefit to command attention, turn heads and dislodge customers from their current choices (Curt Carlson made the same point in episode #37: Mises.org/E4E_37).
2) Make your thinking boundary-less. One of the great restrictions on entrepreneurial creativity is the institutionally and historically imposed tradition of thinking in silos, and thinking that industries have boundaries. Universities have their faculty departments and corporations have their divisions, and they tend to put silos around thinking. But the Elon Musk example of batteries + software + A.I. crosses industry boundaries, technology boundaries, performance boundaries, and financial boundaries. Boundary-less thinking can open up endless new possibilities. Entrepreneurial economics teaches the re-combination of assets, not necessarily the creation of new ones. Busting silos can lead to new combinations.
3) Forecast the exponential. Where in your frame will exponential change occur? Use your imagination to try to forecast it. The future can’t be predicted but it can be imagined. The challenge is to imagine the next fold of the paper and the next one and the next one; and the next combination of two or three or four or more new technologies. The idea of the exponential can be applied everywhere.
Additional Resources "Value Then vs. Value Now" (PDF): Mises.org/E4E_89_PDF
Purchase Jeff Booth’s book, The Price of Tomorrow: Why Deflation is the Key to an Abundant Future: Mises.org/E4E_89_Book
In many situations, the complexities in managing a diverse and layered team of people are to view individuals as ends and not means. Management and organizational frameworks often treat people as means. The business ends are external: so-called shareholder value, or stakeholder value, which is fashionable today, or simply revenue and unit sales goals, or metrics and KPIs.
Managers are taught to look at people through an economic lens as resources ― human resources ― in the same way as material resources and financial resources, to be utilized as efficiently as possible.
But people are not means. They are subjects, and they have subjective ends of their own. They’re searching for identity, meaning, and trying to meet their own potential. If managers recognize this, their approach to people as team members and employees will be much different.
Individuals need to be able to tell their own story in their own space. We work for money but we live for the story. The most important story is the one we tell about ourselves and our values. People need opportunities to tell their story. Everyone at every level in an organization and in every type of role or job needs this opportunity.
To do so, they need their own space in which to create and embellish their story, a space that is unique to them and gives them a fine-grained perspective of which they are masters, and for which others will prize them.
David Hurst gave the example of Costco, where the in-store personnel have space to use their own discretion to serve customers. If a customer (a guest, in Costco parlance) requires assistance in locating an item, a Costco associate will stop whatever they are doing and escort the guest all the way to the shelf location. They have their own space and their own discretion to design and deliver a unique level of service, and a story they can tell about their customer commitment. This becomes a culture that pervades the entire company.
FedEx has similar spaces, and similar stories about individual employees going to extraordinary lengths to make sure packages are delivered on time.
One way to create these spaces is to give everyone intelligence-gathering roles. David Hurst tells the story of delivery truck drivers in the steel fabrication business. He treated them with deference for their ability to gather real-time intelligence: which competitors had trucks in the customer’s yard; what concerns were customer employees talking about; which customers were friendly and which ones adversarial? These frontline employees are able to gather and feedback market intelligence that was faster, deeper, more local, and more detailed than traditional reports. It’s small data, often much more valuable than big data. And the employees can tell their stories about their intelligence gathering and their important role in company processes, from their unique space.
The word in management usage now is fine-grained. The front line has a fine-grained perspective and fine-grained intelligence. This fine grain is highly valuable, especially when shared in collaborative teams and structures where everyone knows their role, which is not tied to hierarchy.
Hierarchy and structure create a cascade of negative effects for the people in them. As companies grow and become larger, they require internal specializations and experts in narrow, technical fields. Specialization brings hierarchy, where general managers can supervise those in specialized roles. Hierarchy leads to careerism and status when employees are not collaborating with each other, but competing. The result is what David calls a power trap. The firm becomes trapped on the right-hand side of his "Management in a Field of Tensions: model.
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The tension for management lies in a continuous pull of the “hard, scientific” side of the model, away from the humanistic side. Austrians lean towards the left-hand side of David’s model: humanistic, treating people as ends, respecting narrative more than data. For example, the exercise of judgment under uncertainty, so central to the Austrian paradigm of the entrepreneurially-driven economic system, lies on the left-hand side of the model. It’s practical, grounded wisdom, when entrepreneurs make decisions when they don’t have all the data. (And the Hayekian insight is that no-one ever has all the data.) They glean what they can from the individual observations of people involved in the situation at hand (small data), and then decide, knowing that the consequences are uncertain, and that they will need to be adaptive to change in the future.
The right-hand side of the model represents the pull of so-called science: hard data, mathematical calculation, plans, and administrative bureaucracy.
Smaller, private, more entrepreneurial companies can often avoid the right-hand side of the model. Smaller and privately held companies have many advantages. They tend to be more frugal in good times and bad, and act carefully with cash, thus retaining flexibility in difficult markets. They have a high bar for capital expenditures and make fewer malinvestment decisions. They often try to avoid carrying too much debt, so that bankers don’t have power over them. And, importantly, they are often better at retaining talent and keeping experience inside the firm. They can avoid the careerism of competing for status in the hierarchy, and just let people become better and better at their jobs. On the left-hand side of the model, as David describes, it’s all about people.
Additional Resources "Lead Like a Gardener! ― Agile and Design Thinking Will Become Management Fads Unless We Expand Our Concept of Management": Mises.org/E4E_88_Article
The New Ecology of Leadership: Business Mastery in a Chaotic World by David Hurst: Mises.org/E4E_88_Book.
Key Takeaways and Actionable Insights An understanding of the Austrian definition of capital is tremendously useful to all business owners and managers. What is capital? Austrian economics has a precise and distinctive definition — unlike business schools and most business publications, books, and columnists. Among those entities, the term capital tends to be used very imprecisely. You might see sentences like, “Entrepreneurs must ensure they have sufficient capital to get their new product to market”, or “to get to break-even”. Such usages imply that capital is a cash reserve to be “burned off” in the process of launching and scaling a business.
Recently, it has become fashionable to coin terms such as human capital, or brand capital, or relationship capital, or even spiritual capital or street capital. All of these terms are sloppy definitions of capital from an Austrian point of view.
And it’s important to note that capital is not the same as capital goods, which are “produced means of production”. Capital is not a means of production, it is a consequence of production.
What, then, is the precise Austrian definition of capital? On the E4E podcast #87, Professor Matthew McCaffrey gives us this definition:
Capital is the monetary value of a business’s claims to income. This includes all of its marketable assets, whether they are tangible or intangible. It’s a sum of individual values. These values are ultimately determined by consumers, because the value of a firm’s assets and the value of its income streams ultimately depend on how consumers value the final product. Crucially, capital is distinct from what are called capital goods or production goods, which are the physical goods used in production. Those are also vital for understanding how entrepreneurship works in practice, but they are not capital in the sense in which we mean it.
In summary:
Capital is a flow (rather than a stock)Coming into your businessFrom consumersReflecting the value consumers perceive in your company’s services. B2B businesses can substitute the term “final purchasers” for consumers if producing goods and services purely for business customers. But it is important to remember that the value of capital always eventually reflects the valuations of goods and services by consumers. The software or professional services your B2B business provides to a business customer will command less of a claim to income if that business customer faces a change in preferences and a decline in market demand from their consumer population. When forecasting future income flows, every business must bear in mind the climate among ultimate consumers.
What are the implications for entrepreneurs and business managers? Flows can be generated via tangible or intangible assets.Consumers’ valuation of services is the key variable.Entrepreneurs must be able to appraise which assets — in which combinations — are generating the flow.The flow can change — even disappear — when consumer preferences change: entrepreneurs must be able to adjust.Large flows can result from a low asset base — and vice versa.Appraisal — predicting future prices and flows — is the vital skill to determine what to invest in, how to organize, and what to produce.Cash flow is the measurement variable.Use cash flow to calculate asset productivity.Update appraisals continuously based on cash flow. What about capital goods? Capital is NOT the same as capital goods.But capital goods can be generators of capital flows.IF consumers value their output.Austrians stress HETEROGENEOUS capital goods, both tangible and intangible.A jigsaw puzzle to assemble, disassemble, and reassemble in the right combination, based on consumers’ valuations. What actions should entrepreneurs take as a consequence of the Austrian view of capital? Always focus on the value you are facilitating from consumers.They, in turn, will generate your capital flow.Measure the flow in dollars — especially the trend.Be a master appraiser: know your asset productivity.Set up your assets for flexibility — be fully able to disassemble and reassemble capital combinations.Experiment frequently with different combinations.Become comfortable with continuous change in asset combinations. Additional Resources Professor McCaffrey made reference to Frank Fetter’s role in defining capital in his online discussion, "Frank Fetter and the Austrian Tradition in the United States": Mises.org/E4E_87_McCaffrey
Professor Peter Klein explains why metaphors like Human Capital are unhelpful to entrepreneurs in his article, "A Note on Human Capital": Mises.org/E4E_87_Klein
Key Takeaways and Actionable Insights Entrepreneurship is a way of life that can be learned around the dinner table. Allan’s parents were entrepreneurs, although it would never have occurred to him to call them that. They were in the service business, including restaurants and car washes. As a kid, Allan would help around the car wash, everything from washing down cars to emptying the trash to accounting. He internalized the idea that entrepreneurship was always doing two jobs, such as running one car wash while getting another ready for opening. The “two jobs” metaphor stayed with him.
Around the dinner table, the family would talk about how the businesses were going. It wasn’t so much a lesson in entrepreneurship as immersion in a lifestyle.
Entrepreneurship can be the source of a sense of control over one’s destiny. Following this childhood immersion, Allan quickly realized his felt need to control his own destiny. Being an employee would not achieve that goal. He did not want to await permission to try new pathways. He studied design in college and took on clients for design work, and quickly found out that he had a taste for business. He found out that print design work was not profitable and in declining demand as design shifted to the web. From web design, he migrated to internet software design and production. He calls this pathway “slowly adapting to what I find interesting”, which has been his story for 20 years.
Allan applied his “two jobs” mentality to launching a SaaS accounting software business. Allan developed a software design and consulting firm, which generated cash flow. He and his business partner poured the cash into developing a superior SaaS accounting software. They worked on it on nights and weekends — doing two jobs. He describes juggling the clients and leads and sales and payroll of the consulting company with the development of a new business with different customers, leads, sales and payroll. The “two jobs” mindset is typical for entrepreneurs as they grow and ideate and innovate.
Agility is a more effective and productive pathway than planning. Allan tells us that he never had an official roadmap or business plan for the SaaS software company, with known milestones a year or two years or more in the future. Entrepreneurial management lies more in knowing how to be nimble, how to move fast, how to make decisions quickly. The hardest part is knowing what features to work on, when to work on them and how long to work on them.
Orchestration is the entrepreneur’s organizational skill. To be an entrepreneur, and to build a business around you, it is necessary to attract talent, motivate talent and keep talent. It’s like being a conductor in an orchestra. You may not be the best violin player, but you know what another great violin player sounds like. You know how to assemble a team of players and blend them in a harmonious way.
And the attitude of the employees is as important, if not more important than the talent. Churn in employees is typically a business killer. It’s important to be able to recognize both talent and the right attitude. Allan ascribes success to transparent and continuous communication about the company’s mission and values — these will attract the right talented people.
The journey is strewn with mistakes all the way to its successful conclusion. Allan built and steadily grew his SaaS software company over a ten year period and then sold it. His analogy is that of the duck that looks like it is gliding smoothly over the water, while kicking like crazy underneath the surface. Self-doubt along the way is normal. Errors and mistakes that require correction are normal. For entrepreneurs, it’s important to become comfortable with being uncomfortable.
Entrepreneurs are in the human reaction business. The measurement of success is making people smile. All businesses are human reaction businesses. The goal is to make an emotional bond with the customer: they enjoy the experience you make possible for them, whether it is managing their own accounting using your software over a long period of time, or whether it is finding out about one new feature that they discover and find works well for them. Entrepreneurs strive for those moments of understanding. Making people smile is the metaphor — but in software, it’s hard to see them smile, so it’s necessary to find the right KPI’s that will be a proxy for smiling. Empathy is the skill of being able to feel when invisible customers are smiling.
Allan advanced into real estate and other ventures — but sees it all as storytelling. After selling his SaaS business, Allan continued in software design and consulting for clients. He also involved himself in real estate, including a brewery in his home town. The brewery is a platform for telling the stories that make up the history of the town. And it is storytelling that Allan makes the overall metaphor of the entrepreneurial life. You are writing the story that your grandkids will tell about you in the future. What is the story you want to write? What is the story you want to tell about your business to attract and engage customers? The great brands and great businesses tell great stories. Entrepreneurship is a story told about life.
Additional Resources "Allan Branch's Entrepreneurial Journey" (PDF): Mises.org/E4E_86_PDF1
Hunter Hastings mentioned effectuation theory in his prologue to the conversation with Allan Branch. For those interested to learn more, refer to the useful definitional academic paper by Saras D. Sarasvathy, "Causation and Effectuation: Toward a Theoretical Shift from Economic Inevitability to Entrepreneurial Contingency" (PDF): Mises.org/E4E_86_PDF2
Key Takeaways and Actionable Insights Why do business schools exist? Dr. Bylund wonders if business schools are facing an existential problem. Originally, their purpose was to train young people for a trade career. They transitioned into the field of management, preparing young people for the practice of management in large corporations. But the transition also turned the schools into creatures of academia, where research and theory are the dominant currency for professorial careers. Research and theory are not well-matched to the teaching of practice skills. So the professors borrowed from the rest of the university, especially the departments of economics, psychology and sociology, in order to concoct a management discipline. The result has been a disconnect with the realities of business.
Business school models and strategies reflect their academic, non-business sources. One of the consequences of the derivative nature of the management discipline in business schools is the unrealistic nature of their models and strategies. Models tend to be static, calling for a “positioning” of firms or brands in a market or industry framework that is given or pre-existing. Dr. Bylund sees this as an extension of the equilibrium principles of classical economics, where the ideal is an absence of change. Business school models tend to require an assumption that industries and markets and competitive conditions are static, enabling the focus to fall on the variables of a firm or brand or offering, and how it penetrates or invades or “disrupts” the status quo.
Business schools miss the continuous dynamics of the Austrian view of business, markets, and economic processes. The Austrian view of the market as a process unpacks a view of entrepreneurship and business management that sheds all vestiges of statics. Austrians understand that consumer preferences are continuously changing and that a firm’s offerings need to be continuously adjusted to reflect those changing consumer preferences. Austrian entrepreneurs know that the features and attributes of their products and services need similar continuous adjustment; the same goes for prices and promotional offers and advertising messages. Competing firms are doing the same, resulting in a complex adaptive system of multidirectional adjustment. Continuous change in response to marketplace changes is the norm. There is no place for fixed assumptions or static thinking or unbreachable boundaries.
The Austrian Business Model focuses entrepreneurs on value agility. Entrepreneurship is the process of discovering how best to contribute to the ongoing market process, and how to facilitate a value experience for customers at every point in time. This focus on value automatically accommodates the changes in customer preferences and competitive offerings. Value in the perception of the customer is always relative to alternatives – either alternative offerings or alternative uses of their money for entirely different purposes (including buying nothing and saving instead). These relative comparisons, and the context in which they are made, are always changing. This is a totally different perspective for entrepreneurs than the “positioning” of business school models.
The Austrian perspective makes many of the standard business school concepts inapplicable. Dr. Bylund’s overall commentary on business school content (their models and their strategy frameworks, for instance) concerns their applicability in real business situations. For example, their concepts of competition generally are framed against competing firms with substitute offerings in a given industry. But entrepreneurs know they are competing for the customer’s use of their dollars in the most favorable subjective value exchange, not against other firms.
Business schools urge business efficiency through cost reduction, but the real business objective is the customer’s value experience. They teach positioning in and penetration of markets, but there is no market without entrepreneurship; entrepreneurs create markets. They teach disruption and substitution, but entrepreneurs facilitate new ways of doing things for customers, which is neither disruption nor substitution — it’s creative advancement. They teach students to prepare comprehensive business plans, which can be useful exercises in thorough preparation, but they don’t substitute for interaction in the marketplace; customers don’t care to see your business plan. And their ideas of incubation are often to protect ideas from real market exposure.
Business schools can sometimes confuse the “who” of entrepreneurship with the “what”. Austrian economics studies and analyses the “what” of entrepreneurship: the action of serving customers in a changing market in conditions of uncertainty. Evaluations of success come after the action is taken; it can’t be predicted, and no entrepreneur is more successful than any other in the planning stages of taking products and services to market. Only the customer decides.
When business schools elevate characters like Elon Musk or Jeff Bezos to iconic status and analyze their character and individual style, they are confusing the “who” of entrepreneurship with the “what”. Musk and Bezos are heroes because customers bought their offerings. Evaluating how and why the customer discovered and experienced value is more important than studying how Musk and Bezos behave.
Additional Resources "Austrian School vs. Business School" (PDF): Mises.org/E4E_85_PDF
The Seen, The Unseen, and The Unrealized by Per Bylund: Mises.org/E4E_85_Book1
The Problem of Production: A New Theory of The Firm by Per Bylund: Mises.org/E4E_85_Book2
Dr. Bylund’s essay, "The Realm Of Entrepreneurship in The Market in The Next Generation Of Austrian Economics": Mises.org/E4E_85_Essay
"The Austrian Business Model" (video): Mises.org/E4E_ABM2
Key Takeaways and Indicated Actions Bob Luddy is founder and CEO of CaptiveAire (CaptiveAire.com), the US market leader in commercial kitchen ventilation systems. It’s a $500MM+ business with 1,000+ employees and a 40+-year success record. Bob explains to Economics tor Entrepreneurs how these principles of Austrian economics, applied as active processes, played a part.
Say’s Law Say’s Law is a fundamental proposition in support of a production-driven market system as opposed to a consumption-driven view. It’s quite difficult to interpret and pithy summaries like “production creates its own demand” and “production precedes demand” don’t help entrepreneurs very much.
Bob Luddy doesn’t interpret, he applies. His application formula is this: new supply that is brought to market can solve problems that have not so far been solved. In that case, demand will result.
He gave this example: in the 1980s, many of the harmful effluents from cooking in a restaurant were escaping into the kitchen and sometimes even into the dining room. Those effluents could contain carcinogens, and at the very least, they're very unpleasant. That was a problem – but it was the status quo.
So Bob thought, in Say’s Law mode: if CaptiveAire could solve that problem, and bring the solution to market at an acceptable price, demand (i.e., lots of customers) would follow. That turned out to be exactly right.
Implied in this formula, of course, is attention to market signals regarding unsolved problems, a problem-solution design process, and a communications and customer interaction capability to inform the market of the new solution. Say’s Law applies, but not in isolation from other entrepreneurial actions. Those actions, Bob tells us, include accuracy and completeness in solving the problem, since many competitors may be trying to address it at the same time. Small details can make a big difference in applying Say’s Law.
Subjective Value Many podcast listeners have asked whether the concept of subjective value — which holds that it is the subjective and emotional evaluation by customers of an entrepreneurial offering that determines its market acceptance – applies equally in B2B markets as in B2C markets. Isn’t subjective value more relevant to consumers’ choices of fashion and food than it is to business customers’ choice of service es from vendors and suppliers?
Bob’s response: The subjectivity of value is very, very clear, and it's reinforced in the market every single day.
He used the example of bringing an integrated ventilation system to a restaurant. CaptiveAire might be successful in explaining all of the problems it's going to solve, its sustainability, and all relevant features and functions. Completion of a sale still comes down to the user subjectively assessing the exchange value, by asking “Am I willing to pay X amount of money to solve these problems?” The customer very well could say, "No, I'd rather live with some of the problems and depart with that much money.”
Bob emphasized the importance of communications in addressing the challenges raised in calibrating subjective value appraisal. A strategy of “solving all the problems” requires clear communications to the customer of how CaptiveAire solves the problems, so that the user can make a fully-informed decision. “If we don't communicate well, the value of the product in the user's mind may be lower. So part of the issue of getting a higher subjectivity of value is to have a full understanding of what the product does.” Clear communication is a component of value.
Comparative Advantage There’s a big difference between competitive advantage and comparative advantage. Bob explains it this way: competitive advantage lies in striving to provide the same service and same solution in a better way than a competitor. Such an advantage may be achievable from time to time, but it is temporary and quite easily taken away by a hard working competitor. The market signals are clear and unobscured, telling the competitor where they must improve and the incentives to do so are compelling. No competitive advantage is sustainable over the long term.
Comparative advantage is different. It’s an unmatched capability, often built over time by accumulating unique knowledge and experience and applying them in a unique capital structure. Such an advantage is longer term, maybe not absolutely invincible, but very hard to overcome.
Bob cited an example outside of his field: winemaking in Napa Valley, California. “If you decided you wanted to make wine and compete with Napa Valley, it's going to be a hard way to go.”
In the case of CapitveAire, “over time, we've been able to develop those design technologies, techniques, automated equipment and software, and when you marry all those things together and you integrate them, we gain a major comparative advantage. It's very hard to overcome because it's not one thing. It's many things, and they're all well thought out and have been developed over a number of years.”
Bob refers to on important element of CaptiveAire’s comparative advantage as “technique”. An example is “bending metal in real time and dynamically stacking it right up on the assembly line”, resulting in elimination of inventory, and very rapid turnaround time. It’s CaptiveAire’s unique methodology, developed over many years. Competitors can attempt to emulate but they fail. It’s a comparative advantage.
Opportunity Cost The cost of any choice or decision includes its opportunity cost: what option must be declined or given up in order to make the choice you prefer.
Bob explains: Understanding opportunity costs means turning down opportunities that would divert resources, and, instead, focus on getting the best utilization out of your human resources possible, and making the most sustainable solutions, which are going to save time and money over a period of time. We make 10 major categories of products. No more. To keep those products at the right price, at a high level of performance and sustainability requires all of our time. So if we divert any of that time, opportunity costs might result in us failing at our most primary mission.
He gave the example of a line of business that required extensive customization. The benefit of customization is that each customer feels that they enjoy unique value. The opportunity cost is that it’s impossible to be all things to all people — it absorbs too much time and too many resources. CaptiveAire addressed the opportunity cost problem by replacing customization with software-enabled adjustability of certain key inputs like voltage and phase. They found that this solution could effectively address 95% of customer-requested flexibility. While competitors asked, “Just tell us what you want, we’ll figure it out” and spent resources on responding, CaptiveAire was able to stay focused on its core mission and core products and services.
Every opportunity that comes a firm’s way must be examined through the lens of opportunity cost. Austrians see opportunity cost as an active process — the same way they see value and resource allocation and pricing and many other elements of business.
Pricing Pricing is a discovery process. At the same time, it’s an element of business strategy. Bob made a strategic decision at the outset to price “lower than the market,” while aiming for highest quality. The market informs CaptiveAire of what the pricing norm is, and therefore what “lower than the market” is. The discovery part is: how low to go to maximize unit sales and revenues. The second part of Austrian pricing theory is that producers choose their own costs. Bob chose to seek ways to keep costs low enough to sustain his pricing and quality strategy, which led him to the efficiencies, automation, speed, inventory-reduction, high technology, and opportunity-cost sensitivity that characterize CaptiveAire.
Price, cost, and profit are integrated in a strategic formula that’s tested every day by the customer’s willingness to pay the price of high quality.
Additional Resources "Bob Luddy’s Effectuation Process" (PDF): Mises.org/E4E_84_PDF1
"Five Active And Integrated Processes Of Austrian Economics" (PDF): Mises.org/E4E_84_PDF2
Entrepreneurial Life: The Path From Startup to Market Leader by Bob Luddy: Mises.org/E4E_84_Book
Key Takeaways The entrepreneurial instinct can be sparked in K-12 and around the family dinner table. An entrepreneurial culture is highly beneficial to society at the global, national, and local levels. We should examine how well we nurture the entrepreneurial instinct in K-12 schooling and in the discussions we have with our kids at home.
Clay Miller got a Commodore 64 (you can look it up!) when he was 11 years old, and his interest in computing, software and writing code started there. He was a programmer at 11 years old (something that is more common today than it was when Clay was young) and developed a taste for programming and an aptitude and some skills. He learned how to jump over hurdles of software-writing complexity at a young age.
A mentor can reinforce a young person’s disposition towards entrepreneurship, and accelerate their progress.
A local tech entrepreneur took Clay under his wing and hired him for programming projects. Clay built accounting software and other products in this arrangement as a high school student. Observing and participating in this entrepreneurial environment at an early stage in life gave Clay the idea of entrepreneurship as a future pursuit. He started to take on consulting assignments while at college, although he wouldn’t yet identify tech entrepreneurship as a “career”. He was able to begin to make the transition from pure programmer to customer service entrepreneur. Starting early can influence a lifelong entrepreneurial journey.
There are many ways to accumulate knowledge, and entrepreneurship is a fast track to applicable knowledge. Clay chose serving customers as a pathway as opposed to continued learning in school and a conventional corporate career path. Both paths are ways to acquire knowledge. Identifying the process you prefer for knowledge acquisition — school or entrepreneurship — is a valid choice. Entrepreneurship may be the quicker and more direct route. And entrepreneurial knowledge is often more applicable, and more rapidly applicable, for your own individual economic ends.
An entrepreneurial leap forward resulted from identifying and supporting a new emergent industry. Clay took a job as a CTO in an emerging industry: organ and tissue transplants. This enabled him to experience economic growth at a higher level through the application of technology in a high-demand environment. He learned about fundraising and financing and shaping resource allocation based on the funding available. He learned about mass customization for a diverse customer base. He learned the role of the technical advisor vis-à-vis the CEO, enabling the executive suite to achieve its vision. Finding a growth industry can accelerate your individual development.
Transition from tech expert to global customer service entrepreneur. Clay was initially a user of offshore outsourced technological services. He mastered the economics and logistics of this organizational arrangement. Quickly, he founded his own Asia-based outsourcing corporation, and added a significant innovation: the embedded outsourced CTO. Often, firms use outsourced technology services for the flexibility of dialing up and dialing down service intensity on demand. There is a downside to this flexibility, which is loss of continuity and accumulated knowledge, as contractors move on to other jobs. Clay performs the role of CTO for his clients, ensuring them continuity of strategy, and keeps his outsourced tech talent available in his own ecosystem, so that accumulated client knowledge is not lost and can be reapplied later in the cycle.
Perception-Decision-Action Clay’s journey can be seen as an illustration of what psychologists call the PDA cycle — Perception, Decision, Action (see Mises.org/E4E_83_PDF1). Entrepreneurs perceive the world around them in a subjective manner, conditioned by their individual circumstances. In Clay’s case, those circumstances included exposure to technology, and some experimentation with it, at an early time in his life. Later, he made some decisions on best choices — for example, between school and entrepreneurship — based on his perceptions. He acted, became a tech entrepreneur, and then a customer service innovator. Every action changes the world, and so changes the entrepreneur’s (and the client’s) perceptions, leading to new decisions and new actions. Entrepreneurial success emerges from the process.
Additional Resources "The Entrepreneur's PDA Cycle" (PDF): Mises.org/E4E_83_PDF1
You might also enjoy reading this paper from our colleagues Nicolai Foss and Peter Klein on the language of opportunity ("Entrepreneurial Opportunities: Who Needs Them?"): Mises.org/E4E_83_PDF2. They say that opportunities do not exist in any objective fashion. They are not “out there” to be “seized”. Entrepreneurs create their own outcomes. Foss and Klein call their process B-A-R: Belief, Action, Results. See if you think B-A-R differs from P-D-A.
At E4E, we believe that Austrian economics can guide business execs and entrepreneurs to better thinking about how to manage businesses that thrive. Business educator David K. Hurst blames neoclassical, Chicago school economics for the bad thinking that pervades business today. Here’s how he phrased it in our @e4epod Episode #82:
I emerged from Chicago believing, or at least accepting, the basic assumptions which lay behind business education at that time, which was heavily influenced by what I came to understand was neoclassical economics. That is, it believed in greed as the primary motivation. It was all about individual self-interest and utility maximization, I think, was the word. It was heavily rationalistic in that it believes that we ought to behave like little mini scientists with everything based on evidence and data and then lastly, the focus was very much on equilibrium, that markets were self-equilibrating and that the natural condition in organizations was stable. Stability was the norm and change was something that you had to manage and that if things went awry, it was mainly because you weren't following standard procedures. Management was essentially about allocating resources... It was nothing about innovation... and making sure things ran in a steady, linear, rational fashion.
When I got into the real world, I found that these principles were, well, wrong.
The right principles are those that Jesus Huerta de Soto includes in his Austrian theory of dynamic efficiency. David Hurst sums them up this way:
Of course the linear, stable, rational model is the way academics think businesses ought to run, if only they would listen to them, and the fact you can't run them that way because the world is nonlinear. It's dynamic.
Organizational Dynamism To illustrate dynamism at work, David described a frantic time of disarray in a newly acquired company when a major project management problem arose, and sclerosis caused by hierarchy and central planning, multiple process manuals, traditional career paths and rigid job descriptions impeded a response.
Spontaneously, individuals on the front line formed small teams (they’d be called Agile today) to hunt down innovative and collaborative solutions to this and other challenges that arose. They were non-hierarchical, with no process manual, no reporting structure and no fixed operating plan.
Similar small, collaborative, horizontal teams multiplied to solve problems of business recapitalization, debt and cash flow management, innovation, pricing and many more. The business, after divesting unproductive divisions and products, became profitable, grew and thrived. There was improvement and it was, as David put it, non-linear.
New Organizational Theory: Boxes and Bubbles David reflected on this experience and developed a theory to explain it. He observed that, in the dynamic crisis time, traditional hierarchy and procedure had faded into the background, and the spontaneous order of agile teams had taken the foreground. Both continued to exist.
I called them boxes and bubbles, boxes being the formal box structure which productive, large-scale organizations end up using, and bubbles were these soft, informal teams that we formed at a moment's notice. They formed easy coalitions with each other and when they did the job, they burst. They disappeared and went back into the mixture out of which new bubbles could come.
The Theory Of Complex Systems Applying complexity theory, David developed what he calls an organic approach to business management, modeled after natural ecosystems, such as a forest. Forests start off as weeds — small and fast — and end up as big and slow trees. Yet forests are dynamic: they renew themselves through fire, burning the obsolete, decadent growth to create the space into which new growth can come. At that stage, the forest starts to build a new community of fresh growth. It continues in an infinite loop, existing for indefinite periods of time.
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Austrian theory, of course, embraces the idea of complex systems. We know that any economic endeavor, any market, and any firm operates within a complex system of millions and billions of provider-customer exchanges, governed by the idiosyncratic subjective value scales of consumers and the entrepreneurs who strive to empathize with them and serve them. We know that these complex systems can’t be managed in any traditional, hierarchical, procedures-manual sense, and they can’t be predicted. We understand business cycles and adaptive behavior.
How Did Business Schools Come to Teach The Wrong Model? How did the business schools get to teach their totally inadequate model?
They adopted this model in the late 1950s. Their goal was to come up with systems to produce economies of scale, how to produce more of the same. Like the steel business - very inefficient, highly polluting but facing tremendous demand for steel for rebuilding the world in the 1950s and there was no reason to change.
The theory that emerged was how to perpetuate this success. But nothing lasts unless it is incessantly renewed. Firms must innovate to maintain dynamic competitiveness. The organizational structure required to run something with economies of scale, a very mechanical, machine-like, productive hierarchy, is very poor at innovation because those are exactly the dynamics that you've got rid of in the pursuit of efficiency, in the pursuit of low prices.
The theory that businesspeople used to support them in this productive model was of course neoclassical economics. It appealed to them to explain why it was all about rationality and it was all about stability, keeping things the same.
The Uses of Knowledge David tells us that Hayek became his guide.
It seemed to me that The Fatal Conceit applied to the corporate world, the mini socialist structures. I mean, when I graduated from business school, the Fortune 500 were the sort of last refuges of Stalinist bureaucracy. They were central planners, so Hayek's critique applied to them. That's the way they work. People at the top were dictators, that’s the word for it.
Businesses fall into what David refers to as a “power trap”, bureaucratic and rigid.
The boss would come and say, "Well, I want to do this deal so find me some assumptions that make it work." Instead of getting evidence-driven strategy, you got strategy-driven evidence. It was totally inverted. The process was actually a process of power, and the structures are structures of power. It ends up with elites”.
The Organic Approach to Management David described working with an entrepreneur in South Africa.
He was Austrian, but not an economist. He was a tool and die maker in Austria and he had come out to South Africa and he had set up a tool and die business to make fuel tanks for the automotive industry in South Africa. This guy was a wizard on the technology of stamping. It was just know-how, practical knowledge.
He wasn't dealing in abstractions at all. It was all about practice and things emerged on the shop floor, "Oops. Okay, so that's interesting." He was continually experimenting, tinkering, and he was hugely successful because he had this extremely efficient, effective process. And he was not intellectual in the remotest. If you tried to ask him, "What principles are you operating by?" he wouldn't be able to tell you and that was okay. It's the power of practice and that the actions come first, and the words come later.
There is a space in my diagram, on the left-hand side, it’s all about acting your way into better ways of thinking and on the right-hand side, it’s about thinking your ways into better way of acting. The two are melded together. It's a dance, if you will, between the two sides.
The way you come out of business school is thinking about the job of management like an engineer. You had this machine which required to be maintained, lubricated, fixed, parts replaced sometimes, but it was essentially a machine, a smooth running machine, and you think like an engineer.
I see the manager as a gardener. A gardener has engineering aspects, but they also have wilder aspects to them. The gardener creates the conditions in which, in the case of enterprises, people can grow. They grow people. That's what it's all about. I see this gardener as the one being able to conduct this dance. You need to dig up soil and replace it. You may need to tear down existing plants and put them on a bonfire and burn them, break out the chainsaw and saw. At other times, you need to supply structure, a lattice on which they can be trained and pruned and all that kind of stuff. The gardener seemed, to me, to capture this duality to the manager's task.
Measuring Unmeasurables Peter Drucker said that there a lot of unmeasurable things which are absolutely valid and are absolutely critical. Like Mises, he understood that measurement is always about the past. It's always about what happened. He says,
The things that really matter are the unmeasurables that refer to the future." The example he gives is the ability of the enterprise to attract young, high motivated people. He said, "If you can't attract these people, eventually it'll show up in the numbers, but it's not something you'll see in the numbers right now because it hasn't happened yet. It's straws in the wind.
How do you measure unmeasurables? Through Hayekian knowledge theory: getting everybody in the organization talking to each other about what's happening, about what they're seeing every day, because that's where it's happening, on the ground. This is all a part of acting our way into better ways of thinking, getting ideas, seeing the opportunities emerge out of what we're doing, out of the action.
Additional Resources David Hurst’s ecosystem model (JPG): Mises.org/E4E_82_JPG
David’s book, The New Ecology Of Leadership: Mises.org/E4E_82_Book
David’s original HBR article on “Boxes and Bubbles”: Mises.org/E4E_82_PDF2
Jesus Huerta de Soto’s side-by-side comparison of elements of Austrian and Neo-Classical economics: Mises.org/E4E_82_PDF1
Key Takeaways And Actionable Insights Dr. Keith Smith, co-founder of The Free Market Medical Association (FMMA.org), is an entrepreneur and free market warrior who is undaunted by the seeming scale of his innovation task: to bring to healthcare the kind of customer experience only entrepreneurial free markets can deliver (see "Pillars of the Free Market Medical Association" (PDF): Mises.org/E4E_81_PDF).
He is laser-focused on the problem to solve.
The aim is to bring buyers and sellers together. As Dr. Smith explains, simply stating that there is a need to bring buyers and sellers together is an indication of dysfunction in the market for healthcare. Buyers and sellers talking directly with each other is what makes a market: willing buyer, willing seller, mutually agreed price.
Buyers are patients who care what healthcare costs. Today, they have sticker shock. Buyers who care about price can be direct-buying individuals, and their proxy buyers, who can include self-funded employer health benefits systems, more and more of which are emerging. Innovations like Health Savings Accounts and high-deductible insurance policies are bringing more direct buying into the market.
Willing sellers should be complete and comprehensive advocates for the patient, across the whole range of their needs, including financial aspects. The targeted customer experience is for patients to feel confident when they visit a doctor that they have an unapologetic advocate. Today, physicians are medical advocates, but to be a more complete advocate, physicians must think and act like entrepreneurs, bearing some risk in serving their patients. Many say, “I don’t want anything to do with the business side or the money side of medicine.” By doing so, they are abandoning their patients to the financial wolves, many of whom are willing to step in and make a living off the patient. It’s not so much willful neglect of the patient’s interests, as simply caving in to a system that has become extremely difficult to navigate.
A problem in healthcare is the dominant presence of intermediaries between the buyer and the seller. Dr. Smith described the wide range of intermediaries, cartels and proxies that get in the way of a direct, transparent and mutually beneficial relationship between buyer and seller. Insurance companies are “money handlers and money changers”, keeping healthcare prices high, so they can offer false discounts and skim off the difference. There are brokers and consultants to employers, whom Dr. Smith calls “self-dealing”, who add a layer of costs. There is Big Pharma, the pharmaceutical industry that largely funds the FDA, making it inevitable that the regulator will protect the pharmaceutical companies and their business model and their pricing.
In the end, the “ultimate culprit” is the Federal Government. None of the financial abuse of the patient would be possible “without Uncle Sam riding shotgun for all of this thievery”.
A solution lies in decentralization, disintermediation and the application of Hayekian knowledge theory. Dr. Smith alluded to F.A. Hayek’s concept of dispersed tacit knowledge in describing the FMMA’s decentralized approach. The Free Market Medical Association establishes local chapters, who follow a small number of “pillars” regarding price and value and mutually beneficial exchange, including equal pricing to all cash buyers of the same service. The chapters are completely free to respond to customer preferences in their own local market. These chapters create new knowledge based on their transactions and experiences in their local market, and can share it with all other chapters.
Austrian principles of decentralization, free exchange without intermediaries, and the recognition of the value-creating dispersed knowledge of patients and entrepreneur-practitioners are Dr. Smith’s starting point.
Additional Resources "Pillars of the Free Market Medical Association" (PDF): Mises.org/E4E_81_PDF
The Free Market Medical Association's annual conference, "Mission Possible: Healthcare Entrepreneurship as the Antidote to the Broken Healthcare System": Mises.org/E4E_81_FMMA
Key Takeaways And Actionable Insights The entrepreneurial life is a life of meaning and purpose. We believe that strongly, and our belief is anchored in the ethic of entrepreneurship: to serve others, making their lives better, and thereby improve one’s own life, making an entrepreneurial profit, both economic and psychic.
In episode #80, we review some deep research support for this linkage between entrepreneurship, free market capitalism, and meaning in life.
An intersection between psychology and economics. Clay Routledge is a social psychologist, with a focus on human motivation: what gives us the energy to pursue our goals and aspirations.
John Bitzan is an economist who has taught courses on international business and international economics. He fully understands the huge role played by economic freedom in elevating people out of poverty and making lives better. He now leads the Challey Institute (full name: Sheila and Robert Challey Institute for Global Innovation and Growth: Mises.org/E4E_80_Challey) that is focused on looking for ways to unleash the power of the private sector to create economic opportunity.
John and Clay collaborated on the research we discuss on E4E #80.
What is meaning and why is it important? Meaning is defined as people’s perception of the coherence, significance and purpose of their lives. We are all trying to find a place in the world where we function, and we have a desire to be significant, to play a role in society, and to have a purposeful existence.
And people understand this about themselves. They have a good subjective sense of what it means to have a meaningful and purposeful life. They have a greater sense of meaning if they play an important part in the lives of others. Meaning embraces a contribution to someone else — to family, to community, to society — beyond just making a contribution to your own welfare.
The strong link between meaning and motivation. People who see their lives as meaningful tend to live longer and healthier lives. Why? Because they are more motivated to live healthy lives. They make the choices that reduce the risk of mortality. They eat healthier, exercise more, avoid harmful behaviors like drug and alcohol abuse. When people have a purpose in life, they take better care of themselves.
Meaning is a motivational force. And that’s how it connects to economics.
Existential agency, capitalism, and entrepreneurship. According to Clay and John, existential agency is the extent to which people believe they have the ability — it’s in their power — to pursue and maintain meaning in their lives. And people’s beliefs about meaning and existential agency influences a range of economic beliefs.
Clay and John researched the connection between people’s beliefs about existential agency and their views towards capitalism and entrepreneurship, both on the macro or institutional level regarding their role in solving important problems, and on the micro or individual level of their own entrepreneurial aspirations. They researched over 1200 Americans and asked questions including both their general views towards economic freedom and their motivations to become an entrepreneur.
The survey revealed that people who have more existential agency, i.e. a greater belief that they can obtain and maintain meaning in life, were more likely to have positive view towards capitalism, about entrepreneurship, and more likely to be motivated to start or run their own business.
It’s not self-interested, it’s pro-social. Clay also emphasized how much meaning in life and existential agency are associated with pro-social beliefs, attitudes, and behaviors. For these people, motivation is not focused solely on their own wellbeing and their own life outcomes. Part of the motivation is to serve a community and serve society. Entrepreneurs are motivated to solve problems for others: entrepreneurship is pro-social. It can solve the major challenges of society, including macro problems like climate change or poverty.
The existential vulnerabilities of our current world. The opposite of existential agency is the feeling of a lack of ability to play a meaningful role, or to take on a meaningful challenge or to see the opportunity to make a direct contribution via one’s own efforts.
Clay and John worry that young people are being educated to believe they have no control over their lives, and don’t have the ability to overcome obstacles that they face. They are told that problems are systemic, and discouraged from thinking about ways they could make a meaningful contribution, or make a difference. They are indoctrinated with a cultural world view that undermines existential agency. Symptoms include a decline of faith in capitalism and its institutions, and a sympathy for socialism.
A focus on meaning is especially important now, when people are told that they need to rely on the state to improve their situation, and are provided with negative work incentives via supplemental unemployment payments that make not working a better financial choice than working.
And Clay and John emphasized that the meaning-motivation axis applies to all social groups, including minorities. It’s important that we give all people — especially the young and minority groups — the message that they have the ability, through the agency of entrepreneurship and the institutions of free markets, to make a difference, contribute to something beyond themselves, and play an important role in society.
Additional Resources Research Brief: "How are attitudes toward entrepreneurship and entrepreneurial motivation affected by meaning?" (PDF): Mises.org/E4E_80_PDF1
Research Brief: "Does a feeling of meaning and purpose in life affect views toward capitalism?" (PDF): Mises.org/E4E_80_PDF2
Research Report: "Does a feeling of meaning and purpose in life affect views toward capitalism?" (PDF): Mises.org/E4E_80_Report
Clay Routledge on "Why Meaning Matters for Freedom and Flourishing" (PDF): Mises.org/E4E_80_PDF3
Key Takeaways and Actionable Insights Steve Phelan has spent a lifetime in entrepreneurship, as a student, a researcher, a teacher, an investor, an innovator and a practitioner. He found that people today — especially young people — are over-focused on the Silicon Valley / Venture Capital / Become A Billionaire model. That’s pretty rare (and may not even be a good model).
He decided, therefore, to classify all the different kinds and flavors of entrepreneurship, to help people think through all the business and lifestyle options. The result is a book called Startup Stories: Lessons For Everyday Entrepreneurs (Mises.org/E4E_79_Book). It’s full of interesting personal interviews and experiences, analysis, data and insights. We’ve drafted a summary of the six levels of entrepreneurship Steven identified below, and in this downloadable Knowledge Map: Mises.org/E4E_79_PDF.
Level 1: The Personal Entrepreneur We’re all capable of entrepreneurial behavior because we all have resources: our brain, our body and our time. If we apply those resources to pursue valuable experiences for others and ourselves, we are personal entrepreneurs.
A career entrepreneur is one who takes personal responsibility as the custodian of their own human capital — the economic value we derive from our own stock of personality traits, knowledge, skills and experience, all of which can be developed. Career entrepreneurs invest in their own human capital and chart a path through life to achieve the highest long term return. Personal responsibility lies at the heart of entrepreneurship.
Being an intrapreneur is another way to exercise personal entrepreneurship. An intrapreneur is an employee who acts entrepreneurially — identifying customers’ desired experiences, designing innovative services and introducing new offerings into the market. While the incentives may be lower-powered than for entrepreneurs, they can nevertheless be attractive in the form of bonuses and stock options. It’s a good route to fulfillment for many.
Level 2: The Nascent Entrepreneur This is the more conventional classification of an entrepreneur starting a business. An embryonic entrepreneur’s business is pre-revenue. They’re engaged in the exciting phase of customer discovery — which can include value proposition development, securing funding, hiring initial employees, assembling a team, planning launch activities, assembling resources, and testing prototypes. They key is action: ideas are plentiful, action is scarce. Embryonic entrepreneurs are action-oriented doers.
Emerging entrepreneurs’ businesses are post-revenue, pre-profit — they are pursuing a scalable and profitable business model. By definition, this stage is temporary — the emerging firm is designed to search for that sustainable model. Constant tweaking and experimenting is the dominant mode. Eventually, emerging entrepreneurs become growth entrepreneurs.
Level 3: The Lifestyle Entrepreneur Entrepreneurship is a lifestyle choice for many — often driven by the desire for autonomy: to personally direct how to work and how to live. One form of lifestyle entrepreneur that Steven identifies is the craft entrepreneur.
Craft entrepreneurs have a highly developed individual talent, skill or expertise and they find a way to capitalize it and apply it entrepreneurially in the marketplace. They’re always trying to improve the quality of their product or service, and to reinforce their own mastery. If they can add some sales and marketing hustle, business can be very good.
A 21st Century version of the craft entrepreneur is the virtual entrepreneur. This is an individual, team or small business that takes advantage of the modern day digital-driven opportunity to interconnect, build online supply chains and download infrastructure. A virtual entrepreneur can run a business from anywhere where they can connect a device with a screen to the internet. There are plenty of challenges — especially in the fragility of the supply chain and finding trusted partners, but many profitable businesses follow this model.
Level 4: The Employer Entrepreneur There is a major change in responsibilities, operations, management and personal experience when an entrepreneur takes on employees. Startup Stories explores two examples: family business owners and small business owners.
Family business owners have the advantage of built in trust and loyalty with their employees, which can result in greater stability. However, it may come with more complexity and tensions in inter-family member relationships.
Small business owners who are employers must delegate some authority and decision-making to employees, and therefore must become experts in identifying, hiring, managing and nurturing. Hiring employees can take your business to a new higher level, but poorly managed employees can damage your business in areas like lost productivity or damage to brand and business reputation. Successful small business entrepreneurs must overcome these challenges.
Level 5: The Growth Entrepreneur Growth entrepreneurs experience the exhilaration of escaping the confines of small business. They can also start thinking about becoming rich if they can sustain the growth. Expansionary entrepreneurs expand to multiple locations, or multiple products line, or to millions of customers on the internet. There are plenty of challenges with managing growth — it may require business model revision; it may consume cash at such a rate that finance management becomes a problem; it may require continual organizational revisions. It can be personally exhausting, as Steve depicts in one of his interviews. But it can also be tremendously rewarding.
Gazelle entrepreneurs, in Steven’s terminology, are those growth entrepreneurs who take venture capital funding to boost growth rates and business acceleration. VC funding enables firms to fly faster and higher. Venture capital is rare and hard to get. It can also be destructive, especially to founders who can lose control of their companies (Steve explained how in the book). Term sheets set up these potentials. Securing venture capital is an exciting and energizing moment and a milestone of achievement. It’s important to read the fine print and think ahead!
Level 6: Super Entrepreneurs This is the peak of the profession. Steve picks out Mavericks and Heroes. The discussion about mavericks is structured around the question: “Are entrepreneurs born or made?” Researchers have tried to establish whether or not there is an entrepreneurial personality, but the consensus is that there are no common traits that predict entrepreneurial success. But some personality traits may be more common in the entrepreneurial community than outside it. The maverick personality is one of them — willing to think and act differently from others, to pursue a distinctive imagination, to bet on a hunch. And the good news is that personality traits are not fixed — habits and behaviors can be acquired over time, through acting and learning. Entrepreneurs are made through action.
The second classification of Super Entrepreneurs that Steven considers are Hero Entrepreneurs. He makes the link between hero status and PR, and from there to the power of heroes to raise funding. It is possible to craft a hero persona, shaping the perception of others through “impression management”.
At E4E, we believe all entrepreneurs are economic heroes. They aim to better the lives of others, bringing new product and services to the market and responding to the preferences of customers based on their positive or negative response. They sacrifice in the short term, while designing their new solutions, in order to benefit in the long term if they serve customers well. This short term sacrifice for long term gain is not only economic, it’s the essence pf morality. We aim to continue to serve this community of heroes.
Additional Resources Learn about the "Austrian Business Model" — a design guide for your firm’s individual business model: Mises.org/E4E_ABM
"6 Levels of Entrepreneurship" (PDF): Mises.org/E4E_79_PDF
Startup Stories: Lessons For Everyday Entrepreneurs by Steven Phelan: Mises.org/E4E_79_Book
To succeed, entrepreneurs must demonstrate superior foresight and judgment, and practice continuous dynamic improvement in their assembly and reassembly of assets to serve the consumer.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "How Murray Rothbard's Theory of Entrepreneur-Driven Progress Can Be Applied to Modern Businesses".
Key Takeaways and Actionable Insights Every business needs a business model, a recipe for generating profitable and sustainable revenues that result from bringing the customer an experience on which they place a high value.
How do entrepreneurs design successful and profitable business models? They combine theory and experience — theory provides the foundational starting point, and experience refines the model based on action-based learning and real-life feedback.
The best theory — the meta-theory — for business models comes from Austrian economics. This is a proposition we intend to demonstrate rigorously and completely in our Economics For Business platform. Dr. Per Bylund joined us on the Economics For Entrepreneurs podcast to provide an exposition and explanation of the core structure of the Austrian Business Model (ABM).
The model can be expressed as 4 core components for the entrepreneur:
Understanding and defining subjective value.Facilitating value for specific customers.Exchanging value with customers in the market.Value dynamics — agility in continuously refining the value proposition. 1. Understanding Value The foundation of the Austrian Business Model is a deep understanding of subjective value. This understanding changes everything: its implications ripple through the entire model from the beginning and throughout all phases.
Value is created only in consumption. The customer (in both B2C and B2B models) creates value. Value is in the customer’s domain. It’s an experience that customers evaluate after the fact against their expectations. The entrepreneur isn’t even present when value is created.
This is a very different premise than we are traditionally taught at business school or even in the everyday language of business discussion. For example, a popular book on business modelsi makes this statement: there is something about some firms that makes them more profitable than their rivals. In the framework of the ABM, we would say: there is something about some customers’ desired experiences that makes facilitating them more profitable than other customers’ desired experiences.
It’s hard to get one’s head around just how different this approach is. It requires some new behaviors:
Obsessive and total focus on the customer — identifying them, understanding them, letting them lead the process of value creation.Selection of a precisely defined group or cohort of customers as your audience, with continuous development of ever deeper and more detailed understanding of their subjective preferences.Development of a value proposition — a hypothesis about how you will help the customer to an experience that they will value. It’s simply that — a hypothesis that you will test as much as possible for verification, but which is never proven until the cycle of market exchange, experience and evaluation is completed. Phase 1 is an understanding phase for the entrepreneur.
- Facilitating Value for Specific Customers Starting from the hypothetical value proposition, the entrepreneur advances to the phase of designing a value experience for the chosen target audience of customers, based on as deep an understanding of their subjective values as it is has been possible to develop so far. The entrepreneur is continually adding to that understanding — creating new knowledge as much and as frequently as they can.
Design consists of imagining every element of the customer’s experience, based on their value learning cycle. What is it about your value proposition that will make them anticipate a valuable experience? What will make them feel that this experience is preferable to any alternative they have, direct or indirect. What will cause them to exchange value — give their dollars for your offering — and what is the price they will be willing to pay? What ensures that they will assess the experience positively after the event?
The key to design is (1) to imagine every possible element of the subjective experience, empathically embracing the customer’s individual context; (2) to understand that every little detail counts and that small differences in delivery can make a huge difference to the perceived experience. In fact, since customer service is so highly developed in modern economies, it is the small details that generate differentiation and uniqueness for your brand.
Then the entrepreneur turns to value assembly, assembling the resources to deliver the desired features and attributes of the experience to market. What is the right organization for market delivery? Since it is impossible to know exactly the costs and quality you will be able to achieve in your firm, Austrian theory advises entrepreneurs to obtain as much of the required capability on the market at market prices — via outsourcing, partnerships, alliances, and external supply chains — and to limit internal capabilities only to those that cannot be obtained on the market, those that are genuinely unique and advantaged for you.
Use a value alignment approach to check for each element that your value delivery is aligned with the customer value preference — that you know what they want and you can deliver it in the way that they want it.
And include communications design and delivery as part of your experience design. It’s not an add-on or a supplement or a marketing budget item to dial up or dial down depending on cash availability. It’s part of the customer experience that you are designing and delivering.
Finally, make measurement part of the experience design. Once in the marketplace, your value proposition goes “wild”. You no longer control it. The customer is creating the value and you are not. The best you can do is to be available if they want to invite you into their process, and to be observant of their behavior. Measurement is observation. Don’t presuppose, but do collect data, preferably qualitative data at the individual customer level. This is your raw input for continuous improvement.
Phase 2 is a customer-led design and assembly phase for the entrepreneur.
- Exchanging Value Does the customer perceive sufficient value to enter into exchange? It’s the ultimate market test. The customer is weighing the benefits they subjectively perceive against the costs, which include money but also any other difficulties or barriers they perceive to making the exchange. Is participating in your offering totally convenient (which is the general standard today) or is there anything in the experience that makes it less convenient and less compelling?
The best way to solve this challenge is to experiment with as many offer bundles as you can in order to observe market results. Does your service sell better online or direct-to-customer? Do customers prefer to subscribe to buy by the unit? If they try, do they convert? Test as many bundles as you can.
Once you have established the right bundle and willingness to pay, calculate your cash flow and choose your costs in order to generate the margins and profits you require. This is the opposite of the margin math taught in business school, where firms calculate their costs and then add a margin. Austrians discover the price the customer is willing to pay, and then chooses the costs compatible with that willingness to pay. The customer determines the price of the exchange, not the entrepreneur.
Cash flow is your most important financial metric. Make sure you monitor it closely and make sure your accounting methods are the right ones to serve your individual ends. Accounting is a tool like any other — use it subjectively to help you meet your goals.
Phase 3 is an experimenting and testing phase for the entrepreneur.
- Value Agility You’ve achieved some marketplace results. You’ve established that the customer perceives value in your offering and they’re willing to pay a price that generates positive cash flow and profit.
That same marketplace is incessantly changing. Your approach to the 4th stage of the Austrian business model is dynamic. You make sure that you have all the feedback loops required to receive marketplace data about the acceptance of your offering, and any changes in customer preferences and competitive behaviors. You manage 360 degree monitoring of the customer experience and you anticipate and expect that your experience design, however excellent, will erode over time. The customer will demand something even better, and competitors will aim to match or improve on your delivery. It’s important to keep your model of customer value preferences fresh, and to be planning and preparing new and improved value facilitations. Agile entrepreneurs continually test and evaluate innovations, and introduce them to the marketplace. Value improvement and value innovation are your goals. The process never stops. The journey never comes to an end.
Your business model must yield sufficient cash flow for substantial amounts of new capital investment each year. Your organizational design must facilitate the addition of new capabilities and the discontinuation or de-emphasis of existing capabilities that no longer are perceived as unique or compelling by the changing customer. Agile entrepreneurs monitor their dynamic capability — how much is being added, how much is being changed or updated. Are you keeping up with the customer, the ecosystem in which you engage, and your competitors?
Phase 4 is a phase of continuous dynamic change for the entrepreneur.
Over the next few months, we’ll be building out the tools and knowledge entrepreneurs need for every one of the four phases of the model and the steps within. Keep up with us at E4EPod.com/signup.
Extra Tools and Resources Mentioned in the Podcast Dr. Bylund’s Mises University Lecture, "Austrian Economics in Business": Mises.org/E4E_78_Lecture1
Dr. Bylund’s Mises University Lecture, "How Entrepreneurs Built the World": Mises.org/E4E_78_Lecture2
"Means-Ends Chain Tool" (PDF): Mises.org/E4E_01_PDF
"Tools for the Value Learning Process" (PDF): Mises.org/E4E_62_PDF
"Identifying Dissatisfaction Interview Guide" (PDF): Mises.org/E4E_Interview
"Insights Generation Tool" (PDF): Mises.org/E4E_67_PDF_A
"ACT! Austrian Capital Theory at Work" (PDF): Mises.org/E4E_19_PDF
"The Austrian Business Model" (video): Mises.org/E4E_ABM
Key Takeaways and Actionable Insights Business strategy and business model design has traditionally been firm-centric. Entrepreneurs are called upon to establish firms, to make the firm the locus of value creation through value proposition design, assembly of resources, and production; and to ensure competitive advantage in comparison to rival firms pursuing the same customers.
There is an entirely different way to approach economic value creation (see Mises.org/E4E_77_PDF). Ralph Welborn discusses this new approach for the 2020s on the Economics For Entrepreneurs podcast, and in his book Topple: The End of the Firm-Based Strategy and the Rise of New Models for Explosive Growth (Mises.org/E4E_77_Book).
The innovation of the new strategic approach is the focus on ecosystems instead of firms. The new approach preserves — and, in fact, elevates and intensifies — the Austrian business model principle of customer sovereignty and the deep understanding of the customer as the first step on the value creation path. But it changes the perspective to the ecosystem level.
Defining the business ecosystem. Ralph defines a business ecosystem as the methods of orchestrating capabilities from diverse organizations to capture new sources of value. Austrians see entrepreneurs as orchestrators, and so we are very comfortable with this starting point. We are equally comfortable with the core analytic action Ralph proposes: studying where value is being created and destroyed within an ecosystem, and taking steps to capture emergent new value.
As an example, think of a consumer’s nutrition ecosystem, and how it might have changed — that is, how new value has been created and old value destroyed — over the past twenty years. In the past, value was created by Big Food firms (think Kraft Heinz) via low prices, convenience packaging (e.g. canned foods and frozen foods), standardization, high volume, and supermarket distribution. But then some consumers sought new value in fresh food, organic food, less processed food, fewer preservative ingredients and fewer additives and new recipes. New brands took advantage of the emergent value opportunities. And even more recently, new value has been created by delivery platforms that can bring the food directly to the home, and escape the “war in the store” for shelf space and distribution slots. You can begin to appreciate how a business ecosystem such as “consumer nutrition” can change, how new value creation can emerge, and how entrepreneurs might take new action.
Ralph mentions another example in his book: the ecosystem in which automobile companies operate has changed from transportation to mobility. The companies must now deliver value in areas such as in-car productivity, entertainment, communications, connectivity and more.
In order to implement an ecosystem-based strategy, Ralph recommends the following steps:
First, shift your unit of focus. Business schools have told us that our point of focus should be our firm, or corporation, or business unit or department: to maximize the performance of that unit in comparison to other firms or units.
The shift is to focus not on the firm but on the ecosystem in which you and your customers engage, in order to develop a new value perspective.
Step one in business is always to identify and know the customer. The added perspective is to identify, and study, the ecosystem in which you and the customer are engaged.
Second, see the ecosystem as a locus of shifting value. Once you’ve defined it, observe the ecosystem as a network of economic interactions where value is being created and destroyed via changing customer preferences and needs. A consequence of these changes will be shifts in the competitive environment, and you can observe these too, as clues.
To continue with our nutrition ecosystem as an example, you can observe the shifts in market share between traditional and innovative food companies, and use these shifts as a signal of changing consumer preferences. Of course, you can also simply observe consumer behavior and conduct traditional research. Plug all of this observation into a dynamic ecosystem perspective: where and how is value being created and destroyed in the ecosystem?
Ralph’s memorable phrase is: value seen is value captured. If you can see where value is shifting and where new value is being created (or will be created in the future) you will be able to capture it.
Third, answer the questions: “How can I fit in to the ecosystem?” and “How can I contribute to the ecosystem?” The changed perspective of the ecosystem approach is the shift from “how can my firm compete with other firms?” to “how can I qualify to be invited into the customer’s ecosystem?” If you have a new line of organic, healthy food products for health- and diet-conscious consumers, how can you engage with the communication channels within the ecosystem to make those consumers aware, how can you utilize those channels to communicate your benefits, how can you engage with ecosystem retailers and distributors to make it convenient for the consumer to buy your physical products, and how can you participate in the consumer’s preparation systems to provide extra service in addition to your physical product? Where is new value emerging? Where is old value being destroyed? How can you take advantage of the shifts?
The answer to the question “How can I contribute to the ecosystem?” requires an analysis and articulation of what are the capabilities required to meet new needs, who has those capabilities (if your firm does not have them all), and how can you orchestrate these capabilities in service of those needs? Perhaps home delivery is required for ultimate customer convenience. Who does that and how can you orchestrate that capability on the customer’s behalf? Perhaps food preparation videos will help the customer get the most value from your product — who can prepare the content (a celebrity chef, perhaps) and which is the best platform to host and deliver the content to the kitchen? Perhaps your packaging can be recycled — how can you orchestrate that to make it convenient for your customer (as Nespresso does, for example, with recycling bags for their capsules, which can be mailed back free, or dropped off at a Nespresso boutique).
To fit in and contribute, choose a bundling or un-bundling strategy. Austrian economics directs entrepreneurs to assemble resources to facilitate customer value in a unique manner. In the book Topple, Ralph Welborn calls this a bundling versus unbundling decision. If you decide to be a bundler, you improve customer value by providing multiple services around the desired benefit — such as amazon does with retailing and delivery, making shopping more convenient. Unbundling refers to a focus on a single benefit-delivering capability, such as manufacturing a new organic food product that is clearly differentiated from the preservative-laden portfolio of the Big Food company. You can choose to be a bundler or an un-bundler based on how you want to deliver value to customers.
Fourth, audit your own capabilities and identify the 20% that deliver the majority of your value. The capabilities underlying your product or service (skill sets, software, distribution, customer relationships, media channels, process) decay over time, often at an accelerating rate. Ralph points out that entrepreneurs should be creating new capabilities continuously, and making those new capabilities into the 20% that drive explosive growth. This is pure Austrian Capital Theory — identifying the business assets that most contribute to customer satisfaction and keeping them refreshed and up-to-date as customer preferences change.
Ralph cites Uber as an example: the new capabilities are mobile connectivity (from carriers), payment transactions (banks and credit card companies) and dynamic GPS and mapping software (from Google and others).
These capabilities are:
Centered around what the customer wants to do.Taking friction out of what it is they want to do, making it extraordinarily convenient.Orchestrating different capabilities from different types of actors and organizations.Reserving the enabling orchestration capabilities to Uber. The implications for business are to: (i) identify your assets and their half-life — the rate of decay; (ii) identify where to play in your newly understood ecosystem and how to develop the new assets and capabilities to do so. This is a continuing process.
Additional Resources "An Ecosystem-Based Development Strategy" (PDF): Mises.org/E4E_77_PDF
Ralph Welborn's book, Topple: The End of the Firm-Based Strategy and the Rise of New Models for Explosive Growth: Mises.org/E4E_77_Book
Key Takeaways There is a group of innovative thinkers in economics calling themselves i4j: innovation for jobs. They focus on an economic theme they refer to as the People-Centered Economy. When many innovators are exploring how to automate jobs and replace human with technology — especially the software called A.I. — they are exploring how to design the structures and incentives to make people even more engaged in the economic process of wealth creation, rather than less.
When thinking about the future of jobs and the people centered economy, we should think of entrepreneurs. In the future, everyone will be an entrepreneur. Entrepreneurship is the people-centered economy, or what we call practical economic humanism.
Is our language right? Entrepreneurship is a tough word for young people to deal with. What does it mean? What exactly is entrepreneurship? What might be more inspiring for them is to focus on the ethic of entrepreneurship. That ethic is service to one’s fellow man — service that is designed to improve their lives. Customers indicate whether or not the entrepreneur is successful in improving their lives by buying or not buying. And it is through the lens of ethical service that they can understand the role of profit. Profit is not the reason people become entrepreneurs — it’s the emergent result. Profit is the signal that society judges that the entrepreneur is allocating scarce resources well. Without profit, the entrepreneur does not continue the service. Service without profit is unsustainable. The ethic of service to others and the emergence of profit as an outcome — a signal of approval — go hand in hand.
In this podcast, we experimented with a new language of entrepreneurship via the acronym S-E-R-V-I-C-E.
S stands for Service: practical economic humanism is entrepreneurs serving others and doing so for profit. It’s the Austrian version of service: I serve you because it is good for me, in every way (purpose, meaning and autonomy). Profit is the signal from the marketplace that the act of serving is positively viewed by customers.
E stands for Empathy. In order to serve, one needs to understand the subjective needs of others and to understand how to meet those needs on the user’s terms. Subjective preferences are idiosyncratic, inconsistent and emotionally based. Empathy recognizes this, and treats everyone’s preferences with respect. Empathy is the number one skill of the entrepreneur.
R stands for Resourcefulness — to meet others' needs in ways that are new, different and better, the entrepreneur assembles resources and persuades others to contribute to the initiative — financiers, employees, partners, vendors. An assembler of scarce resources must convince others that this is the best use that could be made of them — make a business case. There’s a self-reliant resourcefulness in the virtuous character of the entrepreneur.
V stands for Value — creating value and facilitating a valuable experience for customers is the point of entrepreneurship. Value is in the mind of the person who experiences it — it’s a feeling, a satisfaction, the kind you get when a promise is kept. Taken together, all the people whom the entrepreneur serves constitute the market and the market is the judge of what is valuable. Firms and entrepreneurs don’t create value or add value, they make it possible for customers to experience value.
I = Investment, the action of sacrificing in the current time period in order to produce greater value in the next time period. Investment is the opposite of hedonism. It requires the long term view — if I make this sacrifice now, or this investment now, I am giving up alternative current uses of that money or those resources, but I am willing to do so because I see the possibility of a return in the future. Society needs entrepreneur-investors to create the future.
C = Collaborativeness; entrepreneurship requires the assembly and molding of a team, and synthesis of team ideas and contributions; finding the right way to collaborate by maximizing individual talents and perspectives. A supply chain is a collaboration. A factory is a collaboration. A beauty salon is a collaboration. A construction site is a collaboration. Man is naturally collaborative in bringing value experiences to others.
E = Ethical: successful entrepreneurship is moral action, with pure intentions. Any other approach will fail. The idea of exploitation in capitalism is so far wrong and it doesn’t withstand scrutiny. The entrepreneur needs the approval of customers and markets, including the market for labor and for partners. It makes no commercial sense to be unethical.
Perhaps we could communicate the acronym S-E-R-V-I-C-E and the cogent set of ideas behind it, the integrated concept of what entrepreneurs do and what entrepreneurship is.
The mental model is that of SERVICE WARRIORS. Energetic committed people, combating need and want and dissatisfaction. Organizing people and resources in the fight to establish new improved value, to raise standards, to lead the way to a better place.
Models to Graphically Communicate Complex Ideas and Concepts Another part of my discussion with Jeff Saperstein concerned the design of simple visual models to clarify complex processes and concepts. One example to which we referred was that of the Individual Economy. With today’s technology, any individual can become a Service Warrior entrepreneur, integrated into the larger ecosystem of economic services through interconnectivity, networks and global exchanges and supply chains. The idea of the individual economy is explained in Chapter 2 of our book, The Interconnected Individual: Seizing Opportunity in the Era of AI, Platforms, Apps, and Global Exchanges (Mises.org/E4E_76_Interconnected). See also the action model of "The Individual Economy" at Mises.org/E4E_76_PDF. It identifies a process and a journey, with a starting point, key structural elements, relationships and dynamics. That’s a complex system about which authors could write white papers and books — but a simple graphic can capture its essence in one page.
Each week at Economics For Entrepreneurs, we offer such knowledge graphics and models as free downloads. Recently, for example, Dr. Mark Packard offered his groundbreaking theory of marketing for the 2020s in a series of five podcast lessons. We captured the essence of his "Value Learning Process" in one process map: Mises.org/E4E_44_PDF.
Trini Amador presented the essence of three decades of learning about how to build and nurture powerful and effective brands for any kind of business: Mises.org/E4E_30. We captured this expertise in our "Brand Uniqueness Blueprint" (Mises.org/E4E_30_PDF).
Additional Resources "The Individual Economy" (PDF): Mises.org/E4E_76_PDF
Hunter’s Author Page on Amazon.com: Mises.org/E4E_Hunter
Jeff’s Author Page on Amazon.com: Mises.org/E4E_Jeff
Where Good Ideas Come From: The Natural History Of Innovation by Steven Johnson: Mises.org/E4E_76_Book
Key Takeaways and Actionable Insights There are many kinds of entrepreneurs. They are all instigators of win-win arrangements in which customers are served in innovative ways by enterprising individuals and firms. Lives are improved for consumers and producers.
On this week’s Economics For Entrepreneurs podcast we dissect the path to success of an individual who chose the crowded and highly contested field of sports content production, navigated a way to the top, and then broke out in a new entrepreneurial distribution initiative.
Jason Whitlock shares with us many principles of his success (Mises.org/E4E_75_PDF); we highlight just a few of them here to whet your appetite for the podcast.
Choose a field that fits your personality and interests. We have talked a lot with our contributing economics professors about assembling a unique and competitively advantaged set of resources. Jason’s unique resources were a love of sports, some original thinking, and a distinctive personality that he was able to express in writing. He wasn’t deeply technically trained for his first profession (journalism) beyond writing for his college newspaper. That wasn’t the point. His commitment to the pathway — starting at the very lowest point in the climb — was the point. This is what the textbooks and white papers call effectual entrepreneurship.
Credentials are nice but hard work and experience advance you. Jason has won a number of prestigious awards over his time on the path to success. He was delighted to receive them. But he stressed that advancement comes not from the credentials but from the hard work and experience-gathering of which they are a reflection. Experience is the most important: learning from others, learning from circumstances and events, learning from setbacks, learning from observing industry trends and what happens to others. At Mises University 2020, Dr. Per Bylund told us that experienced entrepreneurs are the most Austrian (Mises.org/E4E_75_Bylund) — and therefore the most successful in business — because they are able to glean from their experiences what is most important for the success of a business and what is merely incidental or actually detrimental.
Let your values guide you the whole way — define them, write them down, adhere to them. Jason has thought deeply about — and codified — his own values. He includes them in his personal profile (Outkick.com/Jason-Whitlock) on his entrepreneurial distribution platform, Outkick.com. The entrepreneurial life is a values-driven life.
Your intuition and innate ability to read people are your best tools for managing the future. We discussed the entrepreneurial act of embracing change and trying to “stay ahead of it,” in Jason’s words. How do you do that? He elevates the role of intuition and empathy over data gathering and predictive analytics. Again, at Mises University 2020, Professor Peter Klein spoke of the elevated role Austrian economics allocates to those two cognitive skills, and even cited academic studies about the entrepreneurial advantages of intuition ("smart intuitors") among cognitive skills (Mises.org/E4E_75_Klein).
Always, always put your customer first. Be honest with them, be objective, and serve them distinctively. It is the first principle of Austrian economics in business that the consumer is sovereign and that an Austrian business puts the customer in first role in everything that they do. Jason Whitlock confirmed the same principle without any prompting. For a sports content producer, the customer is the reader, viewer or listener. Jason characterizes his audience as the intelligent sports fan who can appreciate an original take and distinctive reporting on subjects that many other content producers are covering.
He commented on how athletes today don’t understand the principle. The customers are fans who attend the events and enjoy the performance. Athletes sometimes misunderstand and think that “their twitter feeds are their fans” and often go to the point of ridiculing or rejecting or offending their customers. We’d call that a failure to demonstrate empathy, and disrespecting consumer sovereignty. Successful entrepreneurs don’t make that mistake.
These are just a few of the incisive and instinctively Austrian insights from Economics For Entrepreneurs podcast #75 with Jason Whitlock.
Additional Resources "Jason Whitlock's 10 Steps to Entrepreneurial Success" (PDF): Mises.org/E4E_75_PDF
Per Bylund's Mises U lecture, "Austrian Economics in Business": Mises.org/E4E_75_Bylund
Peter Klein's Mises U lecture, "Entrepreneurship": Mises.org/E4E_75_Klein
Download the slides from this lecture at Mises.org/MU20_PPT_23.
Recorded at the Mises Institute in Auburn, Alabama, on 16 July 2020.
Download the slides from this lecture at Mises.org/MU20_PPT_12.
Recorded at the Mises Institute in Auburn, Alabama, on 14 July 2020.
Key Takeaways And Actionable Insights Raushan Gross is one of the outstanding writers on the subject of entrepreneurship. In his latest e-book, The Inspiring Life and Beneficial Impact of Entrepreneurs, he establishes the ground rules of the complex system of entrepreneurial innovation in seven principles.
1) Consumer dissatisfaction is transformed into innovation by alert entrepreneurs. The fuel that powers the engine of innovative progress is consumer dissatisfaction. The creativity of entrepreneurs transforms the fuel into the energy of innovative ideas, positive change and economic growth.
2) The engine keeps running because entrepreneurs continuously compete for customer approval. Consumers and customers accept the latest innovation and keep seeking the next one. This relentless search inspires entrepreneurs to out-do each other in trying to bring the next improvement to market. We call it competition, but it’s really the entrepreneurial engine that never stops.
3) Entrepreneurs are empowered by their continuous learning from a constantly changing marketplace. Some call the entrepreneurial process “trial and error”. Error should not be viewed as a negative concept — it’s learning. The entrepreneur gets smarter with every learning occasion. Learning is continuous because the market is constantly changing.
4) Entrepreneurship is the foundation of a productive society. A productive and progressing society is the result of consumers seeking betterment and entrepreneurs seeking to serve them via innovation and improvement. There’s no alternative, if what we want is progress. All regulation and intervention impede the system. The worst kind of intervention — socialism — destroys it entirely.
5) Entrepreneurship flourishes most where there is a supportive history and culture. To preserve and encourage entrepreneurship and to avoid the descent into a sclerotic interventionist economy, we need to weave recognition of the role of the entrepreneur into our culture and institutions. We need to teach it in our K-12 schools and discuss it around the family dinner table.
6) A world without entrepreneurs would be pretty grim. Economics often sheds light via thought experiments. Here’s one: imagine a world without entrepreneurs. No innovation. No progress. No automobiles and no iPhones. It doesn’t take long to realize the losses we would suffer and the quality of life we would lose.
7) The post-pandemic world is the perfect time to observe the impact of spontaneous agility and adaptiveness. There is a tendency for us to focus on the destruction that resulted from the pandemic and the politicians’ misguided imposition of lockdowns. Raushan Gross looks in the other direction: what an opportunity to marvel at entrepreneurial adaptiveness at work in the economic recovery.
Free Download To download Raushan’s latest ebook, The Inspiring Life and Beneficial Impact of Entrepreneurs, visit E4EPod.com/Raushan.
Download the slides from this lecture at Mises.org/MU20_PPT_03.
Recorded at the Mises Institute in Auburn, Alabama, on 13 July 2020.
Key Takeaways and Actionable Insights At the time of the introduction of any innovation, new product, new service, upgrade or improvement to a current offering — any change, in other words — there is uncertainty for both the customer and the entrepreneur. The customer does not know how to assess the value of the new offering, and the entrepreneur does not know if the customer will decide in favor of choosing the new offering. That’s a lot of complexity to deal with.
Uncertainty can’t be eliminated from business, and, for the entrepreneur, it’s an anxious state of mind when knowledge is absent. Happily, there are tools to help bolster confidence in facing knowledge absences. Mark Packard introduced several in our E4E podcast #73.
1) Use the most appropriate decision logic. All knowledge absences are not the same. There are some unknowns that are knowable — such as costs of goods or market size. And there are some unknowns that are unknowable — such as the future behavior of individuals making choices in a changing and competitive marketplace.
There is also a cost of obtaining more data or more knowledge to fill gaps even when they are fill-able. If the cost of knowledge is high, and the risk of loss from not having the knowledge is low, then it might not be worth pursuing additional knowledge.
There are two types of strategy available to the entrepreneur. There’s a choice between “predictive logic” in which the entrepreneur undergoes more cost to get better data to make a prediction about the future, or “adaptive logic” in which the entrepreneur decides to stick with the amount of information currently available and proceed anyway, being sure to be doing so only when risk of loss is limited, i.e. going with the gut but not betting the farm.
For example, a very high risk factor in an entrepreneurial judgment would be how much the production inputs will cost. But collecting that information is typically pretty low cost, and it may be easy enough to get a price guarantee. So, while predictively estimating total costs is ‘uncertain’ or unpredictable in a strict sense, an adaptive strategy in dealing with uncertain costs is not worth the trouble. A predictive strategy is probably better.
A counter example would be whether consumers would be more drawn to an orange logo or a red one. You can get that data, but it would cost a bit to do enough market research to get a definitive answer. But it’s such a low-risk factor that it’s probably better to just (predictively) pick one.
Mark has provided us with a decision logic tool (PDF): Mises.org/E4E_73_PDF_1
2) Information marketing. Customers choose goods and services for emotional reasons — their feelings about whether or not the new offering will improve their lives and give them satisfaction. But before they can make the emotional decision, they want to make sure they have all the functional information they need to even make the consideration. Will it work? Will it work for me?
Consequently, the customer’s uncertainty about how to choose varies with the amount of information they feel they have versus how much they need to make a decision.
The entrepreneur may believe that they have provided all the information possible or required. But customers don’t always absorb it, aren’t always paying attention, or can’t always remember it, or receive the information in the wrong context.
Wise entrepreneurs continuously monitor the target customer’s level of information. A simple who-what-how-why tool will suffice (and you can add when and where if they’re relevant to your market).
Who? — Is it for me? What — what benefit does it deliver? How — how does it work? Why? — Why should I believe the claims.
Make sure customers can answer these functional questions before working on their emotional acceptance.
Here’s Mark’s checklist for Information Marketing (PDF): Mises.org/E4E_73_PDF_2
3) Opportunity Cost Calculator Economics tells us that the cost of choice for a customer is opportunity cost — what does the customer give up by choosing in favor of the new offering? Opportunity cost calculation may not always be a conscious process for customers (although sometimes it is, such as in comparison shopping for a new car), but it is always an active one.
The entrepreneur should therefore calculate the opportunity cost that’s in the customer’s mind. What alternatives are they considering? How dissatisfied are they with alternatives? How do they feel about the capability of the new offering to resolve their dissatisfaction? How do they relate that to price and exchange value? What adjustments can entrepreneurs make to change the calculation in their favor?
Every customer’s calculation is different, so the entrepreneur should collect the data from individuals rather than in survey data. We provide a calculating mechanism you can use: Mises.org/E4E_73_PDF_3
The Value Learning Process This is the final installment in Mark Packard’s value-dominant marketing series on the Value Learning Process. Check out previous episodes and the tools Mark provided to complete the picture of the value cycle and how to manage it.
44 Value Learning Process: Introduction and Overview with Process Map: Mises.org/E4E_44
55 High-Knowledge Customer Tool and Mindfulness Tool: Mises.org/E4E_55
62 City-of-From, City-of-To Tool: Mises.org/E4E_62
69 The Two Kinds of Knowledge Entrepreneurs Must Have, and How to Compound Them: Mises.org/E4E_69
Additional Resources "Dr. Mark Packard's Decision Logic Model" (PDF): Mises.org/E4E_73_PDF_1
"Information Marketing To Target Customers For New Products" (PDF): Mises.org/E4E_73_PDF_2
"Customer Opportunity Cost Calculator" (PDF): Mises.org/E4E_73_PDF_3
Key Takeaways And Actionable Insights For entrepreneurs, the future is not risky, it’s uncertain.
Risk is a calculable mathematical probability, like the result of 1000 tosses of a (fair) coin, or the likelihood of you being involved in a car accident in 40 years of driving on US interstate highways.
The outcomes of entrepreneurial decision making are not calculable. They can’t be computed. Yet entrepreneurs need to make decisions, without having all the facts in hand today, and without knowing the odds of the future results. That’s uncertainty.
Therefore they exercise judgment. Judgment is action. It’s business practice.
Judgment is not guessing, or speculating, or hoping. Judgment is action. Specifically, judgment is taking ownership of property and resources, combining and recombining them in different ways, and using them to make a product or service to offer to the market.
Judgment also incorporates spirit: the imagination, energy, creativity and bravery that entrepreneurs apply when they act. Judgment is human action.
And judgment is continuous. Entrepreneurs are called upon every minute of every day to make decisions of judgment.
Judgment quickly becomes team action.
As firms grow, the founder can’t be the sole exerciser of judgment, or the only one making commitments or acting creatively and imaginatively. In larger, more complex, multi-divisional forms, there are many executives, managers and employees who will be called upon to make judgments. And they will be well-qualified to do so, since they have special skills and tacit knowledge that the rest of the firm, including the founder, do not have.
In fact the founders or owners (or Board Of Directors) actively seek the judgment of the whole firm, in order to achieve the highest level of business success. Often, they make sure that everyone in the firm has enough “skin in the game” (in the form of incentives, commissions and supplemental compensation) to motivate them to give their best judgment.
How does judgment apply in complex organizations?
The firm develops a mix of original judgment and derived judgment (see Mises.org/E4E_72_PDF).
Derived judgment is Peter Klein’s term for the delegating of decision-making power and its distribution throughout the firm. Original judgment — the ultimate decision-making power — rests with the entrepreneur-founder, or may reside with a Board Of Directors or an appointed CEO. Derived judgment is granted to others throughout the firm who have special knowledge and skills to act creatively and imaginatively on the specific uncertainty they face in their positions.
The skill of original judgment is selecting the right people to exercise derived judgment, and designing the right combination of motivating incentives and appropriate controls.
What’s the best combination of incentives and control?
Austrian subjectivism and individualism, along with opportunity cost analysis, can point the way to the best mix of incentives and control.
Subjectivism tells us that there is no objective right answer to questions about which decision rights the owner should delegate to which employees under specific circumstances. The answer to those questions depends on the particular circumstances of the venture, its technology, its market, its business environment, the characteristics of the employees and the characteristics of the owner.
Individualism tells us that there are no generalizations about people — each one has different knowledge and skills and characteristics like reliability or trustworthiness, as well as creativity and imagination. The entrepreneur must judge each one individually, and match them as well as possible to specific circumstances.
Opportunity cost analysis tells us to always weigh the potential upsides and potential downsides of each choice and each appointment of an individual to a position in which they can exercise derived judgment. Exercise judgment about judgment.
Consequently there are four considerations:
Be as sure as you can to choose the individual with the most (and most relevant) tacit knowledge for the area in which they are going to exercise derived judgment.Choose the individual who adds the greatest amount of experience as possible to the relevant knowledge.Make sure the derived judgment of managers and employees is guided by a well-articulated mission (why we do what we do) and business model (how we do what we do). Pay attention to how well these are understood and shared.Balance knowledge and experience against the potential for abuse (misjudgment) and the potential cost of that abuse should it occur. Don’t risk “destructive entrepreneurship”. There are no “bossless” organizations.
Peter Klein points out that even in the flattest of organizational designs (think Wikipedia, Zappos, Spotify, or W.L. Gore) there is always some kind of governance, either of rules or of hierarchical authority, to limit the risk from derived judgment gone awry.
Don’t design an organization with an excessive amount of derived judgment relative to the controls that are in place.
How good are you at original judgment and at delegating derived judgment?
Entrepreneurship in action is real people in real-life situations. It’s not theory. Some are going to be better than others, as indicated by results and outcomes.
It will be useful for you — although not definitive — to self-assess your entrepreneurial judgment and how you delegate it. Gallup’s Builder self-assessment promises to help you build a thriving company and a winning team. Personality assessments like the Big 5 are less specifically tailored to entrepreneurial judgment but can nonetheless shed some light on personality traits that are applicable in entrepreneurship, whether in a small business, a growth firm or a corporate structure.
Additional Resources "Uncertainty and Entrepreneurship" (PDF): Mises.org/E4E_72_PDF
Read Peter Klein's paper (with Kirsten Foss and Nicolai J. Foss), "Original and Derived Judgment: An Entrepreneurial Theory of Economic Organization" (PDF): Mises.org/E4E_72_Paper
Organizing Entrepreneurial Judgment: A New Approach to the Firm by Peter Klein and Nicolai Foss: Mises.org/E4E_72_Book
Key Takeaways And Actionable Insights Negotiation skills are vital to your business.
How well you negotiate will directly affect your cash flows, your costs, your margins, your scale, your financing and your resource allocation. It will indirectly affect your brand reputation, your organizational designs and your delegated management capabilities based on the employment contracts you negotiate.
Negotiation can be taught and learned.
As with everything in business, knowledge absence renders your outcome more uncertain. If your knowledge of the appropriate skills is lacking, you might experience disappointing results when negotiating with customers, suppliers, partners, employees and others in your ecosystem. If your role includes negotiating, allocate some time to skill development.
Negotiation is a process — best results come from knowing how to do the right things in the right order. For example, taking time to establish shared trust at the outset is better than having to recover lost trust later in the process. Think through the process from beginning to end — including what could go wrong or what unexpected difficulties might arise — so that you are never thrown off-track. When you know the correct next step to advance negotiations, you’ll be prepared in advance for that step and be ready with the appropriate action.
Negotiation is responsive to many Austrian principles.
Individualism: Austrian economics helps us think about the individual with whom we are negotiating, rather than the organization he or she represents. Every individual in every negotiation has unique identity, unique needs, a unique set of preferences and a unique context. Understanding individualism helps build trust and rapport.
Empathy: We are trained in Austrian economics to go inside the mind of the customer, in our imagination, in order to empathically understand their dissatisfactions and unmet needs. The same is true when working with a negotiator on the other side of the desk from us. Empathy helps us understand their goals and motivations, and to potentially create some subjective value from that knowledge. And it helps us think about the best tone and language.
Roundaboutness: Your actions early in the negotiation process will emerge as consequences later. If you pitch an absurdly high price at the beginning of a negotiation, thinking it will give you flexibility to lower it later, you’ll lose the trust of the other party and make negotiating harder. Small positive signals at the beginning can become major negotiating advantages later.
Entrepreneurial mindset: An entrepreneur thinks in terms of solving a problem — or relieving a dissatisfaction — for others. The market rewards creative solutions. Negotiation is an entrepreneurial undertaking — think about how to solve the other party’s problem.
Understanding value and communicating value are critical success factors.
Austrians have the best understanding of value. This is a huge advantage. At the outset, be sure to spend significant time communicating to the one with whom you’re negotiating the value of your offering. Value is not related to cost; it’s related to the experience your customer / partner / supplier is going to have as a result of collaborating or contracting with you. Be sure your counterparty can properly assess the subjective value you are going to create for them. If they anticipate the same value that you propose, then negotiation will not be a barrier to an exchange.
You can establish a negotiation culture.
Some companies — especially a small one negotiating with a large one (and especially with the procurement department!) — fall into the trap of feeling overwhelmed or under-qualified. Confidence in both content and process is important for success in negotiation. You can develop a negotiation culture of confidence via training, practice and preparation.
Negotiation is a universally applicable skill.
Mastery of the negotiation process is a life skill as well as a business skill. You’ll feel confident about establishing and managing relationships between your company and its customers, as well as with people you contract to provide services at your home, and in any kind of association or organization. You might find yourself negotiating with your spouse. Use your skills!
Negotiators are happy people.
Sanjay’s sign-off advice: negotiators are happy people. They know the value they are offering, they know how to get the appropriate rewards for their value, they are comfortable and confident with the process of negotiated value exchange, and they know how to resolve conflicts.
Additional Resources "Negotiation" (PDF): Mises.org/E4E_71_PDF
Discover negotiation readiness: PurpleSkyPartnership.com
Key Takeaways And Actionable Insights How do creative entrepreneurs design and build new businesses, new products and new services that grow and succeed? You’ll make a big difference for your own venture if you follow Per Bylund’s advice to Think Better, and Think Austrian. One step in the right direction is to clear your head of thoughts about competitors to fight, markets to invade, beachheads to take, or moats to construct around your business and your brand.
The alternative way of thinking is to envision your business enterprise, your brand or your offering as an island of specialization. What you create, launch, build, grow and sustain is something that is so special that your customers experience a deep and rich feeling of value that they can’t possibly get anywhere else. For your customers, it provides the business equivalent of a visit to (and eventually permanent residence in) a comfortable, amenity-laden resort on a beautiful tropical island, where the staff recognizes and caters to their every wish. There’s nothing else like it.
How can you create one? There are four principles that successful entrepreneurs follow to build their island.
Aim To Please. That’s not the kind of advice you’ll find in business school or textbooks. Yet it captures the core of our Austrian approach to business. The customer is the reason for you to be in business. Aiming to please them is the right way to think about strategy. Aiming to please is a process of observing, listening, studying and empathically sensing what will please customers the most. You aim to understand their ecosystem and their logic, their hopes and their dreams. Your offering is the way you indicate to them that you can fit in to their ecosystem and contribute to their goals. Your business model is the way you arrange your activities to please customers once you’ve fully understood their preferences and desires. Competition, cost, resources and other considerations are secondary.
Don’t copy — move beyond. Military business metaphors depict competition as conducting wars over business territory, or fighting for customer attention. In Per’s Austrian way of thinking, there is no new value for customers when a firm merely copies what is already offered by others. There’s no point — no value — in fighting over market spaces. Value emerges from what’s new and better and different. Smart entrepreneurial island builders assess the current landscape, predict where the customer will be in the future, and navigate to that place to build a new island.
Build from strength. Entrepreneurs distinguish what is unique about themselves, their partners and employees, their processes, their brand and their resources that can be of benefit to customers. Much of the uniqueness is subjective — the owners’ or the business’s identity, their unique knowledge and expertise, their relationships and interconnections that can co-ordinate the assembly of specific solutions. It’s not about arraying more destroyers on the battle lines than the opponent; it’s arraying a set of uniquely desirable and attractive brand features and attributes that are attractive to the customer.
Maximize value not output. The island builder keeps on building. Not for scale or market share or maximizing output. The direction of growth is to maximize value. Value is a feeling of satisfaction in the customer’s mind. Maximization, in this view, refers to higher levels of satisfaction, over a wider range of experiences, for more customers on more occasions. Maximization is not a quantitative or mathematical concept, to be compared with rivals to ascertain who is “winning”. It’s a qualitative concept — what quality of value has been experienced, and how can it be improved.
The four guiding principles — aim to please, in unique ways, based on your own identity and strengths, always thinking about the value that’s experienced by customers — lead to beautiful businesses. If you are developing visual island imagery in your mind’s eye as you read this, think of a balmy climate, vibrant flowers and trees, bubbling streams and distinctive animals and birds. Let your imagination run free in conjuring up beauty — that’s what entrepreneurs do as the start, grow and sustain their businesses.
Additional Resources "How Entrepreneurs Build Islands of Specialization" (PDF): Mises.org/E4E_70_PDF
For a full-length essay by Per Bylund ("Make Your Startup an Island"), download our latest free e-book, Austrian Economics in Contemporary Business Applications: (PDF): Mises.org/E4B_eBook
For a shorter essay, see Per’s Entrepreneur.com article, "Forget the Moat and Make Your Startup a Tropical Island": Mises.org/E4E_70_Article
For a full exposition of the Austrian theory of the firm and the concept of islands of specialization, see The Problem of Production: A New Theory of The Firm: Mises.org/E4E_70_Book
Key Takeaways and Actionable Insights Innovation is one of the keys to business success. The world is changing at such a pace, and your customers’ preferences are changing so fast, that your business has to change at the same speed, or even faster. How to keep up is a part of the entrepreneurial challenge.
Mark Packard has a big insight about how entrepreneurs manage innovation. Producers don’t innovate. Customers do. That may sound a little odd, but Mark’s Value Learning Process makes it clear. Customers are always looking for new value. They’re always dissatisfied, seeking to make things better for themselves. They know what’s wrong or disappointing or less than perfect with their current experience. And they’re always looking for new solutions, better ways to do things, improved experiences. If you know how to interpret their behavior and their dissatisfactions, they’ll tell you what to do.
Then, as a producer, you need to figure out how to do what the customer wants.
Two kinds of knowledge and two kinds of thinking are essential. Entrepreneurs need to know about what customers want. Then they need the know-how to deliver the solution. Mark calls these two kinds of knowledge: Needs Knowledge and Technical Knowledge. They require two different mindsets.
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Download "The Two Kinds of Knowledge Entrepreneurs Must Have" (PDF) at Mises.org/E4E_69_PDF.
Mindset 1: Think like a customer. If customers are the ones who innovate, entrepreneurs must be able to think like customers. Really think like them. Be dissatisfied. Demand better. We call the required entrepreneurial skillset “empathy”. It’s sentiment mirroring – your brain and sensory system has to be able to mirror those of the customer. You must feel the same feelings they do. It can be done. Practice it.
A big part of the economy is consumers innovating for themselves. Think like they do. Make a list of what’s most important to you. These are innovation opportunities that you know more about than anyone else. Think about how you’d like to improve your experiences in these areas. What features can you not do without? Why? Think like a customer. Start with your own problem in order to immerse yourself in the problems others want to solve.
Mindset 2: Think like a producer. You love your customers. You want to please them. Develop the technical knowledge to do so. This doesn’t necessarily mean high technology. If you want them, for example, to enjoy a new kind of convenience grocery store with an organic food emphasis and lots of innovative food-to-go options, you need to know store operations, supply chain logistics, inventory management, and flexible / adaptive hiring practices. You need mastery of technical knowledge.
And while you don’t need to be a programmer, you do need knowledge of the latest technologies from a producer’s viewpoint: how do these technologies help you to deliver a better, faster, lower cost customer experience. Geeking out on these technologies is a good idea for producers.
Knowledge Compounding. Many innovative solutions come from combining two existing pieces of knowledge. Combining needs knowledge and technical knowledge can produce a new solution to the market. Mark also talks about combining active knowledge — what we know about that’s prominent in our mind — with semi-active knowledge — what we know about that we don’t use every day or is stored away deeper in our memory that’s hidden by our recency bias.
These and other knowledge combinations can generate big ideas. In fact, Curt Carlson in episode #37 told us that combining knowledge is not just additive, it’s multiplicative. Knowledge compounds when we combine it, leading to faster innovative progress. Utilizing Mark Packard’s knowledge combination techniques is the way to get there.
Additional Resource "The Two Kinds of Knowledge Entrepreneurs Must Have" (PDF): Mises.org/E4E_69_PDF
Key Takeaways and Actionable Insights What is Entrepreneurial Intelligence? For Steven Phelan, “It’s all about the spark” — the moment of inspiration in combining disparate elements together to develop a new solution. Humans draw on “the fringes of consciousness” to create new constructs.
Entrepreneurs also take risks, investing time, talent and treasure in their venture in hopes of gain, yet understanding that they could lose something of value to them in the endeavor.
How do we contrast Entrepreneurial Intelligence and Artificial Intelligence? First, we need to differentiate between the narrow and general forms of AI. Narrow AI is software that can solve problems in a single domain. For example, a Nest thermostat can raise the temperature or lower it in a room according to a pre-set rule. “If this, then that” is the general rule for this kind of intelligence. The parameters are designed by the programmers.
For the unstructured problems of life and business, a truly intelligent computer would have to figure out for itself what is important. Part of the problem is that understanding or predicting human motivations — as entrepreneurs do — requires a “theory of mind”, an understanding of what makes humans tick. Entrepreneurs need empathic accuracy — unavailable to AI — to anticipate the needs of consumers. A sentient computer would need self-awareness or consciousness to truly empathize with humans, and have a set of values with which to prioritize decisions.
What’s the role of machine learning? If you work in a business that generates a lot of data, it can be mined by data scientists for patterns, and those patterns might indicate a better way to respond to customer needs. The richest source of data is behavioral — like choosing songs to listen to on Pandora. Machine learning can detect a pattern of what kinds of sings a user chooses most. A human interpreter can translate those patterns into preferences — in other words, motivations are embedded in behavior and machine learning can help entrepreneurs extract them.
So, the entrepreneur’s best resource is entrepreneurial intelligence. The psychologist Howard Gardner helped us to recognize many types of intelligence, including math, language, spatial, musical and social. There are two types that might be indicative of entrepreneurial intelligence: EQ (Emotional intelligence) might be associated with intensified empathic skills and empathic accuracy; CQ (Curiosity Intelligence) is linked to the kind of creativity that finds solutions by combining elements on the “fringes of consciousness”, as Hubert Dreyfus puts it.
Can entrepreneurs and business owners assess their own entrepreneurial intelligence? There are scales to measure EQ and Creativity. Here’s a link to an entrepreneurial quotient assessment: Mises.org/E4E_68_QA
And here is a more action-oriented self-assessment we developed for E4E: Mises.org/E4E_68_SA
The bottom line: Entrepreneurs need knowledge of how to profitably satisfy customer preferences given the resources at hand. This is not a trivial requirement. It is not possible to pre-state all of the uses for a given resource nor to compute the payoff for a given application. Current computational methods are thwarted without a complete list of entrepreneurially valid moves and the payoffs from such moves. No amount of growth in processing power, data communication, or data storage, can solve this problem.
The late Steve Jobs is often held up as the epitome of a successful entrepreneur. His founding of Apple, ousting by his own board, and subsequent return to rescue the company, and then make it the most valuable publicly traded company in the world is the stuff of legend. One of the apparent secrets of his success was to understand that “people don’t know what they want until you show it to them. That’s why I never rely on market research. Our task is to read things that are not yet on the page.”
This ability to “read things that are not yet on the page” lies at the heart of the concept of empathic accuracy. Empathic accuracy is “the ability to accurately infer the specific content of other people’s thoughts and feelings”. Until AI can do this, Entrepreneurial Intelligence is a better tool for the innovating entrepreneur.
Additional Resources "Entrepreneurial Intelligence vs. Artificial Intelligence" (PDF): Mises.org/E4E_68_PDF
"Entrepreneurial judgment as empathic accuracy: a sequential decision-making approach to entrepreneurial action" by Jeffrey S. McMullen (PDF): Mises.org/E4E_68_Article
"Are you ready to be an entrepreneur?" (PDF): Mises.org/E4E_68_QA
"Entrepreneurial Self-Assessment" (PDF): Mises.org/E4E_68_SA
Every successful business is built on empathic understanding of customers’ preferences. As we know from the theories of Austrian economics, the preference scales of every individual are highly subjective, idiosyncratic, context-dependent, and highly changeable. How does an entrepreneur develop the appropriate level of understanding? Can this understanding be a source of business-building advantage?
We talked with Trini Amador, a returning guest and an in-demand global branding and marketing consultant who has developed an effective process for every entrepreneur to achieve a breakthrough level of insight into customer motivations.
Customers bond with businesses and brands they love and trust. The choices they make have their own internal logic. Entrepreneurs must develop insights into their motivations. Insights are the lifeblood of any brand- or business-owner, says Trini. Why do customers behave the way they do — especially in buying or not buying? Insights tell you. They become the difference between “just a business” and a brand that successfully delivers against the needs of their customers.
Insights are the entrepreneur’s understanding of customers’ motivations, values and attitudes. They’re the “Why” in why people act the way they do. Always emotional, always subjective. Entrepreneurs who understand “Why” can design stimulus or communication or innovation to motivate buying behavior.
There’s an insights generation process. It starts with identifying the people you wish to serve. Trini recommends a focus on your “core target” audience — not a general definition of who might buy, rather a highly specific profiling of your most likely and best prospects. Mark Packard, in episode #62, called them “high knowledge” customers. They know what they want, they know the category and they’re precise about what experience is satisfactory and what is not.
There is no shortage of data for you to utilize. Make sure you select the most important and useful data:
Attitudinal data: how your customer feels, especially if they are expressing dissatisfaction;
Behavioral data: behavior reveals preferences — “motivations are embedded in behaviors”.
The best sources of data are first hand observation and one-on-one conversation.
Organize your data in an insightful way. To avoid data overload (there’s so much of it to collect!) Trini suggested couple of organizational techniques.
One is visualization: build a visual profile of the customer with photos and notes indicating their hobbies, favorite brands, activities — visuals that depict their behavior and preferences.
A second is personalization: write a composite profile as if it were one individual and use it as a “one perfect customer” persona.
The objective is to change behaviors. Insight is the required key to unlock the possibility of doing so. Trini cited the example of his own wine brand from Sonoma County, California: Gracianna. For example, the objective may be to get people to visit the tasting room who have never visited before. That’s a behavior change.
Why do people behave the way they do? One inquiry tool is the 5 Why’s, which is a way to examine the sequential rungs on the individual’s means-ends ladder to identify their highest value, the motivation that is ultimately driving them. Trini used the example of why some people feel better about buying a Tesla than an alternative vehicle. Ultimately, they want to feel that they are better citizens of the planet. Trini entertainingly ascends the rungs of the ladder from “need a new car” and “get from A to B” to arrive at “the feeling of being a better citizen”.
Using these tools, we arrive at a deep understanding of why customers make the choices they make — that is, an insight.
The Insight feeds the Behavior Modification tool. The definitive “Why?” that emerges from the 5 Why’s inquiry becomes the current state in the behavior modification tool. This tool has two components:
Attitude Modification: behaviors are related to attitudes, and so to change an attitude can lead to a change in behavior. Attitude modification documents the FROM (the attitude we want to change) and the TO (the new attitude we want to encourage).
Key Marketing Platform: a marketing platform is a staging point for all initiatives aimed at achieving the desired attitude among target customers: communication, promotion, innovation, distribution, relationship.
Continuing the Tesla example, we want our prospective customer to feel that Tesla is the most progressive electric car that helps save the planet in the coolest, most prestigious ultra-premium way. If we can get them to feel that way, they’ll buy. The entrepreneur imagines the future behavior, and then acts through the marketing platform to cultivate that motivation.
How? Consider all resources that fall under the headings of communication, innovation, promotion, expanded distribution, and enhanced relationships. Experiment, experiment, experiment. Test, test, test. We’ll discuss the techniques in a future episode of Economics For Entrepreneurs.
Additional Resources "Insights Statement Template" (PDF): Mises.org/E4E_67_PDF_A
"Marketing Platform Tool": (PDF): Mises.org/E4E_67_PDF_B
One-Question Survey with Free Wine Giveaway: E4EPod.com/Question
Key Takeaways and Actionable Insights A growth business is what John Rossman, in episode #50, termed a flywheel. Using Amazon.com as an example, he gave us this simple image.
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The flywheel looks simple, but in reality it’s quite nuanced. Lower prices and a great customer experience will bring customers in, Bezos reasoned. High traffic will lead to higher sales numbers, which will draw in more third-party, commission-paying sellers. Each additional seller will allow Amazon to get more out of fixed costs like fulfillment centers and the servers needed to run the website. This greater efficiency will then enable it to lower prices further. More sellers will also lead to better selection. All of these effects will come full circle back to a better customer experience.
John Tamny sees the American entrepreneurial economy as a beautiful and productive flywheel (see Mises.orgE4E_66_PDF).
Why are Americans so entrepreneurially focused? We descend from “the crazies” — the other thinkers who came from around the world, dissatisfied with their lives, and willing to cross oceans and borders to get to a place that offers no security but offers freedom. They took the ultimate entrepreneurial leap. We got the nut cases. Steve Jobs, for example, was of Syrian descent. Could he have started Apple in Syria? No.
Entrepreneurs lead us to a better place. John’s definition of an entrepreneur is someone who has a vision that everyone else thinks is ridiculous, yet they follow it anyway. They have no time for the way things are done today. They want something different. And to win consumer acceptance, what’s different must also be better. So they quite literally lead us to a better place. Horse drawn carriages weren’t enough, so Henry Ford gave people something different. Everyone wanted Blackberry phones when Steve Jobs brought out the iPhone, and he quickly demonstrated its superiority. Every entrepreneurial act is speculation — there is never certainty that people are going to want the new product. That’s what is so important about entrepreneurs.
Entrepreneurs need to attract intrepid finance and intrepid financiers. Silicon Valley is littered with VC’s who turned down Facebook, and turned down Amazon. Founding entrepreneurs think differently and have a vision that is far out of the norm, and they need to be matched with financiers who can be strong supporters and collaborators on the path to a better place. Irrespective of whether it is from Wall Street or Sand Hill Road, or from visionary friends and family, it’s critically important that we figure out a way to get financing to brilliant people. Government restrictions on entrepreneurial activity are certainly barriers to growth, but so is failure of imagination on the part of capitalists.
Intrepid lending takes place far away from banks. Unspent wealth is the source, and the more unspent wealth one person has, the more risks they can take. We tend to complain about the antiquated and sclerotic banking system, but it has nothing to do with entrepreneurs and innovation. Banks make loans to entities they know will pay them back. Entrepreneurs fail 90% of the time. Banks want nothing to do with innovation.
Those with unspent wealth are the most crucial people in the economy when they match their unspent wealth with entrepreneurial talent and vision. The more unspent wealth they have – and the less the government takes away from them in taxes — the more intrepid they can be in investing it. When we tax away the wealth if the richest, we tax away the most important wealth of all — that which has the highest odds of being directed towards new ideas that, while they look promising, have high odds of failure.
More and more of us have the opportunity to become entrepreneurs, if we harness the flywheel of original ideas that attract intrepid capital. One of John’s many books, The End Of Work, describes how we are all now so enabled with interconnectivity to resources that we have the chance to make money by doing what we love. Our passion can become our job. If we are able to imagine a future place that is better — that improves the lives of individuals — we can create a growing business. The more of us who can do this, the more we grow the whole economy — which, after all, is made up of individuals. If we can also attract that intrepid capital that John refers to, growth becomes faster and higher.
Besides The End Of Work: Why Your Passion Can Become Your Job, John’s books include Popular Economics: What The Rolling Stones, Downton Abbey and LeBron James Can Teach You About Economics, and Who Needs The Fed: What Taylor Swift, Uber, and Robots Tell Us About Money, Credit, and Why We Should Abolish America's Central Bank.
Additional Resource "John Tamny's Entrepreneurial Flywheel" (PDF): Mises.org/E4E_66_PDF
Key Takeaways and Actionable Insights When we talk about entrepreneurial alertness to opportunity, it can sound pretty vague. What exactly does that mean? How is alertness translated into profitable action?
This week’s guest, David Bienstock, provided us with a very precise example. He had just started his media buying services business when a phone call came in. Do you provide service in the category of political advertising? David’s answer was yes. There was no reason for it to be otherwise because there was no information at the time that would indicate any differences between media buying services in the political advertising category compared to the commercial advertising category.
He was able to transfer existing knowledge from his expertise in media buying and placement, and also develop more and more new knowledge. He thereby identified more and more ways in which political advertising was specialized — factors of timing, competitiveness, geography, pricing, regulation, and many more. David built his own island of specialization and became the foremost expert in a burgeoning field.
What can we learn from following David’s entrepreneurial journey?
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1) The alertness we talk about that entrepreneurs display to opportunities can be triggered by the smallest piece of data. For David, it was one phone call. His instantaneously positive and open response led to a long and successful journey.
2) Wherever there is business expenditure there is an opportunity for an entrepreneurial business service. The business we discussed in episode #65 is campaigning — political, public affairs, ballot measures. How much is spent on campaigns? A lot. There’s the opportunity.
3) The best entrepreneurial businesses are often the ones that clients put you into. David’s inbound phone call was a new client stating an unmet need. That’s all the invitation the alert entrepreneur requires.
4) Opportunities, once seized, expand. David has expanded his original business by adding many related services for current clients to utilize, including multi-channel media, market research and analytics. In addition, he has added multiple new businesses in related spaces. He’s been creative, he’s taken action, he’s been constantly looking for new opportunities that are complementary to the first one that he spotted. However small the start, the next steps will quickly become apparent to the entrepreneur who is not only alert to opportunity but also to expansion and growth.
Additional Resource "David Bienstock’s Logic of Customer-Led Growth" (PDF): Mises.org/E4E_65_PDF
Although many claim "nobody saw this coming," some entrepreneurs planned ahead and also have found ways to cater to customers under new conditions.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "Some Insightful Entrepreneurs Planned for a Pandemic"
Key Takeaways and Actionable Insights Follow the guidance of the Austrian Business Model. The entrepreneurial business model is built on a set of important economic principles. Wandering away from the entrepreneurial pathway can lead to errors that Per Bylund christened UN-trepreneurship.
Focus on serving consumers and customers. The purpose of a business is to create and keep a customer. It’s a demanding task, because customer needs are continuously evolving and changing, and competing entrepreneurs are vying for their dollars. It is critical to maintain intense focus on service to customers.
There is a lot of distracting entrepreneurial advice. You might encounter instructions to “identify and exploit market gaps” or to “seize opportunities”, for example. But there are no such things as gaps to fill or opportunities to grab. The language makes it sound like these are objective phenomena, unmasked by analytics. They’re not. The right strategic platform for entrepreneurs is to focus on serving customers by identifying their preferences and meeting them.
Every hour you spend, every strategic thought you develop, should be focused on the customer.
Productivity lies in returns on customer satisfaction. You’ll hear a lot of talk of generating returns, especially on funds invested by lenders or VCs. These returns are emergent outcomes of other activities. Even profit is an indirect outcome more than it is a goal.
Ludwig von Mises wrote in Human Action that the task of the entrepreneur is to use capital “to the best possible satisfaction of consumers”. Anything else “hurts people’s well-being”. Customer sovereignty, in the language of economics, means that the customer decides, by buying or not buying, what will be the return to the entrepreneur on their investments of time, effort and money. Productivity results from the most efficient assembly and combination of resources to produce customer satisfaction.
Sometimes, business literature and business practice can deviate from this standard. Often, for example, the pursuit of “scaling” — making a firm big, in numbers of employees, say, or number of transactions, as fast as possible — can divert resources from serving customers to serving the needs of infrastructure growth and bureaucracy. Customer satisfaction should be the only focus.
Understand subjective value. The economic concept of value is challenging to master for entrepreneurs. Value is an experience in the customer’s mind. We’ve also identified that it’s a process — a learning process customers initiate and actively conduct to make a decision as to whether an offering has potential value (“I might like it”), relative value (“I think I might feel better about buying X versus Y”), exchange value (“I am willing to pay Z dollars at this point in time to acquire X”), experience value (“my satisfaction was more / less / the same as I expected”) and assessed value (“looking back on it, my value experience was worthwhile and worth repeating unless something with more potential value is offered to me”). All through this cycle, the customer is active in the marketplace, learning about alternative offers, changing their consumption preferences, interacting with other people with different experiences and preferences that might be influential, receiving advertising messages, and generally rearranging their personal value recipe.
It's a challenge to understand and a challenge to keep up. An entrepreneur’s understanding of subjective value is a critical business success component. Importantly, the business school concept of “creating value” can be unhelpful. Value is created by the customer. The role of the entrepreneur is to understand how to fit in to the customer’s life and contribute to it, making possible (“facilitating”) the mental experience we call value.
View pricing as a discovery process, not as an expression of market power. Another challenge of the economic way of thinking to conventional business writing is the understanding of prices. Prices are emergent market signals, ultimately determined by the consumer’s willingness to pay. Prices can’t be “set” by the entrepreneur. There is no “pricing power”. Margins can not be calculated by determining the price you want to sell at and then subtracting the costs you have imposed on yourself.
Entrepreneurs discover prices — the market reveals them. Attempts to use pricing as leverage to grow market share irrespective of costs and profits are doomed to failure if it is later discovered that customers become conditioned to the artificially low prices and resist returning to a higher price.
Follow the entrepreneurial ethic. Per Bylund has emphasized that there is an entrepreneurial ethic that applies. Entrepreneurship is the service of meeting customer needs. Profit emerges as a result of successfully accomplishing this task. Profit is necessary to maintain the service, but it’s not necessarily the primary goal. In some ways, entrepreneurship is a calling. There are social and emotional benefits for taking on the role of the entrepreneur — we can classify them as psychic profit. There is purpose and meaning in the entrepreneurial life.
This should not be confused with the misguided economics of so-called social entrepreneurship or impact entrepreneurship: attempting to rearrange and redistribute resources in society through the active application of the entrepreneur’s personal preferences. Only the customer’s preferences in the marketplace can direct the best allocation of resources. The entrepreneurial ethic is to follow and serve.
Additional Resource "Avoiding The Errors of UN-trepreneurship" (PDF): Mises.org/E4E_64_PDF
Key Takeaways and Actionable Insights Consider these findings from a 2017 report from the G20 Global Partnership For Financial Inclusion, titled Alternative Data: Transforming SME Finance.
Access to financing remains one of the most significant constraints for the survival, growth, and productivity of micro, small and medium enterprises (SME’s).
Digital SME finance, using alternative data, offers an extraordinary opportunity for addressing…this problem.
The world’s stock of digital data will double every two years through 2020. Every time SME’s and their customers use cloud-based services, conduct banking transactions, make or accept digital payments, browse the internet, use their mobile phones, engage in social media, buy or sell electronically, ship packages, or manage their receivables, payables and record-keeping online, they create digital footprints. This real-time and verified data can be mined to determine both capacity and willingness to pay loans.
A rapidly growing crop of technology-focused SME lenders are putting the use of SME digital data, customer needs and advanced analytics at the center of their business models, setting forth new blueprints for disrupting the SME lending status quo.
The report refers to 800+ innovative digital SME lenders. Colloquially, we can refer to them as FinTech.
Dusty Wunderlich, a subject matter expert and seasoned investor in the FinTech field, discusses this lending landscape.
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Download the full PDF graphic at Mises.org/E4E_63_PDF.
Entrepreneurs need capital in the present to deliver goods and services to consumers and customers in the future. Entrepreneurs take scarce resources and apply them to what they believe the consumer will want at a future date. In order to do that entrepreneurs need capital in the present so they can deliver on those goods and services to the consumer in the future in the hope that their forecasting is correct.
That’s why entrepreneurs need to understand capital financing and modern day capital markets. Access to capital has historically been difficult and expensive. Today, it’s becoming easier and less expensive, aided by the digital data revolution referred to in the report quoted above. It’s important for entrepreneurs to be familiar with the new field of FinTech and how to navigate it.
Dusty Wunderlich suggests that entrepreneurs map out the financing alternatives on the axes of their own business stage versus the cost of capital. Cost of capital refers not just to interest rates and fees, but to the requirements that lenders can impose on entrepreneurial borrowers. At the very earliest stages, “friends and family” lenders, angel investors and seed stage venture funds will all require equity stakes, and ratchet up those stakes via deferred interest and debt-to-equity conversion requirements. These early investors perceive themselves as taking a high amount of risk, and the start-up entrepreneur typically has little or no collateral or leverage in negotiation. The best negotiation stance is to generate competition among investors with the quality of the customer value proposition and the business plan and revenue model.
Fintech financing is now available at the earliest of entrepreneurial growth stages. Today, from the very outset of the business journey, start-ups and small businesses can access a range of financing types – debt, convertible notes, equity and SAFE’s (Simple Agreement For Future Equity) - via crowdfunding platforms like nextseed and others like it. Marketing your business to investors on platforms like these taps into your existing skills in marketing and social media, and doesn’t require you develop capabilities in pitching your business that you might not have mastered.
As you advance along the growth curve, FinTech options expand and may offer you the best-priced capital on the market. As a result of the expansion of FinTech based on alternative digital data sources, the potential for connecting your particular business to a well-matched and well-priced source of capital is greater and more precise than ever. Dusty cited a couple of examples like Kabbage (where, incidentally, entrepreneurs can currently get help with PPP loans). There are several more. Because of the competition in the FinTech market and the quality of the information they utilize, capital from these lenders is well-priced – probably approaching Mises’ originary rate of interest, Dusty observes, in a testimony to Austrian free market principles.
It is when your business represents the least risk to lenders that big banks offer their high-requirements business loans. At a later stage of your business journey, banks will lend money against collateral and will impose additional onerous requirements and loan covenants. The entrepreneurial embrace of uncertainty is not for them! Bank financing is at the top when it comes to cost of capital and is to be approached cautiously. It is with bank financing that entrepreneurs become entangled with the negative effects of Federal Reserve repression of interest rates, that can mislead them into making incorrect investment decisions.
The cost of bank financing for mature companies revolves more around terms and covenants than interest rate percentage points. Banks are transactional, whereas entrepreneurs are operationally minded. This can cause a lot of friction if covenants, terms and triggers are not properly set. Entrepreneurs must pay attention to every detail in the loan contract. Great businesses can be ruined because of draconian covenants and triggers banks put into their loan contracts.
Indicated action: Entrepreneurs will be well-rewarded for fully investigating and understanding the emerging world of FinTech and digital SME finance. Be sure to calculate the full cost of capital – not just interest rates – and weigh all options.
Additional Resource "Financial Capital Options For Businesses At All Stages" (PDF): Mises.org/E4E_63_PDF
Key Takeaways and Actionable Insights Innovation and marketing are the two most important functions of entrepreneurial business: bringing innovative new goods and services to market, and convincing customers of their value. On the E4E podcast, we are providing a detailed exposition of Professor Mark Packard’s deep analysis of exactly how customers arrive at, and act upon, their assessment of value. Mark’s insights provide entrepreneurs with a powerful tool to fine tune value propositions for maximum marketplace results.
Value is a process. Value is a feeling that the consumer experiences. To arrive at that experience, consumers actually follow a process — a learning process. This process is actively conducted by the customer — it’s conscious, subjective, sequential, and continuously fine-tuned. There are 5 process steps:
Predicted value (what will the experience be like?)Relative value (comparing that predicted value to existing solutions)Exchange value (putting a price on willingness to pay for the solution)Experienced value (what was it actually like?)Value assessment (comparing experienced value to predicted value). In other words, it’s a cycle.
The first overview of the cycle was presented in E4E episode #44. Next, in Episode #55, Mark provided two tools for entrepreneurs to manage the process: the High Knowledge Customer Tool and the Mindfulness Tool. The first one ensure entrepreneurs talk to the right customers to gather knowledge, and the second helps them focus on the right things.
In the current episode, Mark helps entrepreneurs to identify and gather the right data for the management of the Value Learning Process.
Value Ethnography Ethnography can sound a bit like it’s the activity of explorers in safari suits. But it’s actually the most modern data collection method for the new digital economy. The term is used to describe the process of embedding oneself in the situation that is being studied — in this case, the actions the customer is taking, and the decisions and choices they are making, regarding your value proposition and your business. Why do they do what they do? Why do they choose how they choose? Can they even explain it to themselves? In many cases, the answer is no. Ethnography doesn’t attempt to ask for an explanation or accept the one that’s given. Ethnography observes — it’s a journal record of behavior. And today, ethnography can be conducted via video and clickstreams as well as physical presence. The data streams are rich and deep.
Mark’s lesson to entrepreneurs is to be constantly observant, to watch and monitor what customers do, how they act, what they choose. At every step, ask them why they did what they did. But they might not be able to explain. Some actions may be made without too much thinking. Some may be habit. But, Mark explains, “The reasons are embedded in the behavior.” The reasons people do the things that they do and make the choices they make are embedded in the behavior itself and the observant entrepreneur is able to dig out those embedded reasons.
Therefore, there’s a next step after ethnographic observation: interpretation. And Mark offers us another tool to help us.
City Of From / City Of To Customers are engaged in a continuing journey. Where they start from is their current experience. Call this starting point “the City of From”. And they are always dissatisfied, always seeking something better, aiming at some improvement in their experience. Call this new experience “the City of To”, the destination they want to reach.
The tool Mark calls “City of From / City of To” maps the customer’s journey. To understand where they are now, the entrepreneur as observer collects data or deduces findings about the customer’s current place — current experience - and their reason for being there. Then the entrepreneur as analyst projects the customer’s desired future experience in the City Of To. Why would they move there? Why do they like it better? What was wrong with the City of From and how is it fixed in the City of To?
Download the CITY OF FROM / CITY OF TO Toolkit at Mises.org/E4E_62_PDF.
CITY OF FROMCITY OF TOAttractionWhy am I here?Why did I move?DoubtsWhat am I unsure about here?How are my doubts overcome?What ChangesWhy is this better than before?What will be even better in the future?DissatisfactionsWhat is missing here?What is better here?Motivations to changeWhy should I move?Why did I move?What would I say?The case for moving.The justification for having moved. Empathy and The Customer Knowledge Generation framework. The core skill for entrepreneurs in the analysis of the customer’s experience in the value learning process is empathy — being able to feel what they feel. In fact, as Mark points out, that’s literally impossible. You can’t feel another’s feelings. But the brain is capable of amazing feats of imagination and projection — what Mark calls counterfactuals. You can imagine what another person feels and project that feeling onto your own experience so it’s as if you are experiencing it yourself. You create a mental model in your own mind of the feelings in theirs. It’s a skill you can practice and one that is crucial to unraveling the customer’s value learning experience — to experience it the way they do.
Mark provided a framework that helps you with sharpening your empathic diagnosis capability: Customer Knowledge Generation. There are 5 components, which are actually 5 pitfalls to avoid:
Talk to the right customer — “high knowledge” customers who can truly help you understand value experiences that are most relevant to your business success. We discussed these high knowledge customers and how to identify them in episode #55.Make sure these customers are intrinsically motivated to share the right information. Don’t pay them to participate in your ethnography, but make sure they know there’s something in it for them - a better experience in their future.Assess your own motivation to learn — you must be sincerely committed to the learning process. Don’t “just ask”. Don’t just go through the motions.Be conscious of and actively seek to identify distortions in the information you are receiving from the customer — misstatements, inexact vocabulary, information loss, inattentiveness, looseness in communication. Interpret with rigor.Be aware of your mental model — the experience that you are imagining the customer is having — at all times to make sure it remains congruent, and that the information you are receiving is important and fits the model. Next: changing the customer’s mental model. If you practice ethnography and Customer Knowledge Generation, you’ll allocate a lot of time and effort to construct a model in your own mind of what the customer is experiencing in theirs. The next step is to flip the switch. You are going to adjust their mental model. You want them to consider your value proposition. That’s new for them. They don’t yet have a model of what it feels like to choose your service, or what it might feel like to experience it in the future. They haven’t formed a picture of relative value versus other options. You must provide them with that new model. We’ll talk about that in the next episode with Mark.
Additional Resources “City of From — City of To” Knowledge Graphic (PDF): Mises.org/E4E_62_PDF
Key Takeaways And Actionable Insights Austrians maintain an active focus on business ethics. Why? It’s simple self-interest. As entrepreneurs, we want to succeed; individuals can’t do it alone, we need to co-operate with other people. In continuing transactions and exchanges between two parties, each side must benefit, otherwise one side will not be open to further transactions in the future, and will terminate the relationship.
Ethical entrepreneurs focus on the long term for their entire business ecosystem. That’s why Henry Hazlitt (in The Foundations Of Morality) emphasized morality as simply a focus on the long term: what he called The Long-Run Principle. Entrepreneurship always maintains a focus on the long term (i.e., beyond individual one-time transactions), and good business ethics is simply good business sense in this perspective. Transactions that are mutually beneficial are ethical.
Yousif Almoayyed extends this perspective to the entire business ecosystem: customers, employees, vendors and suppliers, and the community in which a business operates.
Good ethics generate sound business relationships. As we have emphasized many times, business and brands make a promise to their customers. Those customers must have faith that the promise will be kept. Otherwise there will be repercussions such as termination of contracts, and loss of faith in the future relationship. Customers place more trust in a company that demonstrates a higher level of ethics. They’ll pay more and seek to extend their relationship. Banks will extend better terms.
Unethical behavior destroys trust and co-operation and has a very high cost. As Stephen Phelan pointed out in Episode #56, relationships built on trust operate faster with less friction. Trusting partners co-operate better. Information flows unimpeded. Losing these advantages is highly damaging.
Your good business ethics are important to the individual development, personal commitment and productivity of your employees. The company that is ethical will be able to develop the potential of its employees to a higher level. Ethical entrepreneurs give their employees freedom to take initiative, within the norms and cultural guidelines that emerge naturally from collaborative attitudes.
The tactics of implementation can vary by level and role. Front line workers are paid for their production; managers are paid to enhance the productivity of those they manage. Incentives are aligned via wages and salaries and profit sharing so that every employee is looking out for the best interests of the company. When they are, employees think beyond their immediate task; when they do so they are thinking at a higher level. An ethical firm develops employees’ sense of the bigger picture and finding their highest and best role; employees know they’ll be rewarded for doing so.
It’s not appropriate to try to incentivize employees by paying them above market rates. It’s the wrong incentive. They will become defensive and self-protecting; they’ll avoid hiring people to work in their department who might prove to be smarter and more productive, because they become fearful of protecting their over-compensation, knowing they can’t reproduce it elsewhere in the market. Ethics gets compensation right.
Does your firm prize clever, capable people? Does management keep their promises to help employees develop and flourish?
Ethics are fundamental to a business’s relationship with its community. This comes up often in the context of environmentalism. But ethical business is not the powerless victim of activists. Ethical business is honest and truthful about the costs and benefits of specific business activities – and there are always both when viewed from a community perspective — and weighs them carefully in the balance of long term perspective. There is an ethical logic to the market — if business manages resources well and for the net benefit of all, it will be awarded with more resources to manage.
You don’t need to be a trained ethicist. Just ask yourself some simple questions about any firm. Whether you are an employee, a manager, an owner, a shareholder or a stakeholder, you can ask these questions to ascertain the ethical nature of any firm — including your own.
Additional Resources "How to Evaluate the Ethical Norms of a Firm" (PDF): Mises.org/E4E_61_PDF
Join the discussion on the Mises for Business LinkedIn Page: Mises.org/M4BLinkedIn
Key Takeaways And Actionable Insights In episode 60, we are joined by Rory Sutherland, Vice Chairman of Ogilvy, one of the world’s largest advertising and marketing agencies, one with a long tradition of customer insights.
His latest book is titled Alchemy, which explores how a deep understanding of subjective value can lead to outstandingly effective creative marketing. But he doesn’t use the term subjective value — instead, he calls it psycho-logic. One of the key planks in Rory’s argument in favor of psycho-logic is that it deliberately follows the path of Austrian economics, and rejects the mainstream economists’ unrealistic assumptions about the quantified logic and cold, rational calculation of homo economicus. Please listen to the podcast, in which Rory as a raconteur delivers great fun and entertainment as well as helping entrepreneurs to think more incisively about customer motivations.
There is a “black box” in the human mind between objective reality and behavioral choices. The “black box” is subjective value. According to Rory, only Austrian economists understand that when entrepreneurs change the way a product or service is described or change the form of attention, they are able to synthesize new value by making customers think differently about any offering.
He offers many examples. One is the way we consume technology. Mainstream economists view technology through the reductionist lens of efficiency: it replaces human agency and reduces work. Austrians — and advertising agencies — view technology through the humanistic lens of augmentation: it makes us better, gives us alternatives and improves our satisfaction. Changing the form of attention changes perceived value.
Another, even more human, example is about our perception of waiting. If waiting (e.g. in a hospital waiting room) is viewed as delay, it is frustrating. If it is viewed as special treatment (e.g., “We want to assign you exactly the right specialist, so please step into our special waiting room until the doctor is available”) it may be valued as privileged attention.
The shallow kind of quantified logical explanation mainstream economics gives to customer choices completely freezes out the question of subjective perception and emotion. Austrian economics offers entrepreneurs a significant advantage in a better way to think about the mind of the customer — the “black box”.
Psycho-logic elevates the subjective value of meaning over objective reality. One of Rory’s insights is that “How we behave and how we feel is much more a product of meaning than it is of objective circumstance. Our behavior is mostly driven by emotions, and our emotions are mostly driven by meaning rather than objective information.”
One of the consequences is the endorsement of the Austrian method: to observe behavior and work backwards to deduce the emotions and the subjective meaning and individually-specific contextual perceptions that drive behavior.
You can’t rely on market research because a large part of the reason customers might give for their behavior is post-rationalization. Rory says that customers change their behaviors for emotional reasons, and rationalize them with logic later.
The Austrian method of individual analysis is gloriously scalable for entrepreneurs as a result of its fractal characteristics.
The behavioral science of searching for individual motivations in the emotions of subjective value might appear to be un-scalable. But the opposite is true, says Rory. “It’s gloriously scalable. It’s kind of fractal.”
In this context, fractal refers to the existence of similar patterns recurring at smaller scales that can be infinitely self-similar and iterative in processes and over time. Fractal describes what otherwise appear to be partly random or chaotic phenomena — like the spontaneous order that Austrians discern in economic systems.
For entrepreneurs, says Rory, it is possible to learn lessons from the psycho-logical analysis of one customer that can be applied to many more. You can learn something in one business sector and apply it to another, or learn something in a huge organization and apply it to something tiny.
Context is important to customer choice because perception tends to be comparative versus absolute.
Rory is a student of evolutionary psychology. He quotes Don Hoffman in The Case Against Reality: Why Evolution Hid The Truth From Our Eyes: Evolution doesn’t care about accuracy, it cares about fitness. We’ve evolved to develop perceptual mechanisms that are not necessarily designed to present objective reality to us, but to help us survive. The great mistake mainstream economists make is to think humans are trying to optimize the world as though we are engineers or physicists — trying to map objective reality onto behavior — without understanding the “black box” that comes between perception and behavior.
Customer perception price is a relevant example of comparative logic and context at work. Is Nespresso expensive coffee? Yes, if it is compared to Maxwell House or Folgers. No, if compared to visiting a Starbucks store. The frame of reference for comparison changes the behavioral outcome. There is no objective standard.
The most important comparison customers make is with their own expectations.
Rory cites the effect that Yelp restaurant reviews can have on the expectations of prospective diners who read them. If they choose to go to the restaurant, their expectations are shaped in such a way that the actual experience is evaluated against that expectation, not in any absolute way. Depending on a customer’s frame of comparison and their expectation, the same experience can be perceived as brilliant or terrible.
Entrepreneurs can manage customer’s expectations and frame their comparisons. That’s often the role of advertising and marketing. These provide the context in which customers can appreciate and enjoy their experience. Until both the good and its communication are optimized, there is no value.
When entrepreneurs shape the customer’s expectations through advertising, marketing and branding, they are not just adding value for the customer, they are multiplying it.
According to Rory, “Marketing doesn’t add value, but multiplies it. (And bad marketing, by the way, destroys it.)” The good — the product or service offered by the entrepreneur — and the perception of it are interdependent and we should use multiplicative dynamics not additive dynamics. If you have a product but you can’t work out a way to sell it, you have an invention, not an innovation. Marketing takes invention to innovation, or, as Peter Drucker said, the only two things that create value are marketing and innovation.
Rory describes it this way: “Entrepreneurs can discern what people want and find a really clever way to make it, or discover what they can make and find a really clever way to make people want it.” Either or both are fine as paths to profit.
Brands are an excellent technique for expectations management. They represent an exercise in what Austrians call uncertainty and Rory calls outcome variance. Brand preferences are smart behavior on the customer’s part because of the trust and reliability that they perceive in their favorite brands. Choosing an alternative might risk missed expectations.
In the multiplicative dynamics of marketing, entrepreneurs must aim high. “It’s perfectly possible that what is constraining the United States’ economic growth is actually the level of the speed at which consumers’ tastes can change rather than the speed at which producers can manufacture exciting things for them to buy.’
It’s rational for customers to follow habit, to do what others do, in order to avoid outcome variability — to maintain their expectations. There is a cost to early adoption of new innovations.
Therefore, entrepreneurs seeking new customers must pay attention to multiplicative dynamics to elevate customers’ value expectations to a sufficiently high level that they will change their behavior. As Curt Carlson said, this requires an innovation to offer a 2X to 10X better experience.
Because of multiplication of perceived values, Rory advises that it is often effective to focus marketing on one aspect, or one feature, of an offering so that it becomes the key multiplier. It might be the camera on an otherwise industry-average smartphone, or the Uber feature that manages the expectation of when your ride will arrive.
Experimentation and iteration are important tools in the entrepreneur’s effort to unlock psycho-logic. Counter-intuitiveness is crucial. Because value is subjective and entirely contained in the customer’s mind, it’s hard to unlock. That’s why entrepreneurs are the drivers of economic growth. Entrepreneurs, says Rory, do not have to appear logical to everyone else.
Entrepreneurs’ freedom to make counterintuitive bets means that, when they succeed, they’re disproportionately successful, because they represent a biased correction mechanism.
Rory cites James Dyson as a counter-intuitive entrepreneur: “Who needs a $7000 vacuum cleaner?”
Experimentation and iteration are the right technique to get to the successful outcome. And there is nothing more joyful than when a final iteration succeeds!
The language of magic and alchemy is appropriate to describe the entrepreneurial process, subjective value, and the management of expectations and perception. Mises recognized it (see Human Action, Chapter XVI, "Prices," Section 5). Rory Sutherland captures it in his book, Alchemy: The Dark Art And Curious Science Of Creating Magic In Brands, Business and Life.
Additional Resource "Rory Sutherland’s Black Box" (PDF): Mises.org/E4E_60_PDF
Hunter Hastings asks Sean Ring, Finlingo Co-founder and CEO, for his number one secret for entrepreneurial success. His answer: Iteration.
Sean offers additional insights, as we’ll see below, but the power of iteration is his number one: doing things over and over, with a view to improving. Always learning, always changing, never getting tired of improving and tinkering, whether it’s with your life path, your self-knowledge, your skills, your code base or your business. You can never predict the future, but you can always monitor your felt uneasiness and take action to relieve it by doing better.
Key Takeaways and Actionable Insights Sean navigated his lifepath through specialized areas of the financial services industry and through multiple locations around the globe, accumulating knowledge and insight at every step along the way.
Armed with degrees in finance, Sean found his way into banking, and into derivatives accounting with Lehman Brothers. Then to the "back office" (operations) at Credit Suisse, then the front office, then client management. It was a winding path, finding out what he was good at, where he needed to improve, and what he liked and disliked about corporate life. He worked in New York City and London got a taste of international travel and living that he enjoyed.
He took a pause: time off and a self-assessment to organize his individual resources.
The corporate treadmill can be mesmerizing. Sean took a year off to take his bearings, including a measurement of his personality traits using the OCEAN model, as well as subjectively self-assessing his strengths and areas for improvement.
He began to focus on organization — both the entrepreneurial function and the personal skill. Not only was organization a way to self-improve, it was a step on the pathway to entrepreneurship, the role that Joe Salerno describes, from Mises, as supervising and organizing the various elements of productive property into a coherent structure of means, i.e. the firm.
He identified financial training as his professional field.
Sean found he was excellent in front of the class. His communications abilities enabled him to express complex topics so that young trainees would understand and absorb them. His hard work ensured no gaps or weaknesses in his training materials. His gregariousness helped him to learn from other experts. He found himself highly motivated by helping young people embark upon the path as he had followed, but armed by Sean with more knowledge.
At the same time, Sean himself never stopped accumulating certifications, qualification and badges.
Skills need continuous refreshment. In the financial services industry, there are complex technical issues to master, from financial instruments to trading techniques to compliance to ethics. Sean dedicated himself to accumulating a wide range of certifications, both to confirm his own levels of technical excellence in his field, and to communicate to others his rigorous pursuit of knowledge. He is a big believer in testing and its importance in maintaining quality and integrity in service industries like finance where technical complexity sometimes doesn’t combine well with transparent and high-trust relationship practices — what Sean calls the combination of hard skills and soft skills.
And he found a business partner with complementary skills and a shared mindset.
Between them, Sean and his business partner Andy Duncan combine marketing / sales / communications / finance expertise with coding, A.I., and cognitive psychology. They share founders’ ambitions, work together well, and both enjoy Austrian Economics. Entrepreneurial initiatives are more likely to succeed when two or more partners can combine relevant skills and experience in a collaborative relationship.
All these steps bring Sean to a logical milestone on his life path: co-founder and CEO of a tech start-up employing advanced technology to achieve new levels of testing integrity to his industry.
Finlingo employs AI and advanced coding to write exam questions for technically complex financial certifications and to infinitely replicate those questions, so that no two candidates get the same questions, no questions can be memorized, and the exams can’t be stolen or hacked. Instructors and institutions enjoy a write-once-and-relax experience in composing questions and setting exams, a significant relief of uneasiness.
Sean shares his 5 key learnings for a successful entrepreneur’s journey. Iteration: Entrepreneurs learn that they’re wrong every day. Every fork can be re-taken. Every initiative can be improved. Every left turn can be re-thought as a right turn. Keep iterating.Humility: The mindset for iteration is humility – entrepreneurs know that they don’t know a lot, that every decision is based on imperfect knowledge, and every judgement is subject to uncertainty.Self-awareness: Deal with your own internal pressure; manage your own expectations – success does not necessarily come quickly and you don’t necessarily advance in a straight line at a constant pace.Lean cost discipline: Keep costs low, and don’t bankrupt yourself by spending too much too soon. Afford yourself the opportunity to make the mistakes you need to make.Family: Keep your spouse or partner supportive; communicate well. Sean’s Principles of Austrian Economics What are the principles of economics most useful for business success?
Subjective value: Entrepreneurs can easily get wrapped up in their own (objective) beliefs about the importance and market impact of their product or service. The only thing that matters is how customers feel about it. Truly understanding subjective value and thinking and feeling like the customer is a key to success. Sean asks: what is the wish list inside the customer’s mind at any one given moment and where does your service stand on that list. Top of the list may be the pressing need to pick the kids up from school when you are trying to sell an annuity or insurance policy. Be aware, and empathetic. Customer sovereignty: “The market always asserts itself”, in Sean’s phrasing. It tells you what it wants. The market is the real boss. Listen to the market feedback and interpret it intelligently. The market may want features that you think are unimportant. The feedback may come to you as “not easy to use” when the right interpretation is “build me a better dashboard”. Unique assembly of assets: Entrepreneurial success is often a synthesis rather than the invention of a new-to-the-world idea. If a customer needs both A and B, and you can provide a service that integrates A with B, that might be enough to create a new business. No need to invent the wheel. Iterate, iterate, iterate. Additional Resources "Iterating Towards Entrepreneurial Success" (PDF): Mises.org/E4E_59_PDF
Try the "Austrian Entrepreneur’s Journey" course: Mises.org/E4E_Learn
Sean Ring's company: Finlingo.com
Key Takeaways and Actionable insights Entrepreneurs make orchestration a value-producing service. Entrepreneurs don’t necessarily need to own the capital and resources required to deliver value. What they do is organize capital in a new way to facilitate a new value experience for customers. They orchestrate capital, resources, people, skills and technologies. Their orchestration creates a unique combination of resources, uniquely applied for a highly valued customer experience.
First, the entrepreneur imagines the customer’s future experience and how they will value it. Entrepreneurs create their own opportunities by imagining a future experience that customers will find valuable. John Cox, a tax accountant and lawyer, discovered in his client interactions that his customers had to deal with many different service providers when managing their own finances — investment advisors for stocks and bonds, investment funds for non-public investments, tax preparers, tax lawyers, contract lawyers, accountants, estate planners, and many more.
There were inefficiencies and frictions in these arrangements — time and money for the client to talk to the lawyer and accountant separately, and then for the lawyer to talk to the accountant before agreeing on a unified solution for the client. John imagined a future where there was a single point of contact with a better client experience at a faster speed and a lower cost.
Second, the entrepreneur orchestrates top providers in each field to efficiently channel their services through them as a single client contact point. A single point of contact dedicated to the client’s needs can provide a singularly valuable benefit — quality, speed, efficiency, low cost and high trust all in one place. John’s deal with the provider orchestra was to bring customers, providing the players with a place to demonstrate their unique skills and contribution to the integrated offering, as well as a revenue stream at lower cost (no sales costs and lower overhead).
Relationship capital results in the customer getting an integrated, high-quality plan and good outcomes with an interface of both trust and convenience. John brought relationship capital to the client solution in two ways. His clients knew him as a tax accountant and lawyer of high capability and trustworthiness, so that when he added new outside services to his offering, there were grounds for extending their trust. Second, he brought relationships with the outside service providers that the client did not have to develop and maintain themselves.
Better outcomes, lower cost and established trust — a valuable client experience.
Technology brings higher levels of integration to the orchestra. In the earliest days of his orchestration of services, John was a leading edge user of technology. At the beginning, it was the new Digital Equipment Corporation (DEC) mini-computers and peripherals, of which John’s firm was one of the earliest users. Later, he networked many lawyers together on an Apple network — again, as one of the earliest such users. Today it’s the internet that provides the technical backbone for orchestration. Orchestrators are adept at employing the latest technology for managing distributed resources.
Customer value is enhanced even further when the orchestrator has skin in the game. When John expanded his orchestrated offering to include private investments in apartment buildings he purchased, his client relationships were strengthened further by the “skin in the game” effect. Clients believe that when a provider’s own capital is at risk as well as theirs, there is an even greater focus on shared value.
Skin in the game is not mandatory for orchestrators, but it can be relationship-reinforcing in appropriate cases.
Entrepreneurs who excel at orchestration are systems thinkers. Orchestrators assemble a system of services to deliver a unified client experience. Systems thinking requires understanding of what the client wants from the system (safe asset value growth, for example), how they want to interact with the system (one point of contact, unified reports, etc.) as well as which external services to include in the orchestration and how to be the conductor who gets them all working together in harmony.
In addition to assembling the orchestra, the orchestrator must be skilled in higher level ecosystem thinking about the larger systems into which the orchestra must fit: prevailing financial systems, compliance systems, regulatory and reporting systems and so on.
Additional Resources "The Entrepreneurial Skill of Orchestration" (PDF): Mises.org/E4E_58_PDF
Californians for Honest and Non-Partisan Government Effectiveness: Change-CA.org
Key Takeaways and Actionable Insights Two methods of applying reason to the analysis of changing circumstances can be particularly helpful during cases of external, or exogenous, economic shock, such as the current coronavirus panic.
The first is thinking in terms of economic output. The second is systems thinking.
Applying these methods can help Austrian entrepreneurs to make sound decisions amidst the high speed rate of change of economic conditions.
1) Identify the ecosystem in which you operate and analyze expected changes in output. If you operate in the health care ecosystem, output can be expected to rise. More hospital beds in use, more cleaning services utilized, more deliveries to hospitals, additional workers hired. If you operate in the food and beverage ecosystem, output may stay the same but the location of consumption may shift, for example from bars and restaurants and company cafeterias to homes. If you work in the physical mobility ecosystem of cars, buses and planes, output can be expected to decline. In the digital mobility ecosystem of Slack and Zoom and webinars, it can be expected to increase.
Try to approximate the output potential of your ecosystem over the next few weeks.
2) Next, review the conditions in your own micro-system of suppliers, customers and support services (such as banks). Dr. Bylund advises us first to look upstream to suppliers and vendors. The key economic tools here are communication and information. They will not know your business needs in these changed circumstances unless you reach out to tell them. Call them on the phone, talk person-to-person, let them know what you expect and what you need. You’ll be reducing uncertainty for them and you’ll be strengthening your relationship and building trust, with beneficial long term consequences.
If supply might be interrupted, you will benefit from contingency planning which looks at all possible scenarios, which is a characteristic of the Austrian view of uncertainty. Dr. Bylund suggests we look at a worst case scenario, a best case scenario and one in the middle. This will narrow your uncertainty and the range of possible actions and make them more manageable.
3) Next, look downstream to customers and consumers. If you are a B2B entrepreneur, your customers are in the same position as you relative to your upstream suppliers. Talk to them, build relationships and find out their needs. How can you facilitate new value for them? Offer assistance. If you are able to help them with their cash flow or their inventory management or other aspects of their business, it’s an opportunity for long term business building. Extended terms, discounts and bonuses, if you can extend them, have the potential to pay back in the long term via loyalty and extended relationships.
For B2C businesses, the same mindset applies: how can you facilitate new value experiences under changed circumstances. Some of the same tools might apply, such as extended terms, discounts and savings. Or the answer might lie in new distribution methods, such as home delivery or curbside pick-up outside restaurants. Always keep the value process in mind: consumers still want value from you, but the way they experience that value may change.
Of course, in both cases, you must carefully manage your own cash flow, and this is a critical metric under these circumstances. Weak cash flows are the biggest small business killer.
4) Therefore, it also makes sense to look laterally across your ecosystem to collaborators and enablers like banks. Be clear with them what your requirements are, and make sure they communicate clearly to you what new facilities they are able to extend, both of their own volition and in response to new legislation coming from the Federal government. We Austrians are skeptical about government intervention in the economy at any time. However, it behooves all business owners and manages to be up-to-date in their knowledge of available assistance.
Additional Resources "3 Ways to Safeguard Your Business as Coronavirus Spreads" by Dr. Bylund: Mises.org/E4E_57_Article
"Coronapreneurship" (PDF): Mises.org/E4E_57_PDF
Share your comments, suggestions, and ideas on the Mises For Business LinkedIn page: Mises.org/M4BLinkedIn
All business relationships have downside risk: your counterparty / partner / vendor / customer / investor may not perform as you expect or require. In today’s interconnected economy, more and more elements of your business model are provided by relationship partners. It’s wise to recognize downside risk potential and to know how to mitigate it.
Key Takeaways And Actionable Insights There are two relevant types of risk to consider:
Relational risk, sometimes thought of as character risk: that your business partner may not perform as you’ve agreed to because they are taking advantage of you in some way.Performance risk, sometimes thought of as competence risk: your business partner intends to perform as agreed, but is incapable of doing so for competence, capability or resource reasons. For entrepreneurs, there are two levers for risk mitigation: trust and control.
Trust includes Goodwill Trust and Competence Trust — trusting your partner’s character and capabilities respectively.
Control includes output control, behavior control and social control.
Output control is generally thought of as setting measurable targets and monitoring performance relative to those targets. Did your partner meet the agreed-to sales targets in dollars or units? If they did not, they are not performing. This is a means of performance or output control.
Behavioral control focuses not on output but on behavioral inputs: did all the team members check in at 8am this morning as agreed? There is no guarantee that the desired behavior will lead to the desired output performance, but you think they are correlated and the behavioral commitment sends a signal of positive intent.
Social control is thought of as shared values and norms. If the collaborating teams or individuals have shared values and a highly-networked clan-like environment, they are more likely to have shared commitment to the goal.
Trust is much more positive for business relationships than control. When people in business relationships exhibit integrity and good character, and perceive it and experience it in their collaborators, there is less need for output controls and behavioral controls. They’ll do the right thing without those controls in place.
From an economic point of view, trust reduces transaction costs — the cost of making sure that people are following agreements and doing what is expected of them.
Trust is a business competency. Trust holds relationships together. For this reason, it is a business competency. It’s the kind of competency that fits well into the Austrian economics mindset: it’s a soft skill, not quantifiable, highly individualistic, with a significant moral component to it (doing the right thing).
Viewing trust as a business competency means that entrepreneurs are able to develop trust-building as a skill, one that can be reinforced and strengthened over time. It starts with an individual’s nature: you are someone who can be trusted. Such a nature attracts others who value it. Business speeds up, and runs more smoothly, with less need for high-litigation problem solving and more instances of viable handshake agreements. Start with your own character and seek to identify the same character type in those you deal with. There’s an element of Austrian subjectivism: there is no formula for “how I can trust someone”, but you can develop the skill over time, even learning from entrepreneurial error when you mistakenly trust someone who doesn’t deliver.
Trust is a value. People want to feel trusted and seek relationships that feature trust. Trust is a business skill that’s as valuable to you as operational knowledge or financial expertise. Learn how to build and maintain trusted relationships with other stakeholders.
Trust is a resource. Resource and competency are two sides of the same coin. Trust is a resource that fits into Austrian Capital Theory as an asset that generates revenue from customers. Think of relationship capital and social capital and the culture of the organization that generates trust as assets on the balance sheet, even if conventional accounting can not recognize them.
The 4 Cores Of Trust In The Speed Of Trust: The One Thing That Changes Everything, Stephen M.R. Covey identified 4 cores of trust.
Integrity: Honesty — telling the truth and gaining credibility by doing so. Leaving no gap between what you say and what you do. Humility — being concerned about what is right and not just with being right. And the courage to do the right thing.
Intent: People judge you by your intent, which grows out of your character. If you “declare your intent” and your behaviors are consistent with your stated intent, people will trust you. Your motive is clear and honest, and your agenda is open.
Capabilities: Can you do what you say you intend to do? Do you exude confidence in your own capacity?
Results: What’s your track record? Do you take responsibility for results?
Integrity and Intent relate to character, capabilities and results relate to competence.
In a high trust relationship, everything speeds up. Trusting people give you the benefit of the doubt. Morale is high, people volunteer to go the extra mile, and they don’t resist changes you want to make. High trust liberates the relationship and its potential.
But don’t trust too much, or where it’s not justified. In the long run, we all gain by trusting each other to give and not to take. But at the outset, you may not know if you are dealing with a taker or a giver. You should maintain a contingent element in your business relationships.
When you have many opportunities, you should be very intolerant of people who do not live up to their word. Do not be forgiving at all.
If you have fewer opportunities, maybe you have to be more tolerant of others doing the wrong thing and try to remedy the situation while maintaining the relationship. But giving people more than 2 or 3 chances to do the right thing is about the limit. Be willing to cut people off. Re-evaluate and measure the level of trust continuously. Be on guard especially at the earliest stages.
Trust-building Mechanisms Trust in relationships is a business principle, and, as always, entrepreneurs need mechanisms to apply their principles effectively. Steve Phelan gave us the story of a large and successful General Contractor in the building industry. This GC put an enormous amount of time and effort into relationships with sub-contractors, so that there came to be tremendous trust between the parties. He would start them on small jobs, and gradually increase the size of the job in which they were invited to participate. At each escalation, the sub-contractor had the opportunity to prove that they could handle both the competence and character aspects of the relationship, as well as the capability and results aspects. Trust was built over time — a learning process for trust.
The same was true on the customer side. The General Contractor would decline to bid on very large jobs from a developer with whom he had not worked before. He would always start with a small commitment, and demonstrate mutual integrity and shared intent at that level, before proceeding to larger jobs.
Over time, as a result of this trust learning process, the General Contractor’s reputation and relationships became stronger and stronger, enabling smoother and more efficient operations in good times, and resiliency in downturns.
Summary You can build trust in relationships and you can recover it. Don’t just think in terms of compliance, think about building a network of trust around you with customers, suppliers, employees, investors and partners. You can lower transaction costs and make your business run more efficiently. Make the investment to strengthen your capabilities in trust-building. Build a culture and a set of norms where people manage themselves and don’t have to be watched around the clock 24/7. Shape the organization you want to operate and live within for the rest of your life.
Additional Resource "Trust-Building and Control Mechanisms in Business Relationships" (PDF): Mises.org/56_E4E_PDF
The Austrian economic principle of subjective value — placing value entirely in the mind of the customer — helps Austrian entrepreneurs analyze value creation from a unique viewpoint. One of these is the value learning process, a new way of thinking about how to be a critical catalyst for a customer’s value experience.
Customers learn intentionally over time, endlessly looking for new and better ways to satisfy their various needs. Mark’s research has identified 5 stages in this value learning process, depicted in the graphic below (download the PDF at Mises.org/E4E_55_PDF).
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The 5 stages are: Predicted Value, Relative Value, Exchange Value, Experience Value and Value Assessment. Mark describes each stage at the beginning of the podcast.
Because the customer’s value learning process is intentional, it’s one the entrepreneur can monitor, measure and influence. It’s an example of entrepreneurs learning from their customers, as those customers are conducting their valuation.
The customer is intentional, but not necessarily paying attention, when engaging in valuation. Entrepreneurs have some work to do to track the customer’s learning process. They’re not taking note as they go. Mark talks about representationalism: how experience is a mental representation that our minds create from the stimuli that senses pick up. That could be going on while the brain’s attention is elsewhere. We’re not thinking consciously about wearing clothes or sitting on a chair, but we are experiencing those activities and we might defer our learning from them to the future, when thinking about buying new clothes or chairs.
For the entrepreneur to learn from the customer, it’s important to listen to the customers who are paying the most attention. Don’t do your market research with customers from whom you can’t learn because they’re not paying enough attention to your value proposition or to the value experience you are interested in. Find the customers with the most highly developed need, and who are most dissatisfied with the status quo.
Dissatisfaction is a feeling that draws attention away from other distractions. It’s important to customers because it’s disconcerting, unwanted. It’s a high-learning event. In dissatisfaction, customers are finding something new about their need and how to (not) satisfy it. It’s a good time to ask them.
Dissatisfied customers are motivated to share their learning because they are searching for a better solution. Customers are in the learning process and, if they experience dissatisfaction, they know they need to search for an alternative. Sharing dissatisfaction might result in some new learning for them. They’re willing to talk to you because you are trying to solve their problem.
Focus your research on the highest need, high dissatisfaction customer. They’ll yield the richest research results, most likely to help you develop an effective value proposition.
When talking to these customers, it’s critical to utilize mindfulness: ensuring customers are in full experiential mode and ignoring all other distractions. You might think of mindfulness techniques as helping with meditation. But we are able to adapt them for use in our processes of Austrian entrepreneurship. Mark uses step-by-step instructions to talk customers through a mindfulness technique to get the best information and understanding of their needs and satisfaction / dissatisfaction experiences. Entrepreneurs can use the tool at many stages of the value learning process, both at the early development stage for new concepts, and at the marketplace learning stage to tap into their experience of competitive products and services that are making them dissatisfied. We’ve created a new graphic indicating a couple of stages where they could be employed.
With the High Knowledge Customers Tool and the Mindfulness Tool, we’re providing business teams with important equipment to harness the value learning process and reap the developmental benefits of new customer knowledge. We’ll release Dr. Packard’s teaching course in the coming months, as part of our resources platform for entrepreneurs. These tools and several more will be featured in full in Dr. Packard’s new course. Send us your e-mail address via Mises.org/E4E_VLP if you’d like to receive information about its release.
In the meantime, check out our Austrian Entrepreneur’s Journey course at Mises.org/E4E_Learn.
Additional Resource "Tools For The Value Learning Process" (PDF): Mises.org/E4E_55_PDF
Can entrepreneurship be learned? We’d like to believe it can, since entrepreneurs drive economic growth — creating tomorrow as Per Bylund puts it — and betterment for their individual customers and for society.
Emergent circumstances placed Steve Mariotti in the position of teaching entrepreneurship to boys and girls in the nation’s toughest high school. After some trial and error, here’s what he established.
Key Takeaways And Actionable Insights There’s a universal desire for the fruits of entrepreneurship. Steve classified this desire as a drive to escape poverty.
You are restricted from ownership, and all the feelings of pride and fulfillment that come with it, when you are poor. Ownership — what economists call private property — is an exciting prospect. If entrepreneurship provides a route, people will take it.
Steve’s innovative entrepreneurship curriculum generated intense excitement.
He had difficulty in commanding attention for English and Math, but the same students who resisted conventional learning were stimulated and energized by the subject of entrepreneurship.
The open door to learning entrepreneurship is understanding market pricing.
Steve started the entrepreneurial journey for students with thinking about pricing of an everyday product — in his case, wristwatches. Why are there so many prices for wristwatches? Why are there so many kinds of wristwatches at different price points? Why is it that one person would pay a high price for one kind of wristwatch and another person would refuse, preferring an alternative at a different price? Just thinking about pricing in this way was a revelation.
Thinking about pricing can lead to an understanding of unit economics.
Entrepreneurs need to know two prices — the one the buyer will pay and the one that represents their cost. Steve quickly established that this knowledge is harder to establish. Is there a profit in the priced transaction for the entrepreneur once all costs — of time, money, effort and alternatives — are taken into account. This requires an understanding of sourcing and supply chains, wholesalers and vendors, direct and indirect costs and overhead, as well as personal preferences (do you really want to spend all the time and effort that the business will require of you?)
High schools are resistant to teaching entrepreneurship, and Steve’s students were constrained by regulation and authority.
“You may not talk about money in the classroom.” These and other restrictions were typical of the barriers Steve faced – and faced down. Entrepreneurship is one of the most relevant skills to impart to high schoolers, and yet the subject was viewed with disdain.
Steve emphasizes practicality as the critical foundation for teaching entrepreneurship.
He taught his kids unit economics, profit and loss, simple accounting and the practicalities of starting, growing and managing a business. No theory. Everyone in his class succeeded with a starter business. Many went on to greater entrepreneurial success.
Steve has taught entrepreneurship all over the world, and found that culture matters a great deal.
In post-communist Russia, young people could not grasp supply and demand, entrepreneurial profit and unit economics. The labor theory of value had been brainwashed into them.
In post-communist Vietnam, in contrast, people thronged to his teaching and eagerly pursued all the behavioral changes he advocated, both at the entrepreneurial level and the government administrative level (like adopting low, simple tax schemes). Theirs was a more receptive culture.
Additional Resources The role of knowledge in entrepreneurship—"Steve Mariotti Channels F.A. Hayek" (PDF): Mises.org/E4E_54_PDF
"The Austrian Entrepreneur’s Journey" online course: Mises.org/E4E_Learn
Steve’s book, Goodbye Homeboy: How My Students Drove Me Crazy and Inspired a Movement
Steve’s guide, Entrepreneurship: Starting and Operating A Small Business
Key Takeaways And Actionable Insights Entrepreneurs create the future….. Tomorrow will be different. Tomorrow is created by entrepreneurs. From the high street store owner introducing new inventory to the high tech founder introducing new features, entrepreneurs actively participate in changing the future to the way they want it to be.
….and thereby change the world. Real change happens through value exchange in the marketplace, facilitated by real entrepreneurs. Changing the world is a matter of responding to customer dissatisfactions, and not false impulses like so-called “social entrepreneurship”.
To create tomorrow, follow the entrepreneurial ethic. The entrepreneurial ethic is the belief in taking action to deliver an experience of value to the customer. Customers always feel that things could be better in some aspect of their lives. Entrepreneurs are people who bring that betterment. They do so voluntarily, without fraud or coercion, or deception. Their ethic is to improve the lives of one customer at a time, and then eventually a whole segment of customers, and ultimately of all customers. One entrepreneur serving one customer leaves resources available for another entrepreneur to help another customer. It all rolls up to a better society.
The mechanism of the entrepreneurial ethic is customer betterment. Entrepreneurs decide on principles for their business — how are they going to facilitate value — and then seek mechanisms to implement their principles. They put theory into practice, operationalizing the Austrian economics idea of the economy as a process for getting to customer satisfaction. For example, they apply Austrian Capital Theory by always making sure that any investment they make in their business contributes to customer betterment. If it’s not important for the customer, they don’t make the investment. If it is, they do. Customer sovereignty is the theory; always asking what the customer will think of any action the entrepreneur takes is the practice.
Betterment is decided by the customer. The entrepreneurial ethic is that the customer is the boss. The entrepreneur seeks to understand the need for betterment. It is a feeling on the customer’s part, sometimes inarticulate. Customers can’t tell entrepreneurs exactly what they want, but they can express dissatisfaction with the status quo. The entrepreneur gives form to the customer’s dissatisfaction by developing a new value proposition for a new service or product. Do they always get it right? No. The customer’s inarticulateness makes accuracy difficult, and the customer dynamic is continuous change, always rebalancing preferences. The entrepreneur submits to the customer’s decision.
The entrepreneur solves uncertainty, for themselves and society. Future uncertainty can sound like a burden or a barrier. Entrepreneurs solve this problem. Firstly, they recognize uncertainty. It exists: no-one can know the future. Entrepreneurs break down uncertainty by process. Step-by-step, they set out a pathway to their goal of bettering customer’s lives, knowing that there will be changes along the route as customers change and competitors bring even more change. The mechanism here is learning. Each step reveals new knowledge about whether the entrepreneur has imagined the goal and the path accurately. There will be lots of pivots before reaching the market. The earlier and more frequently the customer value learning can be incorporated, the more accurate the pivots. Entrepreneurs are reflective about every step.
When one individual benefits, there are no losers. When an exchange does take place, and the world changes as a result, there are two beneficiaries — the customer, who experiences value and the entrepreneur who facilitated it. But no-one loses. There is a false anti-business meme that the success of an entrepreneur can somehow be interpreted as a loss for society. Especially if that entrepreneur becomes a billionaire by helping an especially large number of customers. It’s just not logical. A gain by one individual can not be a loss for society.
The entrepreneur experiences their own kind of value. A few entrepreneurs become billionaires. Most don’t. They may or may not make more income than they would if they took a corporate job. But the experience of value for the entrepreneur is subjective, just as it is for the customer. They may be pursuing a feeling of self-reliance, or a sense of achievement. Importantly, entrepreneurial goals are long-term, often intergenerational. Many individuals start businesses that they can pass on to their children or to generate the funds for their children to attend college and become doctors or lawyers or economic professors — positions that the entrepreneurial effort of the parents made possible. Other entrepreneurs set up charitable foundations that can deliver benefits for decades.
Additional Resource "The Austrian Entrepreneur’s Journey" (PDF): Mises.org/E4E_53_PDF
Hunter Hastings and Mark Schaefer discuss how human-centered marketing can fix a business function that has lost its way.
Key Takeaways and Actionable Insights Marketing has lost its way — in its current state, it’s no longer a useful business growth tool for entrepreneurs.
An obsession with technology has eclipsed the focus on people and human values.A mania for measurement has obscured emotional connections with customers.“Marketers hide behind their dashboards” and are not conducting conversations with customers. The solution, says Mark Schaefer, lies in the principles of Human-Centered Marketing. Austrians can easily recognize these principles as our own.
Austrian EconomicsHuman-Centered MarketingPrincipleCustomer sovereigntyThe Customer does the marketingMechanismEmpathic diagnosisLive in their homes / offices / factoriesInsightSupport the customer’s highest valuesFind core human truths – deep, deep needs
The customer-sovereignty perspective yields actionable truths.
Customers don’t need ads — they don’t see them, they don’t hear them, they block them.Customers are rebelling against the interrupt-and-annoy approach of marketers.The customer is in charge. What do customers want from marketers? The answer for Mark Schaefer lies in Core Human Truths — what Austrians call Highest Values.
They want to feel loved.They want to be respectedThey want to belongThey want you to advance their self-interestThey want proof that a firm or brand is contributing to their community These are deep human needs that don’t change. Whatever the speed of change in market, these values are constant. Humanism lets marketers hold on to what is not changing, rather than being overwhelmed by change.
Marketing mantras like “loyalty” and “engagement” are false.
Customers don’t want to be loyal; they want freedom and choice — they like shopping around.Engagement does not result from clicking on an e-mail and downloading a white paper or a coupon.These are dashboard measurements, not human values. Mark’s recommendations are grounded in humanism.
Customers respond to shared meaning and shared values — so long as the sharing is authentic. Businesses must be loyal to consumers, never let them down, always be consistent. Live on their island.Seek trust. Marketers have burned through trust. The Edelman Trust Barometer shows trust in business and brands and advertising going down for 11 straight years. Now brands must transcend the public’s mistrust.Flip your branding. A brand is not what you tell customers. A brand today is what customers say about you to their friends and peers. People trust other people.Let customers create their own value. This is pure Austrian Economics: customer value is an experience that takes place entirely in their domain. Brands and businesses facilitate — but can’t create — the customer’s value experience. Customers hire your brand or business or product or service to help them create value. Marketing is promise management.
Choose the promise you make to customers carefully — is it one they really want from you and will they trust you when you make it?Ensure that you have the capabilities to deliver on the promise. Don’t over promise.Keep your promise every time, with no exceptions ever. BONUS: Small and medium businesses have the advantage in human-centered marketing.
The larger the business, the harder it is to connect to customers on an individual, emotional level.Small business has an advantage in showing its face, demonstrating its personality and exhibiting trustworthiness. Free Downloads & Extras "The Future of Marketing Is Austrian" (PDF): Mises.org/E4E_52_PDF
"Understanding The Mind of The Customer" (PDF): E4EPod.com/Mind
Mark Schaefer’s "Human-Centered Marketing Manifesto" (JPG): Mises.org/E4E_52_Rebellion
For comparison, "Menger’s Manifesto" from Principles Of Economics (PDF): Mises.org/E4E_52_Menger
Read Mark’s book, Marketing Rebellion: Mises.org/E4E_52_Book
Mark’s website is BusinessesGrow.com
When we asked international technology entrepreneur Paul Tenney about the pre-requisites to entrepreneurial business success, he said, “Learn accounting”.
Accounting — or economic calculation — is one of the four pillars of entrepreneurship. And when it’s viewed through Austrian eyes, it becomes a more powerful business tool than, perhaps, you might have realized.
Whether we are talking about retrospective accounting (P&L accounting and financial reporting) or commercial pre-calculation to plan future actions (management accounting or cost accounting), how you use the tool makes a difference to the results you get.
Our guest in E4E episode 51, Dr. David Rapp, is an international leader in the field of Accounting and Management Control, a subject he teaches at one of Europe’s top business schools.
Key Takeaways and Actionable Insights Accounting is a means to help you achieve your desired ends — apply judgment when using the tool.
Austrian economics teaches us to subjectively choose goals and then select the best means to achieve those goals. Accounting is just another tool to help the entrepreneur. There are plenty of explicit and implicit options in how to use it. David calls this attitude “purpose orientation” — one of the most important aspects in the field of accounting. Any computation should be shaped by its underlying purpose.
Financial reporting is subject to local rules — but there are always options in applying them.
If the purpose is to pay as little tax as possible, for example, a firm may apply depreciation or amortization rules in such a way as to reduce taxable profits. If the purpose is to present the firm in the best possible light to secure external funding, the same rules might be applied in a different way to display a different calculation of profit. There are options available for valuation of assets and of inventory that can materially affect the balance sheet.
Entrepreneurs should be rigorous in ensuring that their own managerial accounting does not mislead them.
Some modern finance theories and models are unrealistic — such as the standardized Capital Asset Pricing Model and the Weighted Average Cost of Capital approach. The entrepreneur’s task is to apply real world judgement in deciding on future actions. Austrian Economics guides us towards realism not models, and the insights from Austrian Economics are the best ones to integrate into managerial accounting.
Entrepreneurs should bear in mind core Austrian Economics principles to guide their options in accounting.
Dr. Rapp mentioned these principles:
Subjective valueThe importance of opportunity costsDistinguishing between value and priceUnderstanding that prices determine costs rather than vice versa,Differentiating between uncertainty and risk Does accounting send reliable signals of business health to the entrepreneur? Not necessarily. Entrepreneurs should be on their guard.
Dr. Rapp advises us that general guidance to the firm’s owners and management is not possible via accounting. Accounting is not neutral and not a perfect tool for measurement or reporting. Again, the choice of reports comes down to the goal the entrepreneur is pursuing.
If the goal is a sale to an external buyer, then an accounting focus on EBIT might be the best channel for the most relevant business health monitoring. If the goal is external financing from a bank, a more appropriate signal might be found in a solvency measure such as debt-to-equity ratio.
Can accounting accommodate the Austrian Economics mandate for dynamic flexibility — continuous adjustment to changing customer preferences in the marketplace?
Yes, says Dr Rapp: by emphasizing the P&L to reflect the profit-and-loss outcomes of entrepreneurial actions and to reflect how well changing allocation of resources serves customers. Sub-dividing accounts into shorter time periods and different lines of business can more accurately reflect the dynamism of a business. And extensive use of notes to accounts in reports can provide a qualitative flexibility in reporting.
Accounting plays a primary and noble role in the advance of civilization.
Our complex market economy could not have evolved without accounting. It’s an important part of the system that allocated capital to its highest and most profitable use. Accounting is not boring, dry or dispensable. Rather, it’s a mainstay of human progress.
Additional Resource "Accounting From An Austrian (Misesian) Perspective" (PDF): Mises.org/E4E_51_PDF
John Rossman is an advisor who helps leaders compete in the digital era, by crafting and implementing innovative digital business models and capabilities. He was an executive at Amazon and launched the third party selling platform–in that way,he probably directly helped a number of our listeners become successful entrepreneurs. And he is the author of Think Like Amazon: 50 ½ Ideas To Become A Digital Leader—a tremendously useful book for everyone in business because it delivers a long list of actions you can implement immediately.
John asks that, if you read his book:
You leave an authentic review at Amazon.com.You send him feedback about any of the 50 ½ ideas you have implemented in your own business, and tell him the outcome. Principles and Mechanisms John emphasizes the dual roles of what he calls principles and mechanisms in business growth. Principles are designed and communicated by company leadership: they are the few, fully codified, fundamental ways of operating that the entire company cares deeply about and executes unwaveringly. Amazon famously has 14 leadership principles starting with Customer Obsession.
But principles alone will not get the job done. They can’t implement themselves. So the second part of John’s message is that every principle must have a mechanism to operationalize it. A mechanism might consist of a complete set of generally applicable process steps and guidelines to follow them, adapt them to different circumstances, equip them with metrics and arm them accountability. The mechanism ensures that the principle can be executed again and again, by different teams on different projects across different parts of the organization and across cultures and generations. We illustrate a few of the examples that John shared with us in this accompanying graphic.
Principles Of Austrian Economics and Their Mechanisms John’s insight about principles and mechanisms is the same one we implement at Economics For Entrepreneurs. Our principles are principles of economics. Our mechanisms are process tools we’ve summarized in our series of knowledge graphics.
For example, a core principle of Austrian Economics is the subjectivity of value. Every individual customer experiences value in their own idiosyncratic way, and the entrepreneur’s task is to gain insight into each individual’s sense of value, in order to be able to cater to it.We have provided three mechanisms to date for entrepreneurs to use to gather data about how individuals experience value in different ways, and to act upon that economic data:
Use the contextual in-depth interview tool to gather qualitative data for empathic diagnosis.
Follow the value learning process map in order to be able to facilitate value effectively.
Design and deploy a subjective Value Cycle system in order to be able to repeat the value facilitation process.
Our project is to continue to add to the inventory of mechanisms to help entrepreneurs in the implementation of economic principles.
Additional Resources "Principles and Mechanisms" (PDF): Mises.org/E4E_50_PDF
Connect with John Rossman on LinkedIn: Mises.org/E4E_Rossman.
Reflections on Ethics, Freedom, Welfare Economics, Policy, and the Legacy of Austrian EconomicsIsrael M. Kirzner. Eds. Peter J. Boettke and Frédéric SautetCarmel, Ind.: Liberty Fund, 2018xiv + 782 pp.
Abstract: Everyone interested in Austrian economics owes a great debt to the editors of this vast collection of articles by Israel Kirzner. Two themes are commented on here: 1) the value-free nature of economics, and 2) the gap between the Kirznerian account of the entrepreneur and the causal realist view of Salerno and Klein. On the second theme, it appears that Kirzner may have come closer to Rothbard's view that capitalist entrepreneurs appraise profit-making opportunities in the face of an uncertain future.
uncertainty entrepreneurship kirzner Everyone interested in Austrian economics owes a great debt to the editors of the vast collection of articles by Israel Kirzner, one of the foremost students of Ludwig von Mises. Readers will find that Kirzner stresses certain themes repeatedly, and I should like to comment on two of these.
Enemies of the free market often claim that defenders of capitalism are ideologically motivated. Mises, for example, worked in Vienna as an official of the Chamber of Commerce, and he does not disguise his ardent support of the free market. Can those with other ideological commitments reasonably dismiss his views? Kirzner argues that they cannot. Economics is strictly value-free. Mises’s personal values and political allegiances make no more difference to the validity of his economic theory than Einstein’s political views do to the validity of the theory of relativity.
Kirzner puts the point in this way: “Mises, the passionate ideologue on behalf of classical liberalism insisted—in fact he passionately insisted—on the wertfreiheit of the economist. Precisely because he believed that economic science can offer powerful support for classical liberalism, he saw it is as crucially important that the reputability of that science be maintained beyond suspicion…. But the economist’s teachings can have the desired effect, Mises realized, only if the economist qua scientist maintains an austere detachment from the political ideological debates to which the science may be able to make crucial contributions.” (pp. 214–15, emphasis in original)
Even so strong a critic of the free market as Gunnar Myrdal recognized the commitment of the Austrian school to value freedom: “When Gunnar Myrdal wrote his The Political Element in the Development of Economic Theory... he gave the Austrian School high marks for refraining from permitting their political aims to shape their science.” (p. 213)
As an example, when Mises shows that economic calculation under socialism is impossible, this conclusion is in no way dependent on Mises’s own disdain for that system. It is a strictly scientific conclusion.
Important though this theme is, another theme surpasses it in interest to students of contemporary Austrian economics. Kirzner does a good deal to clear up the mystery surrounding his account of the entrepreneur, and in so doing narrows the gap between his position and the “causal realist” view that Joseph Salerno and Peter Klein have taken over and further developed from Mises and Rothbard. Some distance remains, but using material Kirzner himself provides, we can see why the causal realist account is better than its rival.
The key difficulty with Kirzner’s account concerns the opportunities for entrepreneurial discovery that he holds are “out there,” waiting to be found. Is this not bad metaphysics? Kirzner himself recognizes the difficulty:
My theory of entrepreneurship has sometimes been criticized as viewing the future as a kind of tapestry waiting to be unfolded: it is already there; it is simply behind the screen; it has only to be unrolled and then the future will come into the field of vision, whereas the truth surely is, the critics point out, that the future does not “exist” in any philosophically valid sense. It must be created so the notion of alertness in the sense of seeing what is out there in the future is a mistaken notion. (p. 696)
Kirzner accepts the criticism. He is not, he says, assuming that discoveries are “out there” but means only that entrepreneurs try to anticipate the future: “I recognize the philosophical validity of this kind of criticism.... I think the distinction surely is one between an ex ante and an ex post perspective…. From this perspective, the philosophical validity of the idea of future events is really not to the point. Ex post we look back and say: if only I had seen this coming. The opportunity was there. Does an opportunity exist? An opportunity is always something in the future: it does not exist. Yet we do talk about an opportunity existing, meaning that ex post we can say: well, the action I took was successful; or the action I took missed being a more proximate action that I might have taken.” (p. 695)
Has not Kirzner here come closer to Rothbard’s view that capitalist entrepreneurs appraise profit-making opportunities in the face of an uncertain future? Kirzner does not recognize this. He says, “Murray N. Rothbard... has argued that this recognition and emphasis by Mises on the role of uncertainty in the generation of pure profit is inconsistent with the interpretation which the present writer [Kirzner] has given Mises’s theory. For Rothbard, an ‘alertness’ theory of profit of profit must do away with uncertainty…. I have not been able to follow Rothbard’s reasoning on this matter….” (p. 349, note 33)
But exactly the target of Rothbard’s criticism was the view of profit-making opportunities as “out there” in the world, a view Kirzner has given up. In the article that Kirzner cites, Rothbard says:
Moreover, by stressing alertness, Kirzner is emphasizing a quality of perception, of perceiving an opportunity that virtually exists, as a real thing out there. In reality, however, any profit opportunity is uncertain, and rather than be a real existing entity, it must always be subject to uncertainty. It is never as simple as mere alertness. (Rothbard 1985, 281–82)
The difference that remains between Kirzner and the causal realists centers on profits and losses to the entrepreneur. The causal realists stress profits and losses to capitalist investors, but Kirzner is not satisfied: “It is true that the disembodied purely entrepreneurial function cannot be observed in the real world…. So that indeed entrepreneurial losses will, in the real world, be suffered by owners of assets. But this does not mean that the phenomenon of pure entrepreneurial loss is intrinsically associated with the purely capitalist function…. Entrepreneurial profit and loss is to be traced to the purely entrepreneurial function.” (p. 742)
We can use points Kirzner makes elsewhere to render his claim irrelevant. In his penetrating discussion of the Chicago School’s “economic imperialism” Kirzner very effectively notes that, absent the pursuit of monetary profit and loss in the capitalist market, no mechanism exists to enable good insights to drive out bad ones. “Within the setting of the market the entrepreneurial element in human action can be expected to set in motion a process of mutual discovery…. But outside the market setting…. there is nothing in the character of interpersonal interaction which suggests any systematic discovery process (analogous to the discovery process inspired in markets by the lure of pure entrepreneurial profit).” (p. 165)
In his skeptical remarks about non-market “spontaneous order,” Kirzner returns to this theme. “The emergence within society of a common language, a common set of standards for weight and measurement, and common codes of social behavior, differ sharply from the emergence of a market-clearing price for wheat or for unskilled labor in competitive markets…. The demonstration that widely accepted social conventions can emerge without central authoritarian imposition does not necessarily point to any optimality in the resulting conventions. What is demonstrated…. by short-run coordination theory (i.e., by the theory of the free-market economy) is that there does exist a spontaneous tendency toward social optimality under the relevant conditions.” (pp. 64–66)
Kirzner has thus given us sufficient grounds to render nugatory his insistence on “pure” returns to the entrepreneur outside the capitalist market. Nevertheless, readers will close the volume with admiration for Kirzner’s devotion to Austrian economics, immense learning, and dialectical skill.
Storytelling can be a powerful aid to effective business strategy. A good story can identify both a destination and a path to get there, and unite people on a shared journey. That’s why we like to use the Economics For Entrepreneurs podcast to tell journey stories from time to time: to illustrate and inspire.
This week’s guest, Paul Tenney, tells us a particularly illustrative journey story, since it combines an entrepreneurial career of achievement and purposeful geographic mobility.
Key Takeaways And Actionable Insights First, pick a promising industry with a potential for long term growth.
In the 2000’s, Paul identified database marketing technology as a growth industry, with expansive future promise but current low maturity (“e-mail spammers” were disdained at cocktail parties).
Learn and build a track record working for a growth company in the growth industry.
Paul rapidly accumulated executive experience, since growth demands that all employees step up to new responsibilities.
Develop your customer focus.
A fundamental lesson of Austrian Economics is that understanding customers and their needs always comes first in business building. This is especially true in emerging business technology. It’s easy to become focused on “product” (the technology) and lose sight of the customer, who may not understand the tech but view it as a means to an end rather than an end in itself. Paul focused on customer success activities, which revealed customer problems to be solved, and taught him the primacy of customer care in building business relationships.
Accelerate your accumulation of experience.
Experience becomes knowledge and knowledge becomes a personal competitive advantage. A growth business can provide accelerated knowledge-expanding opportunities. In Paul’s case, the opportunity came via an international posting, opening new customer vistas and revealing new customer requirements from the same technology.
Identify a partnering route to launch your business.
Your goal is to establish an independent business to run. The challenge of the transition from employment to entrepreneurship can be modified in a number of ways. One is to find a partnership that can both bear some uncertainty for you, and provide you with a strategic resource advantage. Paul partnered with the company that had previously employed him to provide technology, so that he did not have to build it from scratch. He developed his own customer base using this technology.
Establish an initial value proposition.
The technology partnership supported a strong customer value proposition in Paul’s local geography: experience the benefits of world-class big company tech, with customized / localized service, and the low unit economics that come with the partner’s scale.
Then, take the Customer Success route to deeper understanding of market needs.
Paul had learned how a well-developed Customer Success capability could generate insightful customer problem statements. These represent unmet needs for which Paul’s new company could develop new and unique local solutions.
Gain higher ground with an advanced business proposition.
Paul was able to establish new high levels of customized local service (e.g. language) while maintaining the global list price for technology. Insights gleaned over time led to the realization that simplifying the technology proposition — for example, by reducing the complexity caused by hyper-personalization of e-mail marketing to end-consumers, and focusing on the binary question of whether or not e-mails generated sales — resulted in a better customer value experience.
This focus also resulted in new-to-the-world services (such as the “fatigue curve” and “rehabilitation rate”), further elevating the value proposition.
Paul shared a lot more of his experience: about raising capital, about value theory, about the role of resilience in the entrepreneurial journey, and about the customer success of de-complexifying technology. Don’t miss his inspiring journey.
Additional Resources "Paul Tenney’s Global Entrepreneurial Journey" (PDF): Mises.org/E4E_49_PDF
Innovation often emerges from the combination of existing components in new ways. In Chris Casey’s case, the new combination was his knowledge of Austrian Economics — specifically Business Cycle Theory and Monetary Theory — and of Finance. He invested a great deal of time and effort into mastering both parts of this knowledge combination.
Key Takeaways And Actionable Insights Chris Identified an Un-met Customer Need, A Dearth of Available Solutions, and a Potential for Market Growth.
There were a few — probably a very few — customers for a financial services offering designed with recognition of the relevant principles of Austrian economics in mind. But the fact that there was at least some customer need provided evidence of potential. Then external stimuli such as the 2008 financial crisis and the Ron Paul Presidential Campaigns caused a growth in demand.
A value proposition naturally emerged.
For a narrow but highly receptive target audience, the value proposition that “Austrian Economics is vitally important to designing investment portfolios” proved to be very effective in generating a value anticipation.
Communication skill is a critical element.
A value proposition doesn’t sell itself. Chris utilized — and continuously polished — his communications skills to help customers fully appreciate the direct link to their desired value: a feeling of improved financial security because the uncertainties identified by Austrian Economics are accounted for in portfolio design.
Chris’s implementation was consistent with the value proposition, and capable of delivering.
In portfolio design, the product of Chris’s service firm, the inputs from business cycle theory and monetary theory are top-down elements. Chris added the bottom-up element of personalization of the design process to the individual customer. This is classical Austrian entrepreneurship: understand the customer’s needs, empathize with them, and customize the service so they feel individual satisfaction of idiosyncratic needs. In subjective value analysis, portfolio performance is not the sole criterion for the value experience. Customer feelings are far more significant.
Chris keeps an eye on the competitive frame of reference to maintain the uniqueness of his offering.
Chris’s competition is not other investment advisors. It’s the general demeanor of Wall Street sales-focused firms. “Stay fully invested” and “Don’t try to time the market” are typical sales communications of these firms that don’t truly have customers’ best interests in mind. He can always utilize this contrast as a value frame of reference.
Chris’s success exemplifies the clarity that results from candid entrepreneurial self-assessment and the embrace of the entrepreneurial process.
Self-assessment = In what field am I best resourced to enter and do business?
Entrepreneurial process = Identify opportunity by identifying customer dissatisfactions in that field.
Additional Resources "Chris Casey’s Entrepreneurial Journey" (PDF): Mises.org/E4E_48_PDF
Visit WindRock Wealth Management at WindRockWealth.com
John Chisholm is the author of Unleash Your Inner Company: Use Passion And Perseverance To Build Your Ideal Business.
Entrepreneurship is a process. Taking this view enables successful navigation over time, whatever the interim ups and downs. Sometimes the process can feel like stumbling through a jungle, tripping over rocks and vines, always picking yourself up again and marching onwards. Don’t expect the process map you start with to be the one you continue with. Don’t plan too far ahead. Do be adaptive. Nonetheless, the process view is a source of support during the journey.
Key Takeaways and Actionable Insights Processes require operating tools. John Chisholm’s toolset starts at Need and Advantage.
“All you need is a Need and Advantage.”
Need = "A real, unsatisfied customer need in an area about which you are passionate."
He defines Need in an Austrian way: a subjective value sought or anticipated by a customer. He defines Customer as a living breathing person (or group of people, as with a corporate customer) rather than an abstract “market need”. Unsatisfied means that the need is not addressed by currently available products and services (requiring the entrepreneur to understand customer dissatisfaction). And Real means shared by a sufficient number of customers or sufficiently intense in one or more customers to make it worthy of you to satisfy.
The entrepreneur must have an advantage for satisfying that need. John’s process is aimed at establishing and extending that advantage, in spite of the fact that existing businesses will have more and better resources than you.
John offers a 10-step process for entrepreneurs to follow.
You’ll find John’s process pretty complete, cogent, and consistent with Austrianism. We didn’t cover every step of the process in the podcast, but we did pick out two tools and one principle.
Make a STARS inventory of your resources and strengths and turn them to your advantage.
John recommends making and continuously updating an inventory of your individual strengths. The STARS acronym stands for Skills, Technologies that you know and can use, Assets and Achievements, Relationships and Reputation, and Inner Strengths. He has wise advice on each one of these subjects, and he suggests multiple uses for the completed STARS inventory:
Use it to assess the fit of your strengths with the customer needs you have identified.Use it to identify strengths gaps you’ll need to fill.Use it to build your own self-confidence (most people under-estimate their own strengths).Use it to innovate by making new combinations by pairing STARS elements in new ways. We provide a template with directional examples a Mises.orgE4E_47_PDF1.
Map out a logical and sequential growth path with John’s “bowling pins” methodology.
John’s advice is to avoid tackling too large a market and too large a target customer group at the outset. Focus on a best fit intersection between your resources and customer needs. Label it. Then identify the next most logical adjacent customer need you can fill, ideally leveraging your learning from the first market. Keep on building up the map of adjacent needs to fill. When you’ve got to 10, think of them as bowling pins. Knock them down one by one, starting with the first — that’s your early focus — and ultimately completing them all. That’s your vision — the largest set of customer needs you can possibly fill.
John calls this process Upsizing A Customer Need, and notes that this bowling pin strategy is particularly persuasive to venture capitalists — they like it that you are focused, and also that you have a map to growth.
We reproduce John’s bowling pin map at Mises.org/E4E_47_PDF2.
Make the most of limited resources: Different is better than better.
How do you overcome the fact that existing businesses in a market you are trying to enter have greater resources than you? John’s answer: focus on being different rather than better. If you can identify how to be different — with a different solution, for a different target audience (even if it is small to begin with) you’ll evade competition.
John has additional advice about scalability, network effects, partnering and other tools for growth. Listen to the complete podcast for a rich reward of process tools and methods.
Additional Resources "STARS inventory" (PDF): Mises.org/E4E_47_PDF1
"Upsizing a Customer Need" (PDF): Mises.org/E4E_47_PDF2
Entrepreneurship is action. It’s a process in which the actions of the entrepreneur are decisive. In the final podcast episode of 2019, Hunter Hastings suggests eight action steps you can take for the betterment of your business in 2020 and beyond.
- Conduct an Empathic Diagnosis The entrepreneur’s first job is to understand the customer, their hopes and fears, their goals and wants, and their feelings. There’s a skill for that, and a method. The skill is empathy — the ability to feel what the customer feels.
The method is empathic diagnosis. The secret is not to ask the customer what they want or what they need, but to ask them how they feel. They can tell you that, but they can’t tell you why. That comes in step 2.
To ask them how they feel, use the contextual interview tool.
Think of it as a conversation with a customer whose feelings you are aiming to identify via a discussion in context. Look for responses that have “feeling” words — painful, frustrating, boring, annoying. Success! You’ve hit an emotional seam you can mine. Now dig in to understand their goals, and the means they choose to achieve those goals.
After the interview, you can collate the dissatisfactions, the emotional pain points, and the functional failures. Then you can curate these inputs into functional, cognitive, and emotional components of a potential new solution — that is, new features (functional), new beliefs about what’s possible (cognitive), and better feelings about the experience (emotional). You now have a first building block for the design of a service or innovation that has high potential for facilitating new and higher value for the customer.
- Construct a Means-End Chain to Generate Insights about Hidden Customer Motivations The output of your empathic diagnosis provides the basis for your next step. The goal is to generate an understanding about the motivations of the customer that they can’t quite explain themselves. People do not have introspective access to their motivations. Motivations are unconscious. People don’t know what Rory Sutherland calls the real why that explains their actions. Smart entrepreneurs can find out this real why, using our means-end chain tool.
Take an easel pad or a wall and mark out the links as different levels, starting at the contact point at the bottom and advancing one by one to the highest value at the top. Use sticky notes to populate each level with the appropriate customer responses from the empathic diagnosis. Then join the most pertinent items together that link each level — at this contact point, they perceive these features and attributes, that generate this functional benefit and this emotional benefit, all of which are logically and causally linked to the pursuit of the highest value. Recalculate this sequence a few times until you are confident you’ve identified the strongest route to the highest value the customer is seeking when he or she is in your space. You now have an insight into the customer’s hidden motivations, and you can use it to build a strong brand.
- Build a Strong Brand with Our Brand Uniqueness Blueprint Building a strong brand provides you with a financial machine — a capital asset that can generate customer revenues reliably over time, because it meets customer needs and solves customer problems better than any alternative.
The brand uniqueness blueprint (see Mises.org/E4E_30_PDF) helps you identify the two parts of your brand foundation: who is it for? — that is, whose problem are you solving, whose needs are you meeting? The term for this is relevance. And how are you solving that problem in a superior fashion? — that’s differentiation.
Use our brand uniqueness blueprint by clicking the link. You’ll find an instructions template, an example using a real brand, and a blank template you can use for your own brand. If you want to send us a completed blueprint for your own brand via our Mises for Business LinkedIn page, we’ll be glad to give you our comments.
- Complete a Resource Uniqueness Inventory. Our first three action items have been directed at your customer understanding and embedding that understanding in your brand blueprint.
Let us turn to your firm’s capabilities. You want these to be unique to your purpose, just as your brand is. Austrian economics focuses you on individualism, and that includes your own individual experience, knowledge, and skills. Our fault often lies in underestimating our own unique resources. One answer to this fault is to conduct an inventory or an audit.
In 2019, Dr. Stephen Phelan gave us a resource-based theory of entrepreneurship, under the acronym PROFIT, standing for Physical Resources, Reputational Resources, Organizational Resources, Financial Resources, Intellectual and Human Resources, and Technological Resources. Steve’s list is at Mises.org/E4E_18_PDF. You can use it to organize your understanding of your own resources.
- Imagine a Future Value Experience That Your Resources Can Deliver. Whom shall I serve?
One way to answer this question is to imagine a future experience that customers will value. Mark Packard showed us how to do this by activating customer value as a learning experience in five steps (see Mises.org/E4E_44_PDF).
Predicted value — it’s a picture you generate in the customer’s mind with your value proposition.Relative value — it’s a calculation the customer makes compared with alternatives.Exchange value — getting the customer to actually exchange dollars for your offering.Experience value — the act of consumption in which the customer actually experiences value.Value assessment — the customer conducts an assessment of value retrospectively. Looking back on the cycle, was the experienced value greater or less than the predicted value? Was it better or worse than the alternative, perhaps a brand that the customer abandoned in favor of yours? Does it feel like the experience was worth the dollars given in exchange? This is a place to identify a measurement of the value you have generated — but be careful: it must be a measurement of feelings and perception, which is a tricky measurement proposition. When imagining the new value experience you are trying to facilitate, make sure to imagine every stage in the sequence and how you can best stimulate each one.
- Initiate an Innovation Project to Deliver on the Imagined Value Experience. Innovation is the indispensable fuel of entrepreneurial success. The customer is continuously changing — rebalancing their preferences, seeking improvement in their circumstances, looking to feel better about their current situation. Dynamism on the part of the entrepreneur is mandatory.
Curt Carlson gave entrepreneurs the formula for managing innovation systematically. He uses the formula he calls N-A-B-C.
N stands for identifying the customer need.
The A is your approach — your business model, your uniqueness, your capability of delivering, your technology, your logistics, the complete package of commercially fulfilling the need.
The B is benefits per costs, in Curt’s language — what Mark Packard identified as relative value to the customer.
The C represents competition and alternatives. It’s imperative for entrepreneurs always to understand the alternatives the customer has available to them.
Download the knowledge graphic of the N-A-B-C formulation at Mises.org/E4E_37_PDF.
- Conduct a Time Inventory, Then Cut It. One of the most important ways Austrian economics helps entrepreneurs is with a strategic appreciation of the role of time. Production, the process of delivering a value proposition to the customer, takes time. The entrepreneur assumes the cost of time while the customer values time in their own subjective way and may seek alternatives that offer better time value. We are just beginning to understand how valuable time is to the customer — look at the success of just-in-time restocking systems, same-day delivery and overnight global distribution.
Steve Denning told us that time is now a strategic weapon of the entrepreneur — and a strategic dimension on which competition takes place. The customer wants speed, so the entrepreneur must manufacture speed.
A good step for the entrepreneur is to conduct a time audit. Examine all your processes that take time. Then imagine ways to reduce that time. Look at time from the viewpoint of the customer — where in the service experience would they welcome time reductions or time savings? How could you deliver them? Make time part of your innovation program. Give time back to your customers.
- Identify the Next Innovation That Makes Life Easier for the Customer. Austrian economics always looks at business from the customer’s viewpoint. It sees that the overarching strategy that defines the digital era from a customer perspective is making things easy. Easier by a factor of 10X or 100X. Online purchasing is easier. Overnight delivery is easier. Cloud computing is easier. Subscription models are easier.
Customers today are permanently dissatisfied with the degree of difficulty of getting things done, because they’ve seen how much easier things can be in so many arenas, so many parts of the landscape. Entrepreneurs are competing to make things easier for them.
So, here’s an exercise you can conduct. Imagine a way in which you can make things easier for your customer. Your empathic diagnosis might reveal several ways. Then imagine how your system could deliver the increase in ease — by a 10X or 100X factor. Then imagine a piece of digital intelligence or AI that might be able to implement the improvement for you. Then search for it on Github or elsewhere. You don’t have to develop the technology — you just need to imagine what it can deliver in increased ease for your customer.
Summary In summary, Austrian analysis suggests these eight action items for improving your business by improving your understanding of your customer and your delivery of new and better solutions for them. All eight are practical and depend mainly on imagination. They cover empathic understanding, branding, resource assembly, value learning, innovation, costs, convenience, and time. We hope that we have provided valuable content for you to think about as you make your business more Austrian in 2020. Let us know.
Additional Resource Download "8 Austrian Actions for 2020": Mises.org/E4E_46_PDF.
In an attenuated Christmas Eve podcast, Hunter Hastings highlights four of the useful principles he covered during 2019.
Customer Sovereignty — Which Means Putting Your Customer First. The economists call it customer sovereignty — the principle that it is the consumer who ultimately decides which businesses are successful and which are not, as a result of their purchasing (or not purchasing) entrepreneurial offerings. Stephen Denning calls it The Law Of The Customer. John Rossman calls it Customer Obsession.
Entrepreneurs who understand the leverage of customer sovereignty do everything they can to know and understand their customer’s goals, values and feelings. They seek out negative emotions — disappointments, unease, a feeling that things could be better — because these are the inputs for designing new offerings that customers will welcome to make their lives better and relieve their unease.
The method of Austrian Economics in this regard is empathy. It’s a soft skill you can nurture and develop with practice. Use the empathic diagnosis tool that we provided earlier this year (link below).
The techniques for empathy include the Means-End Ladder (understanding customers’ goals, or ends, and why they select the means they choose to attain them) and Listening From The Heart, a market research technique given to us by Isabel Aneyba.
Peter Klein on Means and Ends
The Means-Ends Ladder Tool
How to use the Means-Ends Ladder Tool
Peter Klein on Entrepreneurial Empathy
Empathy tools for entrepreneurs
Isabel Aneyba: Listening From The Heart And The Techniques Of Empathy
Avoid Competition The mainstream economics concept of competition considers firms competing to sell identical goods to an identical audience. Entrepreneurs take the opposite tack: they choose a select group of customers whom they understand deeply, and they assemble a unique set of capabilities to deliver unique, customized solutions.
The tools we presented during the year include differentiation and branding. Differentiation is the pursuit of uniqueness in your offering. It requires providing your customer with a means to achieve their goals that is different and better than any alternative. That can be faster, or easier to use, or more comfortable, or more personalized, or some other attribute or combination of attributes that the customer prefers. Differentiation is not achieved through pricing. It’s achieved by superior understanding of your customer and their subjective goals.
Trini Amador demonstrated how to capture differentiation in a brand. A brand is a promise — a unique promise only you can keep to help customers achieve their ends. It’s a promise that customers can embrace emotionally, and that you can deliver consistently, every time with certainty and without exception. Promises must be kept. Trini provided us with a templated process for brand building.
Per Bylund: What Is Competition?
Trini Amador on Brand Building
Brand Uniqueness Blueprint
Dynamic flexibility Austrian economics has always been on the leading edge of dynamically flexible resource allocation and capital assembly. Austrians see the worth of capital purely in the future revenue streams that it can generate from customers. If customers change, and the revenue stream changes, the worth of the capital has changed. The capital structure of a firm must change to reflect changes in the marketplace.
This applies to hardware, software, human capital, processes and methods and organization. Old capital must not be allowed to eat up resources that could be better used to serve customers in new ways.
With the arrival of the digital age, dematerialization, interconnectedness that can support rapid assembly and disassembly of global networks and supply chains, practitioners are now able to apply in practice what Austrian theory has been saying all along.
Dynamic flexibility is well-captured in the methods of the Agile revolution, as Steve Denning explained. And the ultimate expression of dynamic flexibility is innovation – the dynamic flexibility to supplant old technologies, old services, old organizational structures with new ones. Curt Carlson gave us his formula for successful innovation, and it’s very Austrian: always start with the customer’s need.
Stephen Denning on Agile resource allocation
Per Bylund on The Laws Of Agile
Curt Carlson on Systematic Innovation
Curt Carlson N-A-B-C innovation system
The Economics Of Value We finished the year with three episodes on the new economics of value. It’s the opposite of traditional economic thinking for entrepreneurs – the economics of scale and cost reduction. The economics of value entail selection of the smallest customer group to serve in the best possible way, so that they can experience maximum subjective value. It involves scaling down – personalization, customization, scarcity, limited availability, and high differentiation. We published a simple guide to the economics of value.
Mark Packard shared his latest research on the economics of value and specifically how customers experience it. They do so as a learning process, one that takes place entirely beyond the entrepreneur’s line of visibility – in the custmer’s perception. Mark explained the neuroscience as well as the economics behind the process, and introduced a 5-part cycle of customer value learning. We published a flow chart and a set of explanatory slides, using pizza as an example.
The power of the value learning cycle is that it replaces the concept of the funnel for entrepreneurs. The funnel has built-in inefficiency – wide at the top and full of costs, with revenue at the end where it’s narrow. There’s a lot of waste. The value learning cycle, when used effectively, engages a small group of customers well-known to the entrepreneur, and guides them logically to an experienced benefit that they assess positively.
Per Bylund on The Economics Of Value
Economics Of Value versus Economics Of Scale
Mark Packard on The Value Learning Process
Value Learning Process Map
To be able to adopt new ideas and successfully apply new techniques, it is sometimes necessary to discard old ones that are barriers to clear thinking. The theory and vocabulary of value illustrate one such barrier.
The language of business schools and many business books is that firms and entrepreneurs create value. That terminology implies that value is somehow embedded in the product or service the firm designs and markets, and that value is formed in the firm’s domain.
The business world has made a little progress in the last few years by opening up to the idea that value is somehow co-created by the provider and the customer. In co-creation, customers’ own usage of the service causes the value to be realized, and their comments, criticisms and suggestions become useful feedback to the provider to further improve the offering.
But we have known since 1871 that value actually lies entirely in the customer’s domain. Carl Menger wrote:
Value is a judgment economizing men make about the importance of the goods at their disposal for the maintenance of their lives and well-being. Hence value does not exist outside the consciousness of men. Now, Mark Packard sheds more light on exactly how value forms and develops “in the consciousness of men” — or, as we would say today, in the customer’s experience.
Key Takeaways and Actionable Insights Mark introduces the concept of value learning. This is the mental process through which the customer advances in response to a value proposition from an entrepreneur or a brand. It’s important for entrepreneurs to understand, monitor and measure the customer’s value learning. There are five stages.
Predicted Value Customers evaluate an offering that’s available to them with a mental prediction: I think that this offering might be valuable to me (i.e. make me feel I am improving my circumstances / make me feel better / help me towards my goal). Predictive value is translated into a price one is willing to pay for that experience. This willingness to pay is then compared to the price of the product. It’s a yes or a no.
Entrepreneurial action: Manage predictions strategically. Persuade customers that the predicted value is worth the cost, but don’t over-hype your product. Identify those customers whose predicted value relative to your price is positive. These are your only current target (unless or until you redesign your value proposition).
Relative Value The customer’s next cognitive action is to identify whether the predicted value is high or low relative to alternatives. These alternatives include not just other products in your industry (if any), but all other ways your customer might also satisfy the need that your product addresses. For example, one alternative is to keep their dollars in their wallet, if they think they can satisfy their own need for themselves at a lower cost (all in). The predicted value of your offering must be greater than all alternatives in their perception.
Entrepreneurial action: Calibrate your offering to the customer’s relative value calculation using price, features and benefits.
Exchange Value If the customer’s Relative Value perception is sufficiently positive, they’ll exchange dollars with you. But remember to account for the customer’s uncertainty. If the relative value is comparable between alternatives, customers will generally prefer the more familiar (certain) value over your uncertain offering.
Entrepreneurial action: Use price discovery techniques to align price and relative value.
Value Experience The customer uses or consumes the product or service. They’re generating feelings and perceptions as they do so, either positive or negative. Many of these are in response to a mental comparison with Predicted Value – is the experience better or worse than predicted?
Entrepreneurial action: Monitor the customer’s perceived experience. Be aware of variables in circumstances (time, place, mood, competitive environment) that can change their perceptions. You may need to guide the customer’s first consumption experience(s) to ensure proper use and optimal experience.
Value Assessment The customer, either concurrently or subsequently, makes a mental value assessment based on their experience. Good or bad? Better or worse than predicted? Does my assessment result in predicted value for a repeat purchase or subscription?
Entrepreneurial action: Measure. This is the stage where measurement becomes useful. Find a measurement that works for you. It could be in sales dollars, purchase volume trends, or customer satisfaction metrics. Such metrics are mere approximations, however, and are neither precise nor set in stone. Be careful how you interpret measured results.
This value learning process is mutual. The customer is always evaluating and re-evaluating and the entrepreneur must keep pace in service, relationship management and innovation. It’s a never-ending cycle of value.
In future podcast episodes, Mark will share some of the new tools he has developed to help entrepreneurs master the cycle.
Additional Resource "Value Is A Learning Process" (PDF): Mises.org/E4E_44_PDF
Immediately after he arrived home from fighting in the war in Vietnam, Vito Bialla started his executive recruiting firm, Bialla & Associates, from scratch. He built it into a professional partnership of the highest repute at the highest level (recruiting CEOs and other C-Suite positions) for the largest global corporations. He also started (and sold) a sportswear company and a Napa Valley winery, launched a venture capital fund, and he holds world records in endurance sports such as long distance swimming, desert trail running and ultra-marathoning. He shared his thoughts about the pathways to success in growing a business, recruiting high-performing executives, and identifying high-potential entrepreneurs.
Key Takeaways And Actionable Insights Grow Your Business No hesitation: Quickly identify your field and your customers. Vito started his own recruiting business just 6 months after starting work for the largest global firm in the field. He knew what he wanted to do, and didn’t wait too long to start the journey.
No compromise: Identify the top customers and the highest standards, and choose those as your targets. No-one wants to buy second best.
No barriers: Vito described how he would get the CEO’s of the top global corporations on the phone (tip: call late at night when their gatekeepers have left) and engage them empathetically. He would build relationships with the best executives at the most successful and admired corporations. He built relationships with the best in business.
Recruit Executive Leaders High Performance: Rather than personality traits or CV’s, Vito looks for performance indicators, especially under difficult conditions. An executive who has “bumped his or head against the wall” — i.e. encountered unexpected difficulties — has acquired experience that will be tremendously valuable in all future situations, however tough.
High trust: These high performance executives are found in high-performing corporations. An important signal is to be in a peer group of high performers and to have won their trust and admiration.
High empathy: If these high performers are to transfer into a new position with a new company, it is imperative that they be accepted into the new culture (rather than try to bring one with them). Empathy is key — to understand the new team and develop their confidence, even when (especially when) acting as the implementer of change.
Identify Entrepreneurs With High Success Potential Un-structured: You can’t learn entrepreneurship in business school, or by working at a large corporation. Structure and process induce a way of thinking that is insufficiently flexible in responding to marketplace changes. The successful entrepreneur knows what to do in a bar fight, when market conditions change radically, cash is running out and the current strategy isn’t working. (Don’t miss Vito’s own “bar fight” story.)
Un-plan: Plans are not particularly useful for entrepreneurs, especially those that are difficult to adjust. Adaptiveness beats planning every time. Vito looks for adaptive personalities (and evidence of previous adaptive behavior) in the entrepreneurs that he finances.
Un-deterrable: Vito’s number one rule is: No Fear. Fear of failure, he says, is unhealthy. Just do it, make something happen, set events in motion and learn from the results.
Additional Resource "Vito Bialla's Patterns to Entrepreneurial Success" (PDF): Mises.org/E4E_43_PDF
Good economic theory predicts effective, cutting edge business practices. For example, the dynamic flexibility of capital resource allocation predicted by Austrian Capital Theory is being realized today via digitization, dematerialization and agile organizational innovations. Entrepreneurs who fully embrace Austrian theory can be leaders in the field of business implementation.
At the same time, economic theory evolves and it’s important to keep up. This week, Hunter Hastings and Per Bylund talk about the economics of value and how this body of theory is superseding old mainstream economic theories from the industrial age. We focused specifically on the industrial-age concept of economies of scale.
Key Takeaways and Actionable Insights Economies of scale can feel daunting to small and medium sized business (97% of all businesses) because of the implication that big businesses enjoy unmatchable efficiencies, advantages in procurement and hiring, and asymmetrical bargaining advantages when negotiating with smaller business as vendors or suppliers.
But this industrial age economic law is not applicable to today’s entrepreneurial businesses. It applies to commodity businesses competing to make the same product and sell it to the same customers. It was historically possible to invest in capital to increase output per worker and lower variable costs to their lowest possible level, thus achieving a price and / or profit advantage, as well as an experience curve benefit of perfecting methods through extended high volume applications. Today, entrepreneurs don’t compete with commodity businesses, or in commodity markets.
Entrepreneurs compete on value, not on cost. Entrepreneurs put the customer in prime position, not production. They select a customer group to serve in the best possible way – so that those customers can experience maximum (subjective) value. Superior service to selected customers to facilitate value for them – not low cost - creates entrepreneurs’ competitive advantage.
Instead of pursuing greater and greater unit volume to lower unit costs, entrepreneurs utilize the customer empathy and feedback cycle to increase the level of value they can facilitate for customers. They process more and more customer feedback to understand better how to improve their experience.
Instead of scaling up, entrepreneurs scale down. Personalization and customization are increasingly effective routes to customer value experiences. Producing less unleashes scarcity, exclusivity, limited availability and uniqueness as value signals to selected customers.
And, when needed, scale can be rented. In the specialized areas where economies of scale are relevant – particularly in shareable infrastructure like the Amazon Marketplace platform or cloud computing – entrepreneurial businesses can “download scale from the internet”, i.e. take advantage of the platform’s scale without building it themselves.
The same customer-first, value-centric model applies In B2B markets. Entrepreneurs identify ways to fit in to the customer’s system in a unique or superior way to re-balance asymmetric bargaining power. Relationship, not scale, brings advantage. Entrepreneurs always put customers and their value experience first, in both B2B and B2C.
Scale is a choice for the entrepreneur. Choose which customers to serve at what scale. The cost connection with scale is far less important than in the past.
Additional Resource "Economics of Value vs. Economies of Scale" (PDF): Mises.org/E4E_42_PDF.
[This article originally appeared in Studies in Logic, Grammar and Rhetoric 57, no. 1 (2019): 161–174. Reprinted here with permission.]
Abstract. The Mengerian-Misesian tradition in economics is also known as the causal-realist approach — in other words, it studies the causal structure of economic phenomena conceived of as outgrowths of real human actions. Thus, it finds verbal descriptions and declarations economically meaningful only insofar as they can be linked with demonstrated preferences and their causal interactions. In this paper, I shall investigate how the approach in question bears on topics such as the economic calculation debate, deliberative democracy, and the provision of public goods. In particular, in the context of discussing the above topics I shall focus on market entrepreneurship understood as a crucial instance of “practicing what one preaches” in the ambit of large-scale social cooperation. In sum, I shall attempt to demonstrate that the Mengerian-Misesian tradition offers unique insights into the logic of communicative rationality by emphasizing and exploring its indispensable associations with the logic of action.
Keywords: causal realism; entrepreneurship; economic calculation; deliberative democracy; public goods; communicative rationality 1. Introduction The Mengerian-Misesian tradition in economics is also known as the causal-realist approach (Salerno 2010). This appellation indicates that the approach in question investigates causal relationships obtaining in the context of real economic phenomena, instead of focusing on the analysis of purely hypothetical or idealized constructs, such as perfect competition or general equilibrium, which stands in stark contrast to the typical approach adopted within neoclassical economics. More specifically, causal realists insist that economic phenomena are analytically meaningful only insofar as they can be traced to preferences demonstrated in specific human actions and their various interrelations (Rothbard 1956). In other words, the Mengerian-Misesian tradition conceives of economic data as words backed by deeds — in the absence of the latter, such data, in the form of, e.g., opinion polls or historical extrapolations, are considered insufficient to bear on issues such as social welfare (Herbener 1997), consumer satisfaction (Hutt 1940), or business competitiveness (Hayek 2002).
This is not to say, however, that such data, even if not useful for the economic theorist, is not useful for various participants in the economic order. On the contrary, it might be thought of as particularly significant for market entrepreneurs, whose role, according to the tradition under consideration, is to exercise business judgment under conditions of uncertainty (Foss and Klein 2012). Such judgment, which aims at imagining future consumer wants, future availability of appropriate factors of production, and future configurations of other relevant data, is necessarily forward-looking, and thus detached from any actually demonstrated preferences, but it can and should rely on supplementary information provided by past market data, including consumer and business surveys. The crucial point in this context is that, first, entrepreneurial judgment is an art rather than an exact science, and second, that it necessarily involves exposing one’s resources to potential losses (Salerno 2008). In other words, in contrast to the predictions of neoclassical economists, entrepreneurial judgments neither aspire to quantitative law-like precision, nor avoid the requirement of “skin in the game”. Thus, as words backed by deeds, and unlike the above-mentioned economic predictions, they are regarded by causal realists as the driving force of the market process — a phenomenon of utmost importance for sound economic science.
This observation underscores another essential aspect of the Mengerian-Misesian tradition — the emphasis that it puts on the entrepreneurial character of all human action, that is, its inherent entanglement with the problems of scarcity and uncertainty. This emphasis allowed its representatives to develop unique insights into subjects such as economic calculation, economic growth, and business cycle theory. More specifically, it allowed causal realists to investigate the role played by entrepreneurial rivalry and competitive bidding for productive resources in the context of developing large-scale social cooperation based on productive specialization and division of labor.
What I wish to argue in the present paper is that an important and perhaps still underappreciated aspect of such insights is that they reveal entrepreneurial action as an embodiment of crucial norms of communicative rationality. This suggests that, contrary to the claims of some of the most notable theorists of the phenomenon in question (Habermas 1984), there exist significant aspects of rationality that cannot be encompassed by successful communication conducted on a purely verbal and deliberative level (Pennington 2003). Similarly, the aforesaid insights cast doubt on the notion that any genuinely rational substantive standards of fairness can be developed by free-floating wraiths debating behind the “veil of ignorance” (Rawls 1971). The essential reason why this is the case is that all purely verbal and deliberative attempts at determining rational social policies are fundamentally detached from considerations of resource scarcity and economic uncertainty.Rawls’ proposal takes into consideration the uncertainty surrounding one’s transition from the world of deliberation behind the veil of ignorance to the world of actual social interaction, but it is detached from the far more important uncertainty pertaining to the world of actual social interaction.
This is not to say that such attempts cannot perform other useful roles. For instance, they are absolutely indispensable as far as theory building is concerned, especially when it consciously utilizes the logical-deductive method, as it clearly does in the causal realist tradition. In other words, while pure deliberation and verbal communication cannot solve the problem of rational allocation of resources in a complex economy or generate any one-size-fits-all models of legal and regulatory frameworks, they constitute crucial tools in the context of deducing the general normative and institutional requirements that must be met if the above tasks are to be accomplished.
Among such requirements are robust property rights, free exchange of property titles, respect for entrepreneurial innovation, and cultural norms that protect all the institutions just mentioned. Only within such a setting can communicative rationality of the verbal and deliberative kind be complemented by its praxeologically active counterpart, whereby concrete simultaneous solutions are devised, implemented, compared, and evaluated in the process of entrepreneurial competition, experimentation, and polycentric empirical learning. In this connection, prices, profits, and losses turn out to be communicative tools no less important than words, verbal arguments, and formal deliberations. In fact, the solutions based on the former can be seen as enjoying greater institutional robustness than those based on the latter (Boettke and Leeson 2004, Leeson and Subrick 2006, Wisniewski 2011), since, first, they are backed by actually demonstrated preferences, thus proving the honest commitment of their implementers, and, second, they are implemented by owners spending their own resources, thus ensuring “skin in the game”.
Having made these general remarks, let me now proceed to a discussion of more specific illustrations of the way in which the entrepreneurial orientation of the causal-realist tradition informs and enriches the notion of communicative rationality.
- Economic calculation Nowadays the economic calculation debate can be seen as little more than an intellectual artifact of the Cold War era, when there existed a genuine and heated theoretical discussion regarding the respective economic merits and demerits of socialism and capitalism. Now, one might argue, this debate is long over, capitalism having been declared a clear winner. However, for a perceptive researcher it remains a treasure trove of causal-realist arguments that demonstrate the unique communicative abilities of market institutions.
The earliest of such arguments, which actually predates the tradition in question and goes back to the beginnings of classical political economy, suggests that, since ownership connotes responsibility for and intimate knowledge of the things owned, and since in a free society individual owners prosper insofar as they harmonize their self-interests with the self-interests of others, there exists no argumentatively deducible vision of a good society superior to the one that emerges from the unhindered interplay of voluntary, contractual human actions (Bastiat 1851, Smith 1976). In view of the remarks included in the introduction, it should immediately become clear that while the argument itself can be made in the course of purely verbal deliberation, its recommendations can be implemented only through the kind of cooperation that relies crucially on extra-verbal signals communicated by continuous market data and the underlying judgments of owners-entrepreneurs.
However, while important in its own right, this particular argument does not belong to the essential core of the economic calculation debate inasmuch as it focuses primarily on psychological incentives, not on economic institutions. A far stronger argument against economic organization based on bureaucratic central planning and the abolition of private property, one that constitutes the main contribution of the causal-realist tradition to the subject under consideration, demonstrates that there can be no such thing as purely “declarative” prices, which are detached from entrepreneurial competition for factors of production (Lavoie 1985, Mises 1990). Nor can such prices serve as a useful starting point in a bureaucratic search for their equilibrium equivalents, guided by demonstrated preferences for various consumer goods and the resulting surpluses and shortages. On the contrary, the only prices that can function as credible signals of relative scarcity under conditions of dynamic uncertainty are intersubjective exchange ratios arrived at through actual entrepreneurial choices and culminating in continuously established “plain states of rest” (Klein 2008). Only such exchange ratios can communicate the relative efficiency (or lack thereof) of various economic solutions in a genuinely rational — i.e., economically meaningful — manner, indicating how closely any such solution measures up against a literally infinite number of potential alternatives (Wisniewski 2015).
The above observation becomes even clearer in the context of the socialist proposal that state-appointed managers could replicate the efficiency of the capitalist price system by pretending to be entrepreneurs and playing competition, speculation, and investment (Mises 1996, pp. 705–710). What such a proposal amounts to is the extension of bureaucratic deliberation into the realm of managerial decision-making, whereby socialist managers may pretend to make authentic entrepreneurial judgments, while in fact remaining within the ambit of purely verbal signaling, which carries no economic meaning as far as rational allocation of resources is concerned. For all practical purposes, a game is a kind of talk — it never crosses over from the realm of declarations into the realm of actions. Thus, playing entrepreneurship is a contradiction in terms, which can never generate the kind of communicative rationality that is necessary to address the challenges posed by scarcity and uncertainty.
It is important to realize here that even a full-blooded entrepreneur can be partially reduced to a mere verbal “player” in the unlikely event of becoming the sole user of a non-specific factor of production (Klein 1996). Under such conditions, his situation is, praxeologically speaking, no different than that of a socialist manager. In other words, he can ceaselessly plan to optimize the use of the factor in question, but, in the absence of competitive bidding for its services, all such plans are bound to remain sheer wordplay, not entrepreneurial action informed by the relevant opportunity costs. Thus, investigating the entrepreneurial aspects of communicative rationality demonstrates the inherent instability of “market monopolies” — i.e., cooperative ventures cut off from the signals necessary to evaluate their cooperative performance.
In sum, emphasizing the competitive-entrepreneurial core of sound economic calculation demonstrates that in the ambit of complex social cooperation actions not only speak louder than words, but are indispensable to make words meaningful in the first place.
- Deliberative democracy Another area in which the notion of communicative rationality occupies a position of central importance is that of the so-called deliberative democracy (see, e.g., Chambers 2003, Thompson 2008). According to its proponents, social empowerment results from increased involvement in the process of democratic decision-making, which should extend beyond mere voting. The extent and specificity of relevant decisions is variously defined by various theorists in the field, but, insofar as the proposal in question advocates a greater politicization of society, it approximates some form of cooperative economic central planning. Thus, it falls prey to all the problems discussed in the previous section.
Worse still, it generates additional problems of its own. If the deliberative procedure under consideration were to be combined with representative democracy — especially as implemented on a scale typical of contemporary nation-states — then no individual citizen would have an incentive to make his deliberative input genuinely thoughtful and informed. Since a single vote in contemporary large-scale representative democracies has an infinitesimally small chance of swaying the election, and since the successful voters can externalize the costs of their decisions onto the unsuccessful voters, the arrangements in question make it rational for voters to be ignorant of relevant issues (Downs 1957, Matsusaka 1995). Worse yet, some voters may use such arrangements to indulge in expressing their irrational preferences (Caplan 2007). “Empowering” them through their involvement in a deliberative process does nothing to address the above problems, since, regardless of the extent of their purely verbal contributions, their lack of ownership interest in the electoral system and their infinitesimal influence on its outcomes ensures that their decisions are characteristically non-entrepreneurial — that is, devoid of the virtue of prudence and insulated from honest engagement with the issues of scarcity and uncertainty.
On the contrary, such engagement is likely to be seen on the part of various special interest groups determined to game the system to their advantage. Such groups, characterized by uniform interests and capable of pursuing highly concentrated profits, can overcome the collective action problem (Olson 1971, Ostrom 1990) precisely by disregarding the deliberative features of the system under consideration and committing their own financial resources to campaigning, lobbying, bribing and other activities encompassed under the umbrella of so-called political entrepreneurship (McCaffrey and Salerno 2011). In other words, far from enhancing the political influence of disorganized have-nots, the model of deliberative democracy provides an additional illustration of the crucial influence of organized haves, which is largely derivative of their role as owner-entrepreneurs — that is, “rational communicators” capable of backing their words with economically meaningful deeds.
The same observations seem to apply to the deliberative story originated by Rawls (1971), which involves propertyless characters debating behind a “veil of ignorance” about the ideal form of a just social system. Such characters, even though they are conceptualized as facing uncertainty about their natural endowments and social position, are nonetheless completely detached from the problems of uncertainty and scarcity that would arise as soon as they learned about their natural endowments and social position. One of the main lessons of the causal-realist tradition is that the viability and efficiency of various specific institutional arrangements can be evaluated only ex post — that is, only as a result of the free unfolding of the rivalrous process taking place among various institutional entrepreneurs (Boettke and Coyne 2009). As a result, it seems inadmissible to suggest, as Rawls does, that the uniquely appropriate shape of a just society can be deduced through purely verbal discussions conducted by disembodied deliberators.
However, one crucial conclusion that can be deduced in such a manner is the one concerning the proper form of the “meta-institutional” conditions under which the above-mentioned rivalrous process can operate uninhibited — conditions that include a robust respect for property rights, freedom of association, and entrepreneurial experimentation. Only in such an environment can institutional entrepreneurs not only freely deliberate about their respective organizational projects, but also implement them based on genuinely contractual and unanimous decisions (Boudreaux and Holcombe 1989, Wisniewski 2017). Thus, contra Rawls, it appears that the kind of communicative rationality that allows for bridging the realm of organizational deliberations and the realm of simultaneously undertaken organizational actions emerges only in society understood not as a single cooperative venture, but as the sum total of cooperative interactions aimed at the actualization of different competing ventures (Chartier 2014).
In sum, while deliberation has its important place as a planning tool, and while its democratic form has its place as an empowering device, neither can help bring about desirable social results when divorced from the realm of entrepreneurial judgment — that is, the realm where words are backed by deeds, and deeds are backed by privately owned resources.
- Public goods The final area which I would like to mention in connection with the importance of looking at the notion of communicative rationality though the lens of the Mengerian-Misesian tradition is that of so-called public goods. According to the dominant neoclassical exposition, these constitute a distinct category of goods characterized by the criteria of non-rivalness and non-excludability (see, e.g., Willis 2002, pp. 161–3; Arnold 2004, pp. 720–3; Ayers and Collinge 2004, pp. 555–9). This is supposed to imply that such goods cannot be effectively provided on the basis of voluntariness, contractuality, and entrepreneurial competition, since no potential consumer should be excluded from their enjoyment and no actual consumer should be allowed to shirk payment for their enjoyment. This, in turn, is supposed to indicate that the “optimal” amount of such goods can be determined and supplied only on the basis of electoral and bureaucratic deliberation.
However, in view of the considerations from the proceeding sections of this paper, it should readily become clear that neoclassical public goods argumentation begs the question against the competitive-entrepreneurial approach by assuming to know in advance what, according to the causal-realist tradition, can be learned only by utilizing the competitive-entrepreneurial procedure.
This can be demonstrated on a number of fronts. First, since costs are inherently subjective and agent-relative phenomena (Buchanan 1969), the putative non-rivalness of any given good cannot be established in the absence of freely demonstrated consumer preferences. If, for instance, a given individual were to desist from consuming a specific good upon noticing that it is being simultaneously consumed by other individuals, then it would be the clearest possible evidence of the fact that the good in question is, in fact, rivalrous. Such evidence, however, can emerge only from the operation of the competitive-entrepreneurial process (Kirzner 1997). Second, since we do not live in a world of Edenic superabundance, even if we were to treat certain consumer goods as non-rivalrous, we would have to bear in mind that the producer goods needed to bring them into existence are clearly rivalrous. This, in turn, implies that their specific uses are associated with specific opportunity costs, which have to be economized on if the “optimal” amount of the relevant final goods is to be produced. However, what these opportunity costs are can, again, be discovered only on the basis of unhampered entrepreneurial competition and simultaneous experimentation. Thus, whether any given good can be classified as non-rivalrous can be established only with the help of the kind of communicative rationality that appears exclusively in the course of actively managing one’s capital assets under conditions of scarcity and uncertainty (Wisniewski 2013a).
Third, “external benefits” is not a term that can be economically operationalized, since, just as in the case of non-rivalness, such putative benefits are by definition detached from actual consumer payments capable of revealing the underlying (momentary) preference scales. This need not necessarily indicate that the term in question has to be expunged from economic theorizing altogether, but it does suggest that it may be advisable to reconceptualize it as an element of the general entrepreneurial challenge. In other words, even though it is impossible to construct a praxeological proof that in any given situation a specific individual is affected by positive externalities, an entrepreneur may speculate that the goods he produces do in fact generate such externalities, and that internalizing them may increase his revenues (Block 1983). Again, whether his speculations in this matter are correct or not can be established only retrospectively, through the operation of the entrepreneurial profit and loss system (Mises 2008). Fourth, it is not the case that subjecting the production of supposedly non-excludable goods to electoral and bureaucratic deliberation eliminates the free rider problem. On the contrary, it may be plausibly suggested that it only recreates this problem in a more troublesome form, since, as long as some members of a given deliberative system are net tax consumers, they are able not only to retain their free rider status, but also to solidify this status in an institutional manner, blocking any attempts by entrepreneurs to internalize the relevant externalities. It is only under such conditions that external benefits become an economically operationalizable phenomenon — where institutional compulsion is involved, benefiting without paying is demonstrable in a praxeologically obvious way. Thus, non-excludability can be seen as a free-floating abstraction when analyzed through the lens of the neoclassical framework, but it assumes a concrete economic meaning when looked at from the vantage point of the Mengerian-Misesian tradition (Wisniewski 2013b).
In sum, while the notion of public goods in its standard formulation appears to be encumbered with a number of conceptual difficulties, its reformulation in the spirit of the causal-realist approach allows for turning it into an element of the mental toolkit that can be profitably utilized in the context of designing entrepreneurial strategies.
- Conclusion It seems rather uncontroversial to suggest that we live in a world of rapidly increasing economic dynamism, social interconnection, and informational complexity. Hence, it goes without saying that the notion of communicative rationality should be seen as ever more pertinent and worthy of investigation. However, as illustrated in the present paper, it is also crucial to realize that in such a world a purely deliberative understanding of communicative rationality is increasingly inadequate, if not outright misleading. As I attempted to demonstrate, the Mengerian-Misesian tradition in economics is uniquely suited to embed the notion in question in the realm of praxeology, thus tying it with the issues of scarcity, uncertainty, profit, loss, ownership, and personal responsibility, and allowing it to assume a causally realistic form. Only having assumed such a form can it then illuminate a number of essential economic phenomena characteristic of today’s cultural, institutional and organizational environment.
For instance, in the contemporary informational milieu, consisting of innumerably many independent, horizontally integrated contextual nodes, it is increasingly important to realize that information asymmetry is not a defect to be rectified by communal deliberation and bureaucratic equalization of access to “intellectual opportunity”, but a necessary condition of specialization, division of labor, and entrepreneurial discovery (DiLorenzo 2011). In other words, the relevant social information, especially that of a highly contextual and tacit nature, can be unveiled and utilized only by means of engaging not in political deliberation, but in market action — and the more complex and information-driven the economy, the more essential this realization becomes.
Furthermore, in a highly interconnected social and economic environment, large-scale mistakes tend to generate destructive domino effects. This is why, if the fragility of the system is to be minimized, the ability to make such mistakes cannot be institutionalized and their perpetrators have to be personally burdened with the associated risks. It might be argued here that deliberative democracies, public-goods-driven interventionisms, and other politico-bureaucratic forms of social organization are particularly prone to institutionalizing such errors, known under the umbrella term “moral hazard”, since they centralize power, monopolize crucial decision-making channels, encourage rational ignorance and rational irrationality, and forcibly externalize the costs of their actions onto others. In other words, it might be argued that it is asymmetry of power and responsibility, not asymmetry of information, that is particularly conducive to the emergence of moral hazard and the resulting systemic fragility (Hülsmann 2006). This, in turn, implies that a maximally decentralized, competitive, entrepreneurial, and private-property-based system of social organization — that is, one that requires backing words with deeds and maintaining “skin in the game” — should be seen as especially resistant to institutionalized moral hazard and systemic fragility (Taleb 2012).
Finally, as the informational complexity of the economy grows, even the quintessentially deliberative elements of the operation of entrepreneurial entities — such as boardroom meetings — increasingly have to be supplemented by the “intrapreneurial” initiative of hired managers and other non-owning employees, encouraged to undertake creative actions through the exercise of “derived judgment” (Foss, Foss, and Klein 2007). As a result, the competitive discovery procedure and the attendant entrepreneurial experimentation can take place not only among institutional market participants, but also within their organizational structures, further enhancing their ability to discover and create socially useful knowledge and communicate it in an effective manner.
Thus, it appears that, in contrast to the beliefs of the proponents of communal deliberation as the best way of generating solutions to complex social issues, the more information-driven the society, the more it has to rely on the kind of communicative rationality that transcends a purely verbal and deliberative level and tackles the problems of scarcity and uncertainty by utilizing the distinctly entrepreneurial aspects of the logic of action. Taken to its logical conclusion, this observation indicates that the approach in question applies not only to “playing the game” of large-scale social cooperation, but to specifying its rules as well (Wisniewski 2013c, 2014). It has been my contention here that only the Mengerian-Misesian tradition in economics, which identifies entrepreneurship as the crucial bridge between word and action in a world of scarce resources and uncertain outcomes, makes this observation sufficiently clear and intellectually fruitful. When combined with the theory of communicative rationality, it allows for formulating a causally realistic vision of practical reasoning that can serve as a solid foundation for the extended order of rational social cooperation (Salerno 1990). It is high time to recognize these gains from trade and use their potential to the fullest.
Austrian economics emphasizes the delivery of value for consumers and customers. Only they can define value, because it’s their subjective experience that is valuable to them. Stephen Denning, author of The Age Of Agile, explains how entrepreneurs can exercise the "Agile" mindset, and offers insight into how Austrian principles inform the latest generation of business strategies for the digital age.
Key Takeaways and Actionable Insights The revolution in value:
In the manufacturing economy, value was seen as making goods and selling goods.In the service economy, value was seen as service delivered to, and co-created by, customers.In the digital economy, all value is realized in the customer’s domain, and even they can’t imagine the value they’ll experience when they start using new digital technologies and methods. In Austrian economics, the theories of customer sovereignty and value in experience that sit behind this value revolution are well established. Now, entrepreneurs are finding ways to implement these Austrian principles. They call the new world of value “Agile”.
According to Stephen Denning, the agile value revolution is a mindset, with three guiding principles.
Obsession with facilitating great customer outcomes.Deliver the great customer outcomes at speed (work in small teams with short cycles)Organize the firm as a network not a hierarchical bureaucracy. Entrepreneurs can exercise this mindset in these ways:
Facilitate new value outcomes for customers.
Entrepreneurs don’t create value — value occurs in the customer’s domain based on their consumption, and their context.Entrepreneurs can’t plan the value outcome — it’s emergent.Even customers can’t imagine what value they’ll experience from a new service or new technology.Therefore, entrepreneurs can facilitate value — make it possible — but only customers can realize value. To facilitate value, fit into the customer’s life.
Responsiveness is not enough — you’ll always be behind the twists and turns of customers’ changing preferences and experience.The art is to keep up with customers in real time as they change.Practice customer anthropology — become part of their lives. Time is value — use it well.
Customers prefer faster over slower.Therefore, speed is value.Use time as a strategic weapon: faster wins. Eliminate all waste.
No value is created inside the firm.Many internal activities are pure waste — reversing value outcomes (e.g. decreasing speed).Estimates vary between 20%-50%+ of firm internal activities are waste.Eliminate all the waste you can identify.Export the savings to the customer. Flexible, dynamic capital allocation.
Move resources and capital around quickly, to value-facilitating applications.Be ruthless in eliminating non value-facilitating projects. Design and operate your firm as a network.
A flotilla of speedboats outperforms a big machine.Change processes from linear to networked — from lean to flow.Change organization from hierarchy to network — no reporting lines.Change leadership thinking — place leadership in the teams that are close to the customer Additional Resource "The Agile Value Revolution" (PDF): Mises.org/E4E_41_PDF
Professor Peter Klein teaches entrepreneurship based on fundamental Austrian principles from Carl Menger’s Principles Of Economics. His advice is unlike anything you’ll get from studying mainstream economics, or from business books and business school classes. In our podcast, Peter explains the fundamentals of economics under ten headings, below, and transforms that economic knowledge into entrepreneurial guidance.
Key Takeaways And Actionable Insights Humanism: Business is about serving others, making their lives better. You can engage customers by understanding their hopes and dreams and their highest aspirations. Make humanism the foundation of your business strategy.
Individualism: To understand customers, you must approach them as individuals, not as “targets” or “segments” or “demographics”. Individualism is a methodology: identify one perfect customer and then try to add more that are closely similar.
Means And Ends: Customers choose products and services that they believe will serve them as means to achieve their preferred ends or goals. Use means-ends analysis to identify the pathways customers will follow to embrace your offering. Think of it as the customer’s journey through a valued experience that you can make possible for them. (Our free e-book, Understanding The Mind Of The Customer can help.)
Subjective Value: Value is an experience felt by the customer. It’s subjective and idiosyncratic, and can change with time and context and mood. Entrepreneurs must be empathic in diagnosing how customers experience value or its opposite, dissatisfaction, and humble in following changes in value perception that can occur quickly and without warning.
Customer Sovereignty: The customer is your boss, and determines what is valuable, what they will buy and refrain from buying, and which products, services and businesses will be successful. Changes in customer preferences can sometimes seem arbitrary and hard to follow; nevertheless, the entrepreneur’s job is to follow, respond, and ideally, imagine where the customer will go next in their search for betterment.
Uncertainty: The future can not be predicted. Extrapolated trends and predictive models can not deal with the changing preferences of customers over time. Even the customer is not sure what value they will experience when they use your product or service — it emerges from the interaction. Entrepreneurs understand this uncertainty and deal with it, by imagining what the future could be, based on their customer understanding, and adjusting to new information as it becomes available.
Deductive Method: Uncertainty sounds so intimidating. Austrian entrepreneurs use the deductive method to help steer them. Find some principles you know to be true — we know for example, that customers are always seeking betterment — and use those principles to reason your way to understanding complex phenomena. Your specialized knowledge of your chosen business specialty will give you solid grounding. By all means add test data and evaluation data and marketplace results data to your reasoning. But try to find the bedrock principles you can reason from.
The logic of cause and effect: All things are subject to the law of cause and effect. If you can identify the causal linkages, you will be firmly in command of your business. Write the story of the future evolution of your growth path in cause-and-effect language and match it to actual events as they unfold.
The role of time in production: Austrian economics has a unique sensitivity to time in the production process. Entrepreneurs must commit capital now to start production that will be completed in the future, without knowing the future nature of the market — what prices will prevail, what competitive firms will do, how the customer will be feeling about future conditions. Time is a danger to entrepreneurial success — so be as quick as possible, make fast decisions, shorten production cycles, and use time as a scarce resource.
The division of the production chain into higher and lower orders: The value of every link in the production chain reflects the revenue flow from customers to which it contributes. If preferences change, the value of upstream production resources changes. Wherever you operate, B2B or B2C, always keep an eye on end-customer behaviors and preferences. As a B2B supplier, you can be very useful to your business customers by alerting them to end-consumer changes.
Additional Resources Download "Menger's Manifesto"—Professor Peter Klein’s list of 10 Austrian Principles from Principles Of Economics (PDF): Mises.org/E4E_40_PDF
Download our free e-book, Understanding The Mind Of The Customer (Mises.org/E4E_Understanding).
Download Menger’s Principles of Economics (Mises.org/E4E_Principles).
Marketing guru and fund investor Hunter Hastings joins the Human Action podcast for a look at Economics for Entrepreneurs, a new platform which uses Austrian theory to teach actionable entrepreneurship.
Can business acumen be taught, or is it innate? Hunter and Jeff examine consumer sovereignty, value creation, and the theory of the firm, all from a unique Austrian perspective. Austrians have a lot to say about how entrepreneurs ought to think, while business schools fail to adjust to the new decentralized, agile world. Austrian economics provides entrepreneurs with a different set of tools than any business book or MBA program, and our new podcast series will help anyone improve their business or career bottom line.
Additional Resources Mises for Business LinkedIn page
Economics for Entrepreneurs (E4E) podcast
Rick Rule is CEO at Sprott US Holdings. His lifetime focus on natural resources finance enabled him to carve a unique pathway to entrepreneurial success. Like many entrepreneurial journeys, Rick’s had some twists and turns. Here are some of the key stages.
Key Takeaways and Actionable Insights Find out early what you love. Rick enjoyed the outdoors, nature and therefore natural resources, the associated science of efficient and effective use of natural resources, and finance. All of us have a combination of likes and preferences that may stimulate us but may not initially appear to present us with an entrepreneurial recipe. But as Curt Carlson explained in Episode #34, combining knowledge from different people and fields can result in compounding insights.
Combine Knowledge in New Ways. Rick combined natural resource science with principles of corporate finance, specifically debt and equity finance for extractive industries. As a result of the special properties of natural resource markets, and firms’ needs for customized financing, an opportunity niche emerged. Rick’s application of his special combination of knowledge placed him in a competitively advantaged position.
Learn By (Hard) Experience. Rick learned not to confuse a bull market with brains, as he puts it. He did business through a complete commodity market cycle in the 1970s through the early 80s, experiencing volatility and ups and downs first hand. Theory is no substitute for experience. Nevertheless, his knowledge of Austrian Business Cycle Theory, Austrian Price Theory (“the cure for high prices is high prices, and the cure for low prices is low prices”) granted him a superior perspective in interpreting market signals.
Develop Deep Market and Customer Understanding. In his focus market, Rick developed a business segmentation that focused on participant firms of a defined size (<$250MM market cap). He studied those customers and understood their circumstances. The consequence of limited information flow (data about these firms did not flow easily between conventional market analysts), was that the firms had limited access to capital. Rick was able to overcome these information gaps, making him a preferred supplier of scarce finance.
Identify a Need You Can Fill For Your Carefully Selected Audience in Your Carefully Selected Market Segment. The business model came together in a way that Rick describes as “lender of last resort to high quality management teams in high quality companies that were not popular” and were therefore capital constrained. In addition, Rick’s understanding of business cycles and commodity prices further strengthened his confidence in lending when others would not, the market rewards for which turned out to be high.
Combine Empathy, Trust and Courage. Rick confirmed the E4E emphasis on empathy as an important skill for entrepreneurs — primarily, in his case, empathy for the customers whom he financed. He sought to combine empathy with trust: in a market where information is scarce, it is imperative to have trust in the sources. “Without trust,” says Rick, “I have no information, and therefore I cannot make decisions.” The third emotional attribute he identified is courage — the courage to have the conviction that your model indicating a future upcycle or price rise is well constructed, and not to second-guess it during the time that the trade is underwater.
Additional Resource "Rick Rule's Path to Entrepreneurial Leadership" (PDF): Mises.org/E4E_39_PDF
The management methods and practices that have been gathered under the term agile claim the status of a Copernican Revolution. Agile reverses the traditional view of business revolving around the firm, instead placing the customer at the center and viewing all other elements as revolving around the customer.
This is a welcome development — but just a step towards the Austrian vision of consumer sovereignty and the concept of value as created by the consumer, not the producer.
Key Takeaways And Actionable Insights We examined the three "Laws of Agile" proposed by Stephen Denning in his book The Age Of Agile, and Per Bylund notes the elements that are useful for entrepreneurs, and the extra insights provided by Austrian Economics that can help entrepreneurs to perform at a higher level in facilitating value experiences for their customers and consumers.
The Law Of The Customer Agile recognizes that the one valid definition of business purpose is to create a customer.The customer — with mercurial thoughts and feelings — is at the center, and demands to be delighted.What the firm thinks it produces is less important than what the customer thinks he / she is buying — what they consider “value”.Everyone in the firm must view the world from the customer’s perspective, and share the goal of delighting the customer.The firm must have accurate and thorough knowledge of the customer.Continuous innovation is a requirement to delight customers.The firm’s structure changes with the marketplace.Speed of response becomes crucial and time is a strategic weapon. Austrian Enhancements The Austrian concept of Customer Sovereignty is even more powerful for entrepreneurs — customers create firms, in the sense that customers decide what is produced by buying / not buying, and therefore which firms are successful.Value is subjective — and so customer preferences can change rapidly and frequently.Responsiveness is not enough — the goal is to imagine the customer’s future needs, and involve them in the production of future value. The Law Of Network Collaborative network of competence replaces hierarchy of authority.The network has no leader, but it does have a shared, compelling goal.The network is the sum of the small groups (rather than individuals) it contains.Each group has an action orientation.The network’s administrative framework stays in the background. No bureaucratic reporting. Austrian Enhancements Agile is based on too narrow a view of the economic network. It’s still producer-centric.The true network is the market — which includes customers (of which there are many more than firms, and who exert more economic influence than firms).Networking the production side of the firm is an incomplete act.A fully-functioning network includes customers and consumers with equally valid connections to the firm, not just collaborative production partners. The Law of Small Teams Big and difficult problems are disaggregated into small batches and performed by small cross functional teams — scaling down the problem.7 +/- 2 is a good rule of thumb for team size.Each team is autonomous, and works in small batches and short cycles.Each team aims to get to “done” — it’s binary: either done or not done, never almost done.No interruption.Radical transparency.Customer feedback each cycle.Retrospective reviews. Austrian Enhancements A pure focus on short term execution can divert attention away from longer term considerations – especially, imagining the future, which is the core component of entrepreneurship.Focus on creating value for the future, while ensuring no loss of current reputation and relationship.Administration — and therefore “bureaucracy” — can’t be eliminated entirely without a reduction in customer value.Required services can be a component of value creation — such as compliance, operations management, etc. Additional Resource "The Laws of Agile Meet Austrian Economics" (PDF): Mises.org/E4E_38_PDF
Is successful value creation through innovation the product of genius? Or, of luck? No, it’s the product of a system, applied with discipline. Utilizing the system can result in repeated success in customer value generation.
Curt Carlson is the world’s leading expert practitioner. He is the founder and CEO of Practice of Innovation, LLC, and was President of SRI International, identified as the most successful innovation company in the world based on its development and introduction of globally important innovations like Siri for the iPhone4 and HDTV. Under Curt’s leadership, SRI grew 3.5X and created tens of billions of dollars of new customer value.
Key Takeways And Indicated Action Curt believes any company can systematically generate new value for customers, and reap the rewards of the market for doing so, when they rigorously apply three fundamental rules:
They have a simple value creation methodology that everyone in the company (and its collaborative partners) can describe, understand and apply every day in every job function. (Curt’s test: ask everyone in the company what the firm’s value creation method is: if they can’t describe it, there isn’t one).They have metrics to define innovation work that is important rather than merely interesting. While subjective value is not quantifiable, there are proxies for measuring importance and market potential.They have a system for active learning. Innovation is a learning science, and active learning is a specific, high speed, high productivity version of learning, applying the best learning science principles. In this week’s podcast, we focus especially on the simple, effective value creation methodology that Curt identifies by the initials N-A-B-C.
N is the identification and quantification of the important customer need. In B2B businesses, it’s possible to monitor financial flows and identify needs based on quantifiable elements — cost savings, time savings, and measurable quality improvements. In consumer businesses, need identification is much harder, and quantification impossible except by proxy, since needs are subjective and individual. Importantly, they are also multi-dimensional, and need identification must encompass all the dimensions.
It’s important to deeply understand human wants, whether it’s for convenience, or higher order wants such as pride and identity. Surveys told Steve Jobs that consumers wanted a “new keyboard” for existing Nokia phones that were hard to use. Jobs’s intuition was that what they really longed for was convenience. The touchscreen on the iPhone provided convenience and opened a doorway to all kinds of additional services.
A is the Approach the entrepreneurial innovator takes to meet the customer need. The approach is the design of an experience that the customer will desire. The Approach mist embrace both the assembly of the right resources into a technical solution, and the business model so that the solution makes money. There’s an iterative back-and-forth between technical solution and business model that can continue for years. Nike’s technical solution for shoes is good but not unique; its business model for sponsoring athletes to inspire aspirational consumers who wanted to “be like Mike” (or, today, like LeBron) elevated their offering from product to experience.
B is Benefits Per Costs. Curt uses this construction to emphasize that there are large buckets of both benefits and of costs. Benefits include not just features and performance and appearance, but also the feelings produced by the experience. Costs are similarly multi-layered: not just dollars, but also the effort required to acquire the product, and perhaps to master its use, the opportunity cost of what is given up, durability, and more. The innovative entrepreneur must look at costs from all of these angles and calculate that the “benefits per costs” for customers are much better than alternatives.
Curt’s rule of thumb is 2X to 10X better. People measure perceived benefits in percentages. 10% better, 50% better, 100% better than the status quo or the alternatives. Transformational innovations are 2X to 10X better.
C is the competition and other alternatives — both today and in the future. What are all the other ways the customer can experience the benefit they seek? What are alternative ways for them to spend their money — perhaps on a different experience that’s not a direct substitute but on which they’ll spend instead of buying our solution. How does your innovation fit into their lives so compellingly as to become preferred over all these alternatives?
N-A-B-C is a simple framework, but it’s not easy to achieve results. It requires iteration at speed among many collaborators (including customers, and possibly investors), all with different and specific talents and tacit knowledge. No individual can command sufficient knowledge, so team learning — active, comparative learning, frequently updated — is critical to the outcome.
The result is transformational: for customers who experience new value, for the firms that facilitate it, and for the individuals who practice the discipline of innovation.
Additional Resources "Curt Carlson's N-A-B-C Innovation" (PDF): Mises.org/E4E_37_PDF
Curt Carlson’s book is Innovation: The Five Disciplines For Creating What Customers Want.
This week, while keeping our eye on our highest value — entrepreneurial success — we raise our focus to the system level and the meta-ideas that sustain entrepreneurial effort and Austrian innovative dynamism.
Key Takeaways and Indicated Action Professor Arthur Diamond has written a wonderful book about nurturing the system in which we entrepreneurs operate. The subtitle of his book is Sustaining Innovative Dynamism. Like all great writers in the Austrian tradition, he recognizes and celebrates the contribution of the entrepreneur to society: to make others’ lives better.
In many ways, this is both an economic and an ethical stance. To quote Jesus Huerta De Soto (in a similarly titled essay, "The Theory of Dynamic Efficiency"):
…the most just society will be the society that most forcefully promotes the entrepreneurial creativity of all the human beings who compose it.De Soto, Jesús Huerta. The Theory of Dynamic Efficiency (Routledge Foundations of the Market Economy) (p. 176). Taylor and Francis. Kindle Edition.
But Professor Diamond is a little bit concerned that the environment for entrepreneurial dynamism is under assault in the US. It’s up to all of us to work hard to sustain the system. Professor Diamond lays out the threats under three headings.
CULTURE The entrepreneurial culture would celebrate the contributions of its entrepreneurs to a better life for all: prosperity, comfort, efficiency, health, personal achievement, and the human augmentation that comes with technology. Our lives are not only more prosperous, but more productive and more enjoyable, longer and healthier, thanks to entrepreneurs.
Often when we do celebrate entrepreneurs, it’s one hand clapping. Bezos, Musk, Gates and Jobs and others are recognized, but also sometimes vilified, and often judged on whether they “give back” — as if there was some guilt about their incredible contributions to human well-being.
And, Professor Diamond points out, a truly entrepreneurial culture would celebrate the lives of meaning and purpose led by entrepreneurs on every scale, from small business to big business.
We can all participate by celebrating the heroic stories of the entrepreneurial life, telling them loud and often.
INSTITUTIONS Under this heading, Professor Diamond focuses on the law, private property and markets.
We can observe our legal institutions turning against entrepreneurs in the form of tort suits and punitive damages. Professor Diamond calls for reform to preclude unreasonable awards of damages, and points to examples where doing so has resulted in unleashing entrepreneurship (such as 7000 new doctor’s practices opened in Texas after a damages cap on malpractice cases was put in place).
Private property protection is fundamental to the economic freedom entrepreneurs exercise to bring the benefits of innovation to society. Government is always tempted to seize private property, and often succumbs to the temptation. We must publicize each instance and protest each time.
Markets are the institution that facilitate the entrepreneur’s presentation of new offerings, and the consumer’s freedom to choose from what’s on offer. We talked about matching venturesome consumers (early adopters) with venturesome entrepreneurs, and removing the barriers that often come between them (for example, in medical innovation markets).
GOVERNANCE At this point, Professor Diamond exhibits amplified animation, recognizing that government regulation is the greatest threat to entrepreneurship and innovative value creation on behalf of others. He’s angry. He discerns two types of anti-entrepreneur regulation. The first is regulation that is sourced in purportedly well-intentioned (but demonstrably wrong-headed) efforts to protect consumers or workers. Here, we must energetically point to the greater benefits that ensue from the exercise of economic freedom than from its constraint.
One particularly important example is medical innovation. Too often, the heroic efforts of medical entrepreneurs to alleviate pain and suffering are thwarted by FDA regulation.
The second kind of regulation is the overtly corrupt protection of industry incumbents and big business, lubricated by lobbying and political quid pro quos. Here, we must all be whistleblowers.
Key Takeaway: Maintain entrepreneurial energy at all times and spread it in all directions.Celebrate heroic stories at every scale. Educate the world on the ethical and moral superiority of the entrepreneurial society, as well as its prosperity and wellbeing. Denounce legal predators, regulation and protectionism. We must contribute to the development of the entrepreneurial culture, institutional framework and governance as much as we do to customer betterment.
Additional Resources "Sustaining Innovative Dynamism" (PDF): Mises.org/E4E_36_PDF
"Entrepreneurial Stories For Young Socialists": Arthur Diamond tells Walt Disney’s story.
"When New Yorkers Cheered The Wright Stuff:: Arthur Diamond tells The Wright Brothers Story.
Openness To Creative Destruction: Sustaining Innovative Dynamism: Arthur Diamond’s book.
Visit Professor Diamond’s personal website (ArtDiamond.com) and blog (ArtDiamondBlog.com), and read his article on Innovation Unbound, which begins: "Inventors and entrepreneurs are key drivers of innovations that result in improvement in human welfare."
Is there a recipe for entrepreneurial success? Chris Wilton has established a successful and growing catering business, and the recipe he developed has some ingredients that every entrepreneur can utilize.
Key Takeaways And Actionable Insights Economists (e.g. Murray Rothbard in Man Economy and State) often talk about the recipe that entrepreneurs develop for business growth and success. They don’t quite mean it literally — a fixed proportion of ingredients combined in the same way and the same sequence every time for the same result — but the analogy is nevertheless useful. Recipes are plans entrepreneurs utilize to advance from one step to the next in pursuing their goals.
A recipe is intellectual property — software if you will. Sometimes it’s opensource, sometimes it’s proprietary. When a chef utilizes a recipe, even one that is well known, both the chef and the customer anticipate something unique: Mary makes the best chocolate cake! Lots of people make chocolate cake, and they might use the same ingredients as Mary, but, in the subjective view of a customer, no one’s result is as good as Mary’s.
To get a result, Mary has to combine hardware with the software, and perhaps there is an edge there. We might call that the capital structure that is perfectly tuned to Mary’s purpose and matches her skills. Perhaps it’s even possible to assemble superior ingredients — a special and better kind of chocolate for example.
Mary might also need collaborators. She certainly needs customers to subjectively evaluate her cake.
We’ve probably tortured the analogy enough at this point. But hopefully, we got you thinking about the role of the entrepreneur in assembling resources in order to produce something that the customer values.
In this week’s podcast, Chris Wilton of Wilton’s Catering gave us his recipe for a successful and growing business. We’ve captured it in the accompanying PDF, linked below.
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Here are some of the headlines:
Start with self-assessment: The one universal attribute of entrepreneurship that everyone seems to agree on is: it’s hard. It requires creativity but also discipline, determination and grit. It’s important to have examined your own disposition before you embark on the entrepreneur’s journey. Passion and drive are mandatory. (There’s a self-assessment tool, and a journey map.)
Identify a market and a customer: Chris Wilton knew his industry, and worked hard to pick the right beachhead customer. The beachhead customer is the first adopter who will be your customer-partner in getting your business off to a good start. Chris chose a nearby university with a highly developed and diverse set of catering needs, where he could develop his unique style of food and service.
Plan, plan, plan: Prior to launch, Chris spent months developing a detailed plan. Working from the customer (what are their needs — identified by multiple, frequent, in-depth customer conversations) backward through on-site service and set-up, delivery, capital equipment, real estate, raw material procurement, recipes, hiring and training and operating manuals. Chris’s time allocation and effort in planning was intensive. And it paid off.
Develop a customer experience, not just a service: Chris is totally focused on delivering a delightful customer experience, which entails a lot of empathic listening to the customer to understand what they expect, and then disciplined and detailed execution at every event and every meal, including the customer experience orientation and training of staff. After the event, always ask and listen for customer reactions. Was the experience good? How could it be better?
Innovate, innovate, innovate: You evaluate so that you can innovate. Innovation is continuous improvement — always looking for something new and better that will create new value for customers. A new or improved recipe, better preparation methods, improved staff training — it’s all innovation when it’s done to elevate the customer experience. One of Chris’s technique’s is sampling events where he can try new things, give away his food for free, and get feedback that he can use to perfect the innovation.
What’s the end-result? For Chris, it’s happiness. He loves and enjoys what he is doing, and he brings happiness to customers, to the attendees at customer events, and to his employees. That’s the great fulfillment of entrepreneurship.
Additional Resource "A Recipe for Entrepreneurial Success" (PDF): Mises.org/E4E_35_PDF
Pricing is fundamental to business success — to generating transactions, to cash flow and to profitable operations. There’s a lot of uncertainty for entrepreneurs in the pricing process, and economics is a good source of clarity. In fact, Peter Klein tells us that economics used to be called price theory, recognizing this fundamental role of pricing in economic exchanges.
Key Takeaways and Actionable Insights Austrian economics offers a special way of thinking about pricing that is helpful for entrepreneurs. Here is a 12-point list of pricing fundamentals.
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Consumers set prices. This insight establishes the right entrepreneurial mindset: the entrepreneur can’t control pricing and shouldn’t try to. It only leads to frustration. Act on the basis of the consumer as the determiner of market prices.
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Consumers don’t set or negotiate the price in every transaction. They are the determiners in the medium and long term. If sufficient numbers of them don’t feel they experience value at the price they’re asked to pay, they won’t buy and the entrepreneur will not be able to generate the revenue that’s called for in their business model. They’ll have to change their price, or their offering or their valued proposition.
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A price holds only for one transaction. Just because it was the right price to get one consumer to transact at one moment in time and one context, does not mean it will hold for the future. Just because it is the sticker price or asking price does not mean the consumer has no alternative but to pay it.
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That’s why Austrian Economics sees pricing as a dynamic and creative discovery process. The entrepreneur is charged with discovering the price the consumer is willing to pay now, in the future, in different circumstances and different contexts.
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Price discovery goes further — to the design of specific packages of product / service and experiences. What will the consumer pay for the product now, with no waiting? What will they pay for same-day delivery? What will they pay for the product / service in a special physical location — is a newly-released movie in a luxury theater valued more than a 3-month old movie on a streaming service? Is a coffee in a cafe where the consumer can sit for a while more valued than a take-away cup?
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The creativity and dynamism of pricing extends to promotions and discounts, including coupons, loyalty bonuses and time-based offers (10% off until midnight!)
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The key to getting this creative and dynamic discovery process right is a deep knowledge of the consumer and their individual preferences. Senior discounts might be effective when they’re offered at a time of day that works for the retired seniors and not for working people. Coupon offers are effective for people with the time and inclination to collect and clip them, but wasted on consumers who feel themselves too busy for such efforts. The smart entrepreneur exercises price segmentation.
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The same principles apply to B2B pricing, although it might not be apparent in the entrepreneur’s subjective experience. The entrepreneur might feel that a retailer or wholesaler or customer to whom he or she is selling makes a take-it-or-leave-it offer on the price they are willing to pay. But the creative dynamism of discovery applies — the entrepreneur experiments with different packages of service levels, contract duration and other variables to find the right value combination that works best for both parties.
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Once prices are discovered, the entrepreneur assembles resources to facilitate a profit at the prevailing price. This process is fundamental to Austrian price theory, yet the opposite of the typical business school scenario of cost-plus pricing. Business schools often get things backwards.
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Entrepreneurs discover many ways to manage costs in the supply chain to meet the price the market dictates. One we talked about was channel management. For example, in the burgeoning Direct To Consumer (DTC) business model, entrepreneurs have eliminated the costs of doing business with physical wholesalers and brick-and-mortar retailers. Often the consumer is willing to pay an unchanged price. Alternatively, the entrepreneur can offer greater value via a lower price, as is the case with Warby Parker in the eyeglasses business, as well as many other innovative DTC brands.
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The key to this process is simply to treat what accounting defines as “costs” as prices that are upstream from the entrepreneur. All prices can be discovered, negotiated or re—channeled. It may not seem that way to the entrepreneur who is buying from a seller with asymmetric negotiating power. But the dynamism, creativity and innovation of the price discovery process is always available and always on the entrepreneur’s side. The only prices we know are historical. All prices in the future are to be discovered and creatively negotiated.
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Sometimes the creative solution is for buyers to organize themselves in a way that brings new negotiating power. Peter Klein used open source software as an example — users who are uncomfortable with the sticker prices of Microsoft or Oracle create an alternative service with an alternative price.
In Summary A price is the outcome of a single transaction — it does not necessarily hold for future transactions.
Prices are determined by the consumer — in the medium to long term.
Ultimately, the consumer also determines prices further up the value chain because all intermediate prices must contribute towards a cost-of-goods that is less than the price the consumer is willing to pay.
Entrepreneurs take control when they consider pricing as a dynamic, creative discovery process. Creativity spans pricing segmentation (different prices for different customers on different occasions in different contexts), pricing objectives (one transaction, multiple transactions, long term loyalty, etc.) and product-service-price repackaging.
In all cases, deep knowledge and understanding of customers and vendors yields the understanding that informs effective creativity and discovery, and experimentation yields new knowledge.
Additional Resource "The Process of Pricing Discovery" (PDF): Mises.org/E4E_34_PDF
Per Bylund teaches us to explore the only two fields that matter for entrepreneurial success: understanding the laws of economics and understanding the mind of the customer. Isabel Aneyba is an expert in the techniques of empathic diagnosis that yield the understanding of the customer’s mind, and she shares these techniques — and her success in starting and growing a customer research company — on the Economics For Entrepreneurs podcast.
Key Takeaways and Actionable Insights Listening to customers is a planned activity. Yes, we suggest regular, frequent, conversational interaction with customers. But not without a calculated purpose. You need to know in advance what you will do with the information — what decisions will you make that you can’t make now. This enables you to define the expected value of the information, and how much of your scarce resources of time and money to allocate to gathering and processing it. If you don’t know the purpose and estimated value of the research, don’t conduct it.
Conduct conversations with customers at least every week. Isabel includes conversations in the customers’ homes or offices, conversations in your offices, face-to-face (including digital face-to-face using webcams). To make emotional connections, we look into each others’ eyes. Certainly, these conversations can be integrated with findings from other customer data sources, but they can’t be replaced.
Exercise your passion for listening; don’t focus on asking questions. The style of conversational research is the opposite of interrogation. Don’t work too hard on composing a list of questions, and sticking to your list. Once the conversation starts, let it flow. Focus on what the customer is thinking and feeling, not on facts. Use non-verbal cues to do so (Isabel tells us how during the podcast). Employ gentle probes (“Tell me more about that”) rather than direct questions. Let the customer do the talking and make it comfortable and easy for them. Good researchers, and all entrepreneurs, have a passion for listening.
Storytelling is the great revealer. Rather than ask a structured set of questions about, for example, the stages of a customer journey, it’s better to get the customer to tell a story, in their own words. Invite them to start at the beginning and continue to the end, without interruption. For example, the story of a visit to the doctor might begin with feeling symptoms and end with the doctor’s prescription. The customer will tell you everything that went on in between, from the drive to the office to the time in the waiting room to the doctor’s demeanor. Let them tell the story uninterrupted. You can loop back later into internal details.
Try other exercises besides asking questions. In some cases, Isabel favors the exercise of having a customer make a collage out of photos, magazine pages and other materials. The choices in the collage can revel preferences, and the customer is naturally open to explaining why they made the choices and what the collage and its elements means to them.
Listen with the heart to uncover hidden truths. Isabel explains how:
Open the conversation with an “emotional handshake”. Find a conversational path (which might not concern your business question) for the customer to express emotion. “What do you love to do?”Listen for the customer’s emotional drivers — expressions like “I feel” or “I enjoy” — when they talk about a behavior or choice or a functional benefit. These expressions reveal emotions, and you can gently probe whether these emotions represent the subjective reason why customers behave as they do.Interpretation is required — the customer won’t tell you that they take action X because of emotional driver Y. You have to make the connection. Then gently probe to see if you can find confirmation. Apply the learning to design a better customer experience. Remember that customer research has a purpose. Your purpose in business is to create and keep a customer. Customers purchase your good and services for the experience they anticipate. By listening for their emotional drivers, you’ll identify gaps in the current experience — examples of customer unease. Use the information you gather to eliminate the gaps, and relieve the unease.
Compute the return on information. How much does the information gathering cost? How much value will you able to facilitate for the customer by designing an experience they feel better about?
Additional Resources "5 Steps To Help You Listen With Your Heart" (PDF): Mises.org/E4E_33_PDF
Isabel Aneyba's company, COMARKA Consulting & Marketing Research
"Qual Method Aims to Unite Clients, Respondents in Co-creation"
"Let’s Work Together: The Consumer Co-Creation Camp"
James Beardsley owns and runs a law practice. He decided from the outset that he would run it like a business — not all lawyers do — and, once he had discovered Austrian Economics, he saw more clearly how to succeed in reaching his goal.
Hunter Hastings and James discuss the principles of Austrian Economics that James puts to work.
Key Takeaways And Actionable Insights Self-assessment: The entrepreneur is an individual with a role to play in society — someone who breaks new economic ground as a business owner, leader, team member, or contributor. That’s why we say that the entrepreneurial journey starts with self-assessment. James Beardsley’s was that he wanted to be a different kind of lawyer — one who ran a business rather than just a professional practice. That’s a commitment to approach, method and lifelong learning — a commitment he has maintained for many years.
Find applicable models: James sought models and principles for successful businesses of all kinds. Entrepreneurs break new ground, but before they do, there is no reason to ignore the empirical and historical data that can provide a foundation on which to build a new approach.
Read the books that can help you establish core principles: James was reading business and investment texts, and discovered Austrian Economics, which he felt covered the same topics with better logic and greater clarity. Austrian logic — breaking issues and challenges down to their simplest and most basic levels, establishing understanding at that level, and then building up from there — helped him immensely. He did not become an expert on economics, but identified and applied the core principles.
Identify the customer and their problem-to-solve with precision: James’s chosen target customer is very precise: people who experienced injury in a car accident. This precision yields certainty in the process of developing services for the customer.
Think from the perspective of the customer: Having identified the customer, think like they think. Accident victims are jarred; their lives have been changed dramatically; they are experiencing emotional turmoil; they don’t know how the legal process works; they may be angry or scared. Trying to think the way they think, and accepting their need, can lead to providing the compassionate help they are seeking.
Know their personal value scales: Every individual has their own value scale, and what is most important to one customer is not the same as what is most important to another. James’s firm seeks to understand each individual client’s personal value scale and to respond appropriately.
The customer creates value: At E4E, we try to stress that value is subjective and therefore created by the customer; the entrepreneur is a facilitator. James’s process is a striking example: accept the customer’s perspective, identify and adjust to their personal value scale, and let them determine the kind of service they prefer.
Empathy is the most important entrepreneurial skill: Throughout our conversation, James stressed the central role of empathy as the skill that he and his team employ to enable them to think from the customer’s perspective, identify their values, and to provide them with the reassurance they need in a difficult period in their life. The empathic process builds trust and long-term relationships.
Empathic diagnosis is the specific application of empathy: James stresses listening, trying to understand how the customer is feeling, understanding that perhaps they do not know how to react and therefore may not be able to communicate clearly, or may do so through a veil of denial or anger or frustration.
Hire people with the right disposition for the empathic process: Assembling the best set of entrepreneurial resources includes hiring the right people. Some people — but not all — can be trained to serve the customer with empathy. Provide them with a process and system to guide them, but recognize that not everyone will prove themselves at the task, and make a change as soon as the need for one is indicated. It’s critical for the health of your business.
Marketing is a fundamental tool for business success: Many entrepreneurs don’t leave enough resources for marketing, and this can be an error. James takes the Austrian causal-realist approach, which is the professors’ term for the base logic of Austrian Economics. “Realist” means seeing the world as it really is, rather than how you would like it to be. Law firms need clients and they are not just going to walk through the door. James’s target customers are unaware of the availability of the services that can help them. Therefore advertising is required. “Causal” means understanding what works to solve the problem at hand. In this case, James built up a database of “what works and what doesn’t” to bring clients to the firm, and advertising — specifically TV advertising — proved to be the right tool, as measured by revenue realized minus costs expended.
Understand and employ the concept of opportunity cost: Resource allocation and spending decisions are always trade-offs and the best tool to make them definitively is to apply the concept of opportunity cost. If I allocate resource X (e.g. an advertising budget), what is the next best resource I am choosing not to allocate (e.g. hiring an additional staff member)? Is that the best use of resources? Which one will serve the client best? Which one will deliver most revenue for the firm? The point is to do the analysis carefully and honestly, so that you can be confident in the decision.
Understand the value (and cost) of time: Austrian Economics focuses quite specifically on the time it takes to produce, and the cost to the entrepreneur of this production timeline. Costs are incurred while no revenue comes in. James methodically addressed this cash flow challenge, and has become adept at identifying cases that can be expected to settle faster, and he will select for that attribute even if the end-revenue is smaller. “The prospect of getting paid two years out is less risky than getting paid four years out.”
Take active steps to manage and reduce uncertainty: We always highlight the role of uncertainty about the future as an important component of entrepreneurial action. James has found ways to narrow uncertainty. One example is to take only cases where the responsibility is clear, and so the uncertainty is limited to the settlement. That is less uncertain than being unsure whether you will win or lose the case. Another uncertainty-narrowing action is to keep a sufficient cash reserve so that fluctuations in cash flow will not impair ongoing business processes. This makes possible the avoidance of debt obligations, which are always troublesome for a professional services business.
Additional Resource Download "Austrian Economics: A New Lens" (PDF): Mises.org/E4E_32_PDF.
Predictive analytics can’t predict! That was Dr. Per Bylund’s provocative introduction to our discussion of the uses and drawbacks of big data in the context of the entrepreneurial mission.
Key Takeaways and Actionable Insights The claims made on behalf of the analytical powers of big data may be exaggerated, and entrepreneurs should learn what they can and can not expect from the application of big data analytics to business. Otherwise there is the chance of both error and wasted spending on the tools of business intelligence. It’s important to distinguish between the different roles of multiple data types.
Pattern recognition is not prediction. Dr Bylund contrasted what Big Data can and can’t do for entrepreneurs. He used an example of analytics predicting the outcomes of future NFL games. Here there are large sets of historical data on players, teams, plays and previous outcomes. There are limited potential outcomes (e.g. one team will win the game — there is no third team that will unexpectedly turn up to change the range of possible outcomes). The predictive analytics got the outcome right about 75% of the time. In a world of more open-ended results (e.g. predicting the outcome of a multi-team tournament), big data could be expected to be right fewer times. There is danger in over-reliance on the law of large numbers and tendencies like reversion to the mean. Pattern recognition from historical data sets (which is what big data does well) is not prediction.
Download the "Big Data vs. Big Ideas" PDF.
In fact, in the world of economics and entrepreneurship, there is no prediction. Entrepreneurs deal with social phenomena that emerge from individuals’ actions and interactions, across billions and trillions of instances. Entrepreneurial outcomes depend on how people act, and how they act depends on their feelings, how they see the world (subjectivism) and what they feel like doing. We can’t know or predict that. There may be some general rules that apply in many cases (for example, raising prices rapidly and significantly in a competitive market will, all other things being equal, result in a reduced unit volume of sales). But those rules don’t predict the decisions of specific individuals in specific cases.
Mainstream economists and central planners long for a mechanistic world: turn a dial, get a result. But this approach is not valid. In the economy or any market, all variables are dependent on all other variables. Everything affects everything. The consequences of any action — like central bank interest rate tinkering — affect different people in different ways, and whoever is affected first or last will experience different consequences and react in different ways.
The core of the issue is that human behavior is unpredictable. Subjective choices can’t be predicted. Prediction implies precision, and that’s not available.
Yet the entrepreneur must deal with the future. The entrepreneur seeks to produce a good or a service that consumers will consider valuable at some point in the future. Even if they tell you today that they will value your offering in the future, they may change their minds.
Is there any contribution that big data can make, any help that it can offer? We discussed these areas:
It’s hard to know what people might want in the future. But it might be possible to identify what specific people will not want, based on their past behaviors. Data can show you which purchases cluster together, and which don’t. Beef purchasers may also buy red wine. Vegans won’t buy beef. Facebook and other ad targeting tools (which use big data effectively) can help you avoid marketing beef to vegans or pasta to keto diet followers.Data can sometimes detect dissatisfactions, which are the universal raw material for entrepreneurs. Analysis of sentiments expressed in reviews can guide you in the right direction. Writing a negative review on Yelp or Trip Advisor is both a behavior and an expression of sentiment and data analytics can detect patterns here. But Dr.Bylund advises us that it can only provide a guide – there is no substitute for talking directly to consumers, human to human.Data can help with segmentation. If you want to better understand a geographical market segment or a demographic segment or a behavioral segment, there are lots of data that can detect the differences between segments, and this can help you with targeting of communications (but not necessarily with the message).Quantitative data can be combined with qualitative data to sharpen insights. Dr. Smita Bakshi, in our episode #24 described how analysis of student performance data (50% of computer science students don’t complete their first year course) combined with personal discussions with students in class, delivered an empathic understanding of their struggles, from which her team developed a winning interactive learning tool for computer programming languages. Sometimes an entrepreneur can skip the big data analytics, but never the empathic diagnosis. Entrepreneurship consists of understanding the mind of the consumer and understanding the economics of the marketplace. Where the market is heading and what will be in consumers’ minds in the future are more the realm of judgment than analytics.
Entrepreneurs behave differently than dig data driven large corporates. They think harder about the customer, they study human motivation, they utilize the rich qualitative data that comes from talking to customers, and they concentrate their capital and resources on developing and extrapolating their customer understanding. They uncover subjective value — the value that only exists in the mind of the consumer. Imagination is the key to the future. Entrepreneurs try to succeed in bringing about that imagined future. Big data might help them avoid mistakes, but it’s impossible to rely on the past to produce the future.
Additional Resource Download "Big Data vs. Big Ideas" (PDF): Mises.org/E4E_31_PDF.
In Austrian Capital Theory, Brands are valuable financial assets. Brands are architected in response to the subjective value preferences of consumers, and the more accurate the responsiveness, the higher, faster, longer and more reliable are the future cash flows. Brands are promises of value and, when the promise is kept, the result is delighted, enthusiastic and loyal consumers.
In this episode of the E4E Podcast (Mises.org/E4E), global branding expert Trini Amador explains how every business and every entrepreneur can methodically build a strong brand to deliver consumer value and unleash cash flow.
The entrepreneur makes a promise that the consumer will experience value. The brand is the promise. Here are the principles for building a strong brand:
Key Takeaways and Actionable Insights There are two pillars to the construction: Relevance and Differentiation.
Pillar 1: Relevance
It’s central to economics, because economics deals with individuals and their preferences and their choices. Your brand is not for everyone, it’s for specific individuals. It’s important to know them and understand them deeply.
Relevance Box 1: Core Target
Many brand owners think that the more customers they target, the more they will sell. The opposite is true. Define your target audience as narrowly as possible.
Relevance Box 2: Core Needs and Insights
Strong brands are built on unique entrepreneurial insights into the motivations of their core target audience. Entrepreneurs use the deductive method: observing behavior and deducing motivations from those observations, using tools like the Means-End Chain.
Relevance Box 3: Customer’s Frame Of Reference
This component is based on the Austrian value principle that the customer finds value in meeting a need in a way that is better (for them) than direct substitutes, indirect substitutes, or than non-purchase or deferred purchase.
Pillar 2: Differentiation
In Pillar two, we build an implementation of the Austrian principle of uniqueness in your entrepreneurial offering. A brand is the ideal platform for communicating uniqueness.
Differentiation Box 1: Brand Promise
The brand promise is to deliver in a unique way the highest possible level of benefit, which is an emotional benefit, the consumer feeling that your offering assures they will achieve their highest fulfillment.
Differentiation Box 2: Brand Delivery
Brand delivery is how the brand keeps the promise it makes.
Differentiation Box 3: Brand Character
Customers are people and they relate to brands subjectively — almost as if the brand were a person.
Building the 6-Box Brand Foundation brings clarity about what your brand stands for, defines your competitive advantage, and ensures that your entire team knows what they must deliver, and what the customer expects.
Additional Resources Download the free "Brand Uniqueness Blueprint" (PDF) to help you implement your own brand-building process: Mises.org/E4E_30_PDF.
CALL FOR PAPERS Special Issue of The Quarterly Journal of Austrian Economics:AUSTRIAN ENTREPRENEURSHIP THEORY Submission window: March 15 – April 15, 2020Guest editor: Per Bylund, School of Entrepreneurship, Oklahoma State University
Overview Austrian economics is a widely respected body of theory in management broadly (e.g., Jacobson, 1992) and, especially, in entrepreneurship (Klein & Bylund, 2014). Indeed, entrepreneurship theory attempts to understand the entrepreneurial opportunity, following the works by Venkataraman (1997), Shane and Venkataraman (2000), and Shane (2003). This so-called individual-opportunity nexus builds on the theories of Israel Kirzner (1973, 1997, 2009), an Austrian economist, and Joseph Schumpeter (1934, [1942] 1947), trained by prominent Austrian economists. It has generated a vast literature that is focused on discussing the nature of opportunities, whether they are discovered (as per Kirzner and Shane) or created through an enactment process (Alvarez & Barney, 2007). More recently, the ‘Austrian’ influence continues as one of the challengers to entrepreneurial opportunity theory is the so-called judgment-based approach (Foss & Klein, 2012; 2015; Foss, Klein & Bjørnskov, 2019; McMullen, 2015), inspired by Austrian economist Ludwig von Mises (1998) and ‘proto-Austrian’ Richard Cantillon ([1755] 1931). Without exaggerating, therefore, the Austrian school of economics has provided fertile theoretical ground to plant seeds for the burgeoning and growing field of entrepreneurship. Despite this common ground, Austrian economists have done little to learn from and integrate entrepreneurship scholarship, and entrepreneurship scholars have likewise refrained from considering the fuller Austrian theory as framework for their research. This special issue is intended to support further mutual learning and theory development, if not integration of theories, by facilitating scholarly dis- course where Austrian economics and entrepreneurship theory intersect and overlap.
Background Both the field of entrepreneurship and the Austrian school of economics are presently at ‘critical junctures’. In entrepreneurship, after some three decades of theorizing on the entrepreneurial opportunity, scholars have started considering alternative approaches such as studying judgment through uncertain investments (Klein, 2008) and new venture ideas (Davidsson, 2015). At the same time, the influence of alternative theories such as effectuation theory (Sarasvathy, 2001) have been growing, leaving the field without an obvious way forward.
Similarly, Austrian economics has, after decades of decline and marginalization, regained some of its former influence and — following the financial crisis — its attractiveness among the public as well as scholars out of the economics mainstream. Yet for the school to again become a major influence in economics and beyond, it needs to meet the new challenges and questions with new theory development (e.g., Bylund, 2016).
While overlapping with respect to both subject matter and theory, entrepreneurship scholars have been hesitant to enter Austrian discourse and Austrian economists have largely refrained from contributing to the entrepreneurship literature. There is much to gain from addressing this overlap: entrepreneurship theory could overcome many theoretical problems by considering Austrian economic theory for asking new questions, answering hitherto seemingly unanswerable questions, and solving disagreements and disputes regarding theoretical explanations; and Austrian economists could draw from the entrepreneurship literature to further strengthen and elaborate on the microfoundations for entrepreneurship and the market process.
The timing is thus right for pursuing Austrian themes and further leveraging Austrian theory in entrepreneurship, and for extending and elaborating on Austrian entrepreneurship theory.
Submission Process and Deadlines Papers will be reviewed according to the QJAE double-blind review process.The deadline for submission is April 15, 2020.Manuscripts should be submitted through the QJAE online submission process.Authors are encouraged to also submit their papers to the Austrian Economics Research Conference, which will be held March 20-21, 2020.For questions, please e-mail guest editor Per Bylund or assistant editor Timothy Terrell.
Have you heard of the knowing-doing gap? Accumulating unique knowledge — expertise, processes, experience, skills, recipes, qualifications etc — is important, as we always emphasize at Economics For Entrepreneurs (Mises.org/E4E). In business, that’s half the story. The second part is effective action, judged by results. Knowing what to do translated into actually doing it. Becoming not just a learning organization but a doing organization.
Key Takeaways and Indicated Actions Dr. Per Bylund frames it this way: having a great idea for a business is not the crucial element for success. It’s whether you can pull off the idea in implementation. That’s what investors and customers are looking for — not the idea, but executing the idea.
Dr. Bylund guides us with 5 Austrian action principles.
Principle 1: Consumer sovereignty. The consumer is boss and decides whether a business is executing well, i.e. to customers’ satisfaction. The only purpose of a business is to make and keep customers. Amazon calls this customer obsession — everything starts and ends with the customer, and the customer is central to every decision, in every resource allocation, and is invisibly present in every meeting and presentation. Does your company act this way? Are you certain you know and understand your customers’ needs and preferences, and their hopes and dreams? Are you deeply immersed in customer knowledge? Do you talk one-on-one with customers as often as possible? Do you go out to the building sites where they use your equipment, or to the offices where they use your software, or to the homes where they consume your food and beverage products? The consumer culture is exemplified by anthropology — getting out there with your users. Jeff Bezos observes that consumer-obsessed companies act differently. What actions are you taking to observe, understand and serve individual customers better?
Principle 2: Subjective Value. The consumer or customer you are getting close to by implementing Principle 1 is the decision-maker on whether or not your firm is providing value. Their decision is subjective — it’s entirely theirs, entirely emotional, entirely about their perception. Do you know what factors are the most persuasive and influential in creating a positive perception? We discussed a case study of premium vodka. The basic liquid is to a great extent an undifferentiated commodity. Differentiation comes from the varied subjective experience a consumer can feel in ordering and consuming and sharing a brand of vodka. How much of that perception is affected by the bottle shape design and the label design? How much by the social prestige of the location where the brand is served? How much by the consumer’s perception of the merit of the people who drink this brand? It’s hard to know but necessary to find out.
One route to implementation success in business is to manage expectations. Find out what customers expect, then make a promise to meet those expectations and keep your promise. So often in business, promises are made but not kept. That means you created an expectation, then did not meet it. You should make sure to do the opposite.
Principle 3: Dynamic Resource Allocation. The Austrian principle is that the firm’s capital and resources are, at all times, a reflection of the market and of customer preferences. What does that mean and how can a firm activate this principle? In practice it means two things. First, do not lock in to any asset or resource that is difficult to change or adjust on short notice. Stay flexible at all times. Second, make sure that you are collecting market signals — data — that tell you what you need to know about customer preferences today (not yesterday) and will provide you with insights into where they might shift tomorrow. Based on those insights, conduct experiments and tests that can be quickly scaled up when they show results, and quickly shut down when they don’t. If you find yourself responding to changes in customer preferences — or, even worse, changes in competitors’ behavior that seem to be more responsive to customers than your own — it’s too late. Get comfortable with continuous change.
Principle 4: Dynamic organization. How can you identify and eliminate all the barriers to your team’s empowerment to serve the customer in the way the customer prefers? Often, the barriers can be found in rules. In customer service, for example, there may be rules about the level of decision-making delegated to a customer representative, or even the amount of time a representative can spend on the phone with a customer. Examine all your rules, standardized protocols and bureaucratic structures. For each one, ask: does this contribute to the satisfaction of the customer? Does it produce customer value? Or is it to cut cost and minimize risk? Cutting costs will never add value. To be great at implementation, examine all practices to make sure they are value-creating and not value-consuming. Who decides? Your customer.
Perhaps you have employees who are not value-creating. You can’t afford them.
Principle 5: Measuring The Right Things. With metrics, most business advice is to be objective and numeric. You are advised to measure sales, profits, distribution, etc., and take surveys of customer satisfaction expressed as numbers on a scale or percentages compared to a norm. For great execution, it is far more important to measure subjective value, and to shed light on what the firm is doing right in the creation of consumer value and where it is falling short. This is a challenge, but not an impossible one. There are places to look, such as sources of spontaneous praise. Your firm’s Trip Advisor comments from recent visitors, for example, if natural, honest and spontaneous, can be great indicators for you. The same goes for other spontaneous commentary channels. Commit to conducting a minimum number of in-person one-on-one customer conversations every week. Summarize them. Conduct sentiment analysis. Try to develop data on the direction that sentiment is trending — modern tools can do this via language analysis and emotional content analysis. Commit your firm to becoming the best at monitoring, projecting and analyzing subjective customer perceptions.
Additional Resources 5 Ways To Analyze Executional Excellence (PDF): Mises.org/E4E_29_PDF
Do you have any experience of measuring subjective value creation? What has worked for you? Share your ideas in the Mises for Business group on LinkedIn.
Negotiation is a capability that entrepreneurs use almost all the time. It’s an area of entrepreneurial performance where an understanding and application of Austrian Economics can be very helpful.
It’s all Austrian! Negotiation skills represent one of the resources entrepreneurs must assemble and maintain. The value of any resource is subjectively determined, and so the price is never fixed, it’s subject to negotiation. Two people can have different subjective opinions about the value of a resource – and those opinions can change, e.g. during the course of a negotiation, when one agent changes the opinion of another.
Key Takeaways Negotiation starts on Day 1 and never stops. Founders deciding to set up a company negotiate over who plays what role, who gets what share of the equity, and so on. From Day 1, the entrepreneur bargains for advantage, putting the best case forward at all times, and always thinking ahead to the next negotiation.
In Bargaining For Advantage (Revised Edition, 2018), Richard Shell lays out six principles of negotiation that Professor Steven Phelan, himself a teacher of negotiation strategies to entrepreneurs in business school, reviewed and illustrated with examples.
Subjectivism: Know Your Own Bargaining Style. The entrepreneurial journey starts from self-assessment: Who Am I? Some people are uncomfortable with negotiation, and sellers might take advantage by making only fixed offers. There is a competitive negotiation style and a cooperative negotiation style, and some points on the spectrum between them. (Most professional negotiators think of themselves as cooperative.) Don’t feel bad if you hate the confrontation of traditional negotiation. You don’t have to drive the hardest bargain. You can control the timeline for greater reflection. You can prepare yourself well to reduce your anxiety. Know yourself, accept your self—knowledge, and learn how to apply it for advantage.
Know your ends and select the best means. Ends-means analysis is fundamental to entrepreneurship, as it is to negotiation. Identify your own expectations, set your goals high, and be ambitious. Remember that a goal is not a fixed point — like a price to settle on. It’s complex and layered and can have a lot of non-monetary components. These are the elements you can vary to adjust the bargaining advantage in your favor, by using them as concessions, or trading them for a better deal. For example, you may be able to reach the price you want by providing seller financing.
Use external — and authoritative — standards and norms to help you. Norms can narrow the uncertainty in negotiation for both sides. For example, real estate agents use “comps” (recent sales prices of comparable homes in the local area) to narrow the range of possible prices in a transaction. Of course, there are multiple norms and standards that could be used — like price per square foot, or lot size, or views — and you should know them all, select your preference, and then argue persuasively in favor. Pick a standard that shows your offer in the best light.
Time preference — thinking long term. A negotiation might seem like the very definition of short-term: you want a good outcome now! But is this the last time you’ll negotiate with this party? Does your agreement in this situation potentially affect future negotiations? If you bargain a new hire down to the lowest compensation level, do you risk them leaving in the future and jeopardizing a team project? Think of the second order consequences and the lifetime of your business. It’s a mark of the good economist — and the good negotiator — to always think in the long term.
Use empathy as the planning basis of all negotiations. We’ve emphasized many times that the core skill of the entrepreneur is empathy — understanding the feelings of the other party, whether that’s a customer or a party to a negotiation. Why is the other party negotiating with you at all? What do they want — or need? Get to know them as people. Take them to dinner. Meet their family. Can you ethically meet their personal needs as well as their corporate needs? You can never eliminate all uncertainty, but deeply understanding the other party can go a long way towards doing so.
Find your leverage: the situational advantage to reach agreement on your terms. Of course, leverage in a negotiation can be positive or negative at the outset, depending on the situation. You should always look for ways to reduce the value of the other party’s alternatives (that’s their leverage) and increase the value of their own. Put scarcity on your side by having more than one bidder for what you are offering. Use time — leverage can change over time, especially if you can wait and the other party can not. One useful tool is BATNA — best alternative to a negotiated agreement. If you have more alternatives than the party on the other side of the table, that gives you leverage.
Use the six principles to prepare a strategy. Shell recommends that you make your opening position as aggressive as you can, and support it with the best norms and standards you can compile. That will put the other party in the position of having to find contrary logic as a counter — it’s called anchoring: your opening bid becomes the anchor for locating the range of negotiation. Never meet in the middle. Let the other party concede first. Shell refers to if — then thinking. If you’re called upon to make a concession, then you know exactly what counter — concession you are going to call for from the other party. Never concede voluntarily, always ask for a responding concession.
Have a specific negotiation plan in mind. Use the accompanying planning tool, adapted from Richard Shell’s book. Physically fill it out, use empathy, acknowledge uncertainty, gather as much information as you can, find your own norms and predict which ones the other party will use, find a good agent if you need one. Planning in advance will give you confidence and help you succeed, even if you don’t relish negotiating.
Additional Resource 10-Step Planning Guide (PDF): https://Mises.org/E4E_28_PDF
There are many, many pathways of entrepreneurial opportunity in creative services, where it is eminently possible to succeed on talent, where big companies are eager to work with small creative companies and individuals, where agile low-overhead business models are thriving, and where technology is the entrepreneur’s friend.
It’s an exciting time for entrepreneurs to be in the creative industry, say Cheryl and Cliff Pia, founders of the Pia Agency, a leading video and audio production firm working with many of the leading brands and largest companies worldwide. It’s an industry of rapid change — for example from the orderly process of television advertising to the frantic chaos of social media and web advertising and YouTube and Twitter videos. Change is confusing and scary for established businesses, and therefore full of opportunity for innovative entrepreneurial creativity. Centripetal forces of decentralization are breaking up the “Big Agency” structures and their retainer fee-based business model. If you can become the best at a specialized service, many doors are open.
Key Takeaways and Indicated Actions The pathways of the creative industry often start very differently than for more traditional industries. Cheryl and Cliff provided E4E listeners with their creative origin stories.
Cliff played in bands and as a studio musician. He played some jazz and learned the “jazz method” (you don’t know what is coming next so relax and pick it up when it comes to you). He performed comedy in clubs and learned how to act on his intuition, read the mood of the room, and be hyper-responsive to audience input. By “always sitting next to the sound engineer” — and asking questions — he learned the technology and techniques of recording.
Cheryl worked in the music industry because that’s what her friends were involved in, and then in the film industry. She learned about music publishing through another friend, saw an opportunity and started her own publishing company. She also worked in the film industry and the non-profit sector, learning development and fundraising. Learning, learning, learning all the time.
Force majeure can be the catalyst to make the ultimate creative leap to start a new company. The key is to do it fearlessly, with grit and courage.
Cliff’s position at a corporate was eliminated in an economic downturn. He had started a new division for his company to produce television advertising. Faced with a need, he and Cheryl started their own TV production company: The Pia Agency. “The phone didn’t ring for seven months,” Cliff told us. They didn’t quit. Entrepreneurs embrace that uncertainty and answer it with problem-solving action.
Often, the first problem for entrepreneurs to solve is their own. The Pia Agency opened in Arizona and the critical mass of clients was located on the East Coast. The new agency found the solution in the adoption of cutting-edge technology for time-shifting and location-shifting (e.g. working with animators and voice talent all over the world) and remote online collaboration (e.g. online real-time video editing with remote studios, which sounds commonplace today but for which the Pia agency had to invent a new digital toolbox at the time).
Growth comes from demonstrating value, and a people-first approach. The new system worked, and the Pia Agency began to get work from big name clients like Hewlett Packard and Merrill Lynch, among many more. High quality work generates recommendations — from one brand manager to another in a multi-brand company, and from one company to another when clients change jobs and take their valued relationships with them. Cliff told us that a “people-first” approach — treat clients like people, empathize with them holistically, not just in their business lives — generate not only meaningful relationships but the pass-along recommendations that cause service businesses to grow. Austrian empathy and the role of trust are all pervasive in successful service providers. It’s the human moments that are the most valuable; paydays follow.
Innovation consists simply of new ways to serve clients by responding to their expressed needs.
Innovation 1: Speed and Responsiveness. TV Production processes were traditionally slow and linear and expensive. But clients preferred speed and responsiveness to rapid market change. The Pia Agency developed speed and responsiveness capabilities (e.g. multiple editors working on the same video at the same time) and a fast-turnaround culture (e.g. hired a key producer from the news industry who was used to high-speed turnaround). This became part of the agency’s unique value to clients.
Innovation 2: Sonic Branding. In the internet age, when we listen on laptop computers, phones and earbuds, audio has taken a second position to video. Consumers put up with generically poor quality. But as voice-shopping evolves, consumers are going to hear brands instead of seeing them. Audio will regain its importance. Cheryl and Cliff understand audio and have developed and invested in capabilities in “sonic branding”: distinctively identifying brands though their audio signature. There is huge growth potential in this new field.
Greater growth comes with adding new external resources. Cheryl took an MBA so she could better direct the growth phase of the Pia Agency. She found she was able to apply this resource directly and immediately. And then Cliff and Cheryl merged their agency into a larger global group called Creative Drive, to establish the organization model of the future, an independent collective of content creators, a larger expression of the speed and responsiveness operational model. The Pia Agency has access to a larger client base, a more widely distributed set of relationships, and to expertise in new channels, such as e-commerce. The journey continues.
Cheryl and Cliff recommend their journey map to creative entrepreneurs for consideration.
If you enjoy music or film or art, and you have a talent, there is every opportunity to do what you love and what you are good at, and the challenge is to learn how to get paid for it. The recommendation they make is to work in an appropriate part of the industry for an established company. For example, you might love music and performing, but you also might realize that music production is more lucrative than performing. The key is to create value, and therefore to understand what others find valuable, and what they will pay for the value brought into their lives. Get a job where you can learn in an area you’re passionate about, and learn what the world will pay for. Start there. Learn more, work with like-minded people. The pathways of entrepreneurship will open up to you.
Additional Resources Cheryl and Cliff’s Entrepreneurial Journey Map (PDF): https://mises.org/E4E_27_PDF
Creative freelancers can register at the CreativeDrive Work Market.
Dr. Bylund observes that students, when selecting entrepreneurial projects for his course, lean heavily towards consumer products and services. Does this represent smart entrepreneurial thinking, or not? Is it biased by (lack of) marketplace experience? Is it biased by media reporting and “buzz”? And what can practicing entrepreneurs learn from a reasoned analysis of the profit opportunities in Business-to-Business ventures compared to Business-to-Consumer ventures?
Key Takeaways and Actionable Insights The economy — measured by Gross Output — is 70% production. That means that 70% of entrepreneurial opportunities arise in the supply chain stages that are prior to the final consumer purchase.
Keynesian economists believe that the economy is defined by consumption. Hence all their policies are justified as supporting or boosting consumption. Austrian economists think differently, and recognize that production is the health of the economy. People produce so that they can then exchange with others — that’s simple way to invoke Say’s Law. Keynesians use the metric of GDP to indicate economic growth or decline, and that metric is 70-75% composed of consumption. Economist Mark Skousen led the charge for an alternative metric, Gross Output or GO to track the size of the economy. GO measures the value of all production at every stage of the supply chain, i.e. every transaction where one entrepreneur or firm sells to another. GO identifies pre-consumption transactions as 75% of the economy. As Dr. Bylund says, it’s where the money is for entrepreneurs.
For the entrepreneur, B2B — producing input for other firms — offers advantages of structure, standardization and scale.
Structure: When an entrepreneur sells inputs for another firm’s production, the customer provides structured guidance on measurements, quality, delivery methods and timing — a blueprint for what they want to receive and how they want to receive it. Demand is codified. If the supplying entrepreneur can meet these codes, and a bid and a supply contract are approved, then a great deal of certainty is created around the business relationship.
This does not mean that there is no room for innovation. That comes in the elements of the business relationship that are not contracted. The creative entrepreneur can innovate in speed, responsiveness, ideation, and spotting new opportunities for efficiency. Innovation occurs at the edges of the structure, while the structure itself provides stability.
Standardization: Once the structured relationship is defined and agreed and the production interchange is established, the supplier-entrepreneur benefits from maintenance of the standard. There is precise knowledge of the ingredients to use, the production process to follow, the production rate and delivery specifications. This adds to certainty, and allows for the negotiation of lower costs.
Scale: Obviously the scale opportunity for the supplier is dependent on the size of the buyer and the size of the contract — it’s in the buyer’s hands. Nevertheless, contract reliability represents scale over time, and future volume assumes some (although not complete) predictability. The supplier can concentrate on efficiency measures to lower costs when there is no need to concern themselves with throughput variability.
These advantages are reversed in B2C businesses, where the trend is towards the opposite of structure, standardization and scale: personalization. Dr. Bylund called the B2C market ephemeral and flimsy. He was referring to the changeability of the consumer. Austrians understand that value is the subjective perception of the consumer. And the consumer is emotional, idiosyncratic and inconsistent in their continual rearrangement of value scales — what they prefer today is often different than what they prefer tomorrow, even if it is not obvious to the entrepreneur what change in conditions has brought this about. Consumers’ moods change and their choices change. Our free pdf points out the techniques required to manage in this context — tight targeting, deep empathy, and micro-segmentation.)
An entrepreneur’s production cycle may be 5 months or 5 weeks, but the consumer can change their mind in 5 minutes. They are on a different cycle. Their demand can not be relied upon. Continuous change is required of the entrepreneur competing for the consumer’s dollar, and continuous change is a tough business model. (Listen to our previous podcast on Austrian Capital Theory for the best tips on how to manage for continuous change.)
There are business channels where both B2B and B2C models are required. Some entrepreneurs find themselves moving their consumer goods to their end-consumer through distribution channels owned and operated by big businesses, such as CPG manufacturers of foods and beverages that sell on the shelves of Whole Foods or Walmart. The Walmart and Whole Foods relationships are B2B, even though the entrepreneur is in the B2C space. It is necessary to focus on producing value for the consumer, and educating the retailer about their benefit in passing on that value, as well as their role in communicating it to the consumer. At the same time, it is necessary to comply with the structure, standardization and scale rules set by the big business. We might call this a B2B2C business. It requires skills for both B2B and B2C.
Competing in B2B remains challenging, of course, but entrepreneurs should consider the size of the opportunity and the reduced uncertainty that are potentially available. In B2B, the entrepreneur is required to compete with other suppliers, to get costs and prices right to meet the customer’s needs, and to work hard to meet supply chain standards and specifications, and to negotiate contracts. Those requirements may be preferable and less uncertain than the ephemerality and flimsiness of consumer markets.
Additional Resource B2B, B2C, and B2B2C (in PDF): https://Mises.org/E4E_26_PDF
Austrian economics has valuable and important things to say about organizing entrepreneurial firms.
Key Takeaways And Actionable Insights Organization can make a crucial difference to entrepreneurial success. Ideas alone are not enough — execution is needed and the details of execution are important. The entrepreneur must design an organization for detailed, effective and efficient execution. Some entrepreneurs shy away, thinking it drudgery. That’s a mistake.
Organization is never static, but always dynamic. It’s not a structure, it’s a process. It’s your business model. It’s the collaboration that achieves the desired return on the entrepreneur’s imagination. Austrian economics doesn’t prescribe a fixed way to “do” organization (unlike the rules- and framework-based approaches of consultants and organization gurus). It provides the right way to think about organization.
Organizational design starts with the entrepreneur’s ends in mind. The purpose of the organization is to create customer value. Everything about the entrepreneurial firm is customer value, and so organization must be all about customer value. Elevate those elements that deliver customer value, and eliminate those that don’t. Everything that is not customer value, or gets in the way of creating customer value, or diverts resources from customer value, is waste and inefficiency.
Start with the best combination you can — in the current moment — of people and resources and capabilities to create the most customer value possible.
Delegate as much entrepreneurial judgment as you can — to people with the same customer value-creation focus as you, but greater expertise and knowledge in specific areas of the business. Hire good people (or engage good contractors and vendors) who have the right skills and experience for a specific task or field, and then give them as much authority as possible. Don’t worry about over-delegating. Rather, worry about retaining too much control and becoming a limiting factor. Employees may find better ways to utilize an asset or expand a capability than you could have done in their place. They may show more ingenuity. Make sure your organization is consistent with the most productive use of available resources. It’s becoming more and more inefficient over time to exercise authority through control mechanisms. You can’t afford the transaction costs. By delegating, you lower your monitoring and management costs.
The owner-entrepreneur’s role is to design the rules of the game: making specifying decisions and determining how performance will be evaluated. You retain ownership control by making what Peter Klein calls specifying decisions up-front: how you are going to run the business, tight or loose; defining in advance what discretion employees have, so that they don’t have to ask about every decision.
The second tool of control is defining the measurements of success and holding your team members to your metrics.
Outsource as much as possible. The entrepreneur defines what resources and functions are crucial and proprietary to the business of customer value creation, and keeps control over them. Everything else can be outsourced — items like payroll services, accounting, transportation, legal, anything that constitutes overhead, and any tasks that are routinized. Just make sure there is no possible damage to the customer experience.
Employment contracts and compensation systems are tools of entrepreneurial control. The specifying decisions can often be captured in the employment contract, where decision rights can be traded for benefits, and incentives can be defined to motivate the right levels of performance and the right feelings of participation and motivation. Go-getters and exceptionally creative people can be turned into “proxy-entrepreneurs”, exercising entrepreneurial judgment that is derived from the owner’s original judgment. There are no hard and fast rules about this trade-off, and it’s often a matter of gut feel. The savvy entrepreneur constructs a mental model of how the organization operates when it’s “just right” and makes adjustments when it’s not.
How you finance your business has major implications for your governance of your own company. Venture capitalists want a major say, often a board seat and supervision of critical decisions. Lenders may have covenants that affect your governance decisions, and most definitely affect reporting. Friends and family will want to look over your shoulder, at minimum. When you are planning your financing, be sure to think about how it will affect your organization, and whether you want to accept the inevitable constraints.
In all cases, be ready to make adjustments to your organization design, your specifying decisions, your resources, and your metrics. The entire point of flexible, dynamic organization is to facilitate change and adjustment on the fly. Plan to monitor continuously, and make changes whenever indicated. Never get locked in to a poorly functioning organization: change it.
Additional Resource Organizational Designs (PDF): https://Mises.org/E4E_25_PDF
Dr. Smita Bakshi, an engineer passionate about her mission, makes an impact by combining what the world needs and what the world will pay for.
Key Takeaways And Actionable Insights What is the nature of the journey from growing up in India and Africa, to an education in America and the successful founding, growing and managing a high-impact ed tech business that helps instructors teach and students learn computer science?
The answer is: it’s not direct, and it’s not planned from start to finish.
It’s powered by individual drive, assembling knowledge, collaborating with a changing circle of smart and accomplished people, identifying the right pain point to address, and eventually finding — and then keeping — your focus.
The journey starts with individual drive: to better your own circumstances and those of your family. You are not necessarily called to change the world or start a brilliant new company. You find your drive at an early age to do better, move forward, expand your opportunity and improve life for you and your family. Perhaps there is some hardship in your early experience that provides greater determination and zeal. Channel it well.
Don’t necessarily expect a direct path. Keep moving forward, accumulate knowledge and experiences, and gradually start to narrow your preferences. Dr. Smita Bakshi identified engineering as her pathway. Her undergraduate degree was gained in India, and her Master’s and Doctor’s in the USA. Then she taught. Then she took an MBA. Then she worked for a small company in an engineering role, then a large one. There was diverse knowledge around engineering and its application in business and commerce. She established what she was good at.
Finding out what the world needs is a process of experimentation and discovery. It’s not always clear, and sometimes the people with the need can’t articulate it. Dr. Bakshi realized that her passion could not be fulfilled working on server configuration software, because, important though it undoubtedly is, it was too far removed from observable human impact. She made human impact her passion and began to experiment and investigate — in finance, healthcare and education. The idea was not necessarily to start and own a business, but to find the right place and the right way to make an impact.
There are two challenges in finding out what the world needs. The first is articulation: the customer can’t translate their felt unease into an articulated need. No-one "needed" Uber to fix the problems of the taxi industry. All the taxi user knew was that they were unhappy with the existing experience. In what way? In many, many ways. Uncertainty of getting a ride when wanted; uncertainty of the quality; uncertainty of the costs. It takes entrepreneurial skill to articulate a solution and a business model.
The second challenge is scale. Is the need big enough to support a business? Answering that question also requires entrepreneurial imagination.
A mission emerges when you can identify a pain point within your circle of human impact that’s big enough and important enough to generate significant revenues. Dr. Bakshi started a consulting business helping start-ups to fashion business plans for their ideas and technologies. She rapidly found that it’s easy to identify pain points — engineering-speak for market needs or problems-to-be-solved — but that many of them are not significant enough to generate a business. A pain point is only half of a value proposition. Customers can live with pain points that don’t cripple them. It’s important to find the ones that they can’t live with. She advised all of her consulting clients that their ideas would not translate into effective business plans.
Having identified a significant pain point, with a potential for real human impact via a new solution, the next step is product-market fit. Imperfect is OK at the outset, improving steadily over time. Product-market fit is Silicon Valley-speak for the solution to the two challenges of articulation and scale: a set of features and benefits that truly meets the market’s need, and delivers an experience that matches the expectations that a sufficient customers have in their mind when they buy the product, and for which they will pay.
Dr. Bakshi found an unarticulated need in Higher Education for teaching Computer Science (CS). The inputs were part data (more than 50% of students abandon their CS course in Year 1 because the struggle to learn is too difficult) and part sentiment (instructor unease not only at this student struggle, but also at the instructor struggle of teaching with tools that were a poor fit to the task — text books — and the imbalance of administration (especially grading) versus teaching.
The answer was an educational technology solution — a web application instead of a text book, facilitating learning in as interactive a manner as possible, with limited text, interactive, animation, built in labs (tests for students to see if they can write short pieces of code), and auto grading. The brand name was Zybooks.
Importantly, the pilot looked nothing like the Zybooks product today. Once the product was in the market and began to generate feedback, there was a process of continuous updating, improvement and adding features. The MVP (minimum viable product) model worked for Zybooks because the first experience, though imperfect, was a sufficient improvement over the status quo of CS textbooks.
The harder part of success is adoption, rather than product design and launch. Even though the market has confirmed the need, that doesn’t mean adoption is ensured. Dr. Bakshi had commitments from target customers that “if you build it, I will use it”. That turned out to be an unreliable promise. Dr. Bakshi had to take an engineer’s approach to understanding how the market really worked. In this case, the higher education market, there is no incentive for the adoption of the best technology and best practice. In business, there is an expectation of switching to a new service — e.g. a CRM suite — if it is the best performer and an improvement over existing choices. This is not true in higher ed. The instructor has the academic freedom to use whatever techniques he or she prefers.
The engineering solution was direct sales: one-on-one, telephone, email, online and in-person, whatever it took to influence one instructor at a time.
The final part of the journey is “crossing the chasm” from early adopters to early majority. The famous technology adoption life cycle chart suggests that the first 2.5% of a market are the innovators who grab at new technology. The next 13.5% are the early adopters who like to be not necessarily the first but at the front end of adoption. But then there is a chasm to cross before bringing in the early majority, who are more skeptical and less open to change. Dr. Bakshi feels she is still not across the chasm, but is making progress.
The keys, she suggested are:
Focus: don’t be tempted to stray from your core mission and core product. Stick with what you do well, and what your core knowledge and core capabilities fully support.Never compromise — and always keep improving — product-market fit. Is the user experience exactly what the customer wants — and ideally, even exceeds their expectations. Obsess about this fit, and make sure the people in your company think and act as one in their alignment around this singular purpose. When there is time to reflect on the journey, Ikigai is a good philosophy.
IKIGAI CIRCLESSMITA’S IKIGAIFind out what you love.Engineering.Invest in becoming really good at it.3 degrees, teaching, working at small and large engineering companies.Impact: find out what the world needs.A better way to teach and learn computer science.Business model: make sure you can be paid.Design, launch, get adoption for, and scale Zybooks.
The result is a life well-lived.
Additional Resource Ikigai (PDF): https://Mises.org/E4E_24_PDF
Business strategy in books and business schools has tended to towards metaphors of sports or war. There are playing fields or battlefields, and the strategy question is “Where to play, and how to win?” In other words, it’s competitive strategy, where one firm wins and others lose, within some pre-set boundaries of industry structure. This is hardly useful for the start-up or SME entrepreneur, or indeed for any executive in any company who is dedicated to delivering customer value.
Austrian entrepreneurship, built on foundations from Austrian Economics, focuses on the strategic question of how to facilitate customer value. That requires a 100% focus on the customer — not competitors or industry structures. Per Bylund explains how adherence to this one core principle drives a very different approach to business strategy.
Show Notes Strategy in business schools is about how to gain competitive advantage. Austrian entrepreneurs think differently — they are constantly probing their own customer understanding rather than thinking about competition. An entrepreneur’s time is his or her most valuable resource, and they don’t waste it thinking about other entrepreneurs. Competition is usually understood as a firm’s relative position in a well-defined industry. It’s an idea from the economics of the early 20th century, when economists were thinking about market structures like oligopolies producing near-identical goods and services, and how firms performed within these structures. 21st century entrepreneurs don’t think that way.
Entrepreneurs pursue uniqueness: to become the customer’s choice by delivering the greatest value. Entrepreneurs spend their strategy time focused externally on customers and target customers. They are the ones who create value, in the form of an experience of satisfaction or pleasure. The entrepreneur’s task is to facilitate that value experience by offering a product or service that will be perceived as valuable. If the customer is dissatisfied with the status quo, then the entrepreneur’s strategy is to bring to market a solution that eliminates that felt dissatisfaction.
Deep understanding and deep empathy are the entrepreneur’s strategy tools. How can entrepreneurs facilitate value, if customers are the only ones who can create it? The answer lies in deep understanding of customers at the emotional level — how they feel. There is no shortage of data to help shed light: just initiate a conversation with them and they’ll talk about their dissatisfactions and hopes and concerns. They won’t design new products and services for you — that’s the entrepreneur’s job. But the application of deep empathy — truly understanding how the customer feels by seeing things from their perspective rather than yours — will take you to the level of understanding that’s required. If you are really, really good at this — in fact, if you can make it a unique capability — then you’ll realize success. Empathy is the best strategy.
Austrian entrepreneurs are rivals with each other for the customer’s dollar. Entrepreneurs’ continuous striving for uniqueness enables more and more satisfying and valuable customer experiences. All entrepreneurs are rivals — to do a better job of facilitating value for customers. If the customer buys a new digital printer rather than a new dress, the printer maker and the dressmaker are rivals. The dressmaker is stimulated to raise their game in value facilitation so that, next time, the customer buys the dress instead of, say, a bathroom rug.
There are some tools for customer understanding. The best one is conversation. We discussed various research techniques and tools such as the Voice Of The Customer, a method of data and information collection across all kinds of knowledge categories, capable of analysis and potentially leading to insightful interpretation. Dr. Bylund thought these tools worthwhile, but with the risk of being too formalistic. The Austrian route to deep understanding is one-on-one conversation: talking with customers about their feelings and their lives and their preferences, and perhaps getting them to discuss a prototype or rough description of a product or service. Numerical surveys and quantitative analysis are less useful.
There are also tools for internal allocation of resources to support uniqueness of products and services. We discussed the VRIN principle: reviewing the resources and capabilities of the entrepreneurial firm to ensure they are:
VALUE-CREATING: how much does a resource or capability or software feature or service element directly contribute to facilitating a valuable experience for the customer.
RARE: to achieve your uniqueness in delivering value, look for resources and capabilities that are unique, or at least rare. These could be particularly skillful individuals on the team or processes and recipes developed over time that are uniquely refined and uniquely aligned with the value preferences of your target customers.
Inimitable: if your capability can be imitated with a similar (but perhaps not identical) feature that delivers the same level of customer value, then your uniqueness is temporary.
Non-substitutable: if you are able to preserve uniqueness, but customers find they can substitute an alternative about which they feel just as good, then you are marketplace position in not sustainable. Customers can sometimes find value not only in direct substitutes but also indirect substitutes — like choosing a glass of wine over a glass of beer. Your unique beer recipe isn’t non-substitutable.
The VRIN formula is a useful lens to look at your internal capabilities. But Dr. Bylund stressed again and again that the strategy answer can not be found inside the company. Entrepreneurs must only think about the customer, and how to facilitate the greatest possible value for them. It’s the only way to build and sustain a business. Always reinvent and innovate. Always look for some new value that you can deliver. Keep talking to the customer, keep tapping in to the infinite resource that their dissatisfactions represent — just ask them, they’ll tell you.
Additional Resource Voice of the Customer (PDF): https://Mises.org/E4E_23_PDF
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Entrepreneurs operate in the future. They imagine a future where lives are improved because dissatisfactions are removed and there’s greater well-being to enjoy. Everyone can embrace that future. So what could go wrong? Well, your customer may expect more than they feel they actually get, so they stop being a customer. Investors and bankers may expect you to get to your next milestone faster, putting you in a race to recover their confidence. Suppliers may expect a better relationship than they actually experience, and they become more difficult to deal with. And heck, you didn’t expect all this angst, so you are dealing with your own disappointments.
What’s the commonality here? Mis-managed expectations. Steve Phelan reckons you might spend half your time as an entrepreneur on the task of expectations management. If you can do it well, it’s a resource for you. Follow these management steps.
Definition: Expectations management is actively and purposefully changing someone’s opinion about the value of a resource or asset. For example, many start-up or growing businesses suffer from a perception liability of newness or smallness. Target customers or potential investors or even potential employees might have a negative expectation about the company’s future prospects, which might present a barrier to securing capital or resources. You need to overcome the risk premium of smallness / newness in their eyes. You do so through expectations management.
At the outset, when you are identifying your entrepreneurial opportunity and polishing your idea for a new business, a new project, or a new expansion phase, the expectations that most require management are your own. Get help. Entrepreneurs are confident, action-oriented people. Confidence is good — but research indicates that entrepreneurs are often over-confident about their plans. Steve Phelan calls this the Identification Phase, the point at which the entrepreneur forms the belief that arranging a new set of resources to serve customers in new and better way will achieve a profit.
While start-up entrepreneurs tend to over-confidence, those in business over 5 years tend to demonstrate tighter control over their expectations about what’s possible. So experience can be a good expectations management tool. But, if you don’t have the experience, try to gather more perspective from people who have. Assemble an extended team, even if it’s only by e-mail or Slack. Ask them to share their experience to substitute for your own experience gaps.
When you’re assembling resources, your goal is to give the right impression of a solid plan, trustworthy management, and a well-paced path to profits. Your target audience may be investors, whether friends and family or venture capital, or credit providers, like banks. In addition to the quality of your plan, your ability to manage expectations is also influenced by soft skills such as presentation style, and environmental variables such as how you dress. As always, the entrepreneur’s go-to tool is empathy. Take the time to learn about your audience’s history and preferences and form a clear idea about their goals and motivations. VC’s are portfolio managers — show them you fit. Bankers want zero defaults — assure them you can easily clear that bar.
If you are managing potential employees’ expectations, try to be sure you know how they form them. Are they thinking about future equity and getting rich? Or is security a higher preference for them? What about commuting versus working from home? What improvement over their current job are they are expecting? In order to manage expectations, you need to know and understand what the target audience expects.
In your growth phase, expectations management shifts to customers. They form their expectations entirely subjectively, and your task is to align with them emotionally. Austrian economists understand that it is customers who create value – it’s a consequence of their satisfaction, which only they can determine. In fact, they form satisfaction expectations in advance, based on your value proposition. If their experience is less than their expectation, they’ll be disappointed, even if your product or service performed well. Therefore, expectations management with customers is a matter of alignment.
If you operate a B2B business, the alignment vector is always trust. Customers are taking a risk when they embrace a new supplier or a new idea or a new product. Trust helps them embrace that risk. What is the signal of trust that will make the difference? Can it be influenced by guarantees or warranties? How can you demonstrate that the service level you promise will be the service level you deliver? And take the time required to identify the customer’s transaction cost (the cost of taking on a new supplier) and opportunity cost (what’s the alternative to your service). Be sure to address those two costs directly.
At some point, you will prefer to release assets. This is the time to manage expectations upwards. The exit stage may apply to selected assets — for example, you may want to reshuffle your capital structure by selling some and buying others — or you may be exiting a business by selling it. Steve Phelan had two pieces of advice for the exit stage. One was directed at the entrepreneur’s own expectations — to think about exit at the purchase stage (“making money on the buy”) so that there’s an advance plan for a realistic exit price. The second was to let multiple bidders be the influencers of each other’s expectations. Otherwise, you’ll need a strong case to manage expectations to be higher than the market average. For a hard asset, you may have to demonstrate how your ownership was a positive contributor to value — e.g. a superior maintenance regimen. For a financial asset, you may have to demonstrate the opposite — that new ownership can get a higher return. For example, entrepreneurs selling a business to a strategic buyer must create the expectations that the greater resources of the new owner can accelerate growth, reduce costs or increase profitability.
Do’s and don’ts. Manage expectations every day. Where are they set in the minds of others? Do they need adjusting?
Don’t create negative expectations (e.g. by failing to meet deadlines or over-promising). Don’t ignore inputs or advice. Don’t set expectations that can’t possibly be attained.
Your brand is not just your promise. It’s keeping your promise.
Additional Resource Entrepreneurship as Expectations Management (PDF): https://Mises.org/E4E_22_PDF
Hunter Hastings and Peter Klein emphasize profitable value creation as the role of the entrepreneur. Managing costs can contribute to profitability — but there are some costs that are not easy to calculate and not even that easy to identify in some cases. They are not captured by traditional cost accounting. Economists call them transaction costs. They are the costs of acquiring, assembling, monitoring and managing and, in some cases, discarding or re-purposing the resources and assets your firm utilizes to produce output. They are not production costs per se; they are not value creation costs. They’re administrative and managerial costs.
Peter Klein explains.
Show Notes Think of any transaction, like buying a cup of coffee at a Starbucks store. Now think of all the economic costs of that transaction above and beyond the actual dollars you hand over to the barista. There’s the cost of traveling to the store, in both time and money (gasoline if you drive) and wear and tear on your vehicle. There is time spent on studying the menu, explaining your choice and waiting for delivery — and time is the entrepreneur’s most precious scarce resource.
Now apply that same thinking to the acquisition of any resource you want to bring into the firm to support your business model. There are many transaction costs in addition to the purchase price. There is the time taken to research features and attributes, and comparative pricing. There may be negotiation or haggling with the vendor. There may be legal costs in a contracting process. There may be integration costs to fit the new resource into your production chain. If you’re buying from a wholesaler, there are issues of timely delivery and accurate order fulfillment you must monitor and manage. If the new resource is an employee you are hiring, there are advertising, interviewing and negotiation costs, as well as the benefits package that accompanies the salary agreement. All of these transaction costs, across the entirety of your business, add up to an amount that is pretty significant.
And, once you own the resource, transaction costs don’t disappear. They transform into monitoring and managements costs. Peter used the example of Walmart’s trucking fleet. Walmart owns many trucks and the drivers are employees. There are extensive monitoring costs associated with the ownership of these resources and the employment of the drivers and mechanics and service technicians. This group of costs can be characterized as the cost of confidence that you are getting the performance that you want out of the resource you own. In the case of Walmart’s truck fleet, these costs include monitoring the vehicles themselves (location, speed, downtime, tons hauled, gasoline used, etc), the drivers’ productivity, the maintenance burden, delivery accuracy and many more metrics. Walmart employs people and uses technology assets to implement all this monitoring, and those monitoring resources are not really creating value; they’re supervisory overhead.
Another kind of transaction cost arises when you decide you want to recombine, reshuffle or discard assets, or to use them in a new way. In the entrepreneur’s uncertain business environment, it’s never certain that the asset you have acquired or the people you have hired are always going to be perfectly tuned to your business model. Circumstances change, and you want to make adjustments. Is the asset adjustable? Does the employee have exactly the skills you want for a new process or method? Will you be able reprogram the asset or redirect the employee to a new job function? In many cases, you might have need of the legal system for a revised contract (legal costs are transaction costs), or there may be regulations preventing you from closing a plant or laying off workers. Any time you are constrained from making the adjustments you want at the speed you prefer, you are facing transaction costs. Could you have anticipated the situation when you first contracted for the resource or first hired the worker? Probably not — but trying to do so would be a transaction cost in itself!
Often, the issues raised by the problems of transaction costs are characterized as “make versus buy” decisions. Or rent versus own. Or in-house versus outsource. It seems that there is a tendency today towards organizational models that are asset-lite, with a lot of the control that the firm seeks to exert over resources being exercised through renting or outsourcing, or by utilizing independent contractors rather than directly hiring employees. (Actually, Peter disputes this, suggesting that many such business models get a lot of publicity but there is no general tendency across multiple business sectors.) Does a virtual organization chart or a network model compared to a hierarchical model always have lower transaction costs?
Not necessarily. Compare Amazon, which mostly utilizes FedEx and UPS and USPS to make deliveries. Amazon still has many of the monitoring cots that Walmart has — it’s just that they are monitoring an outside vendor. Yes, FedEx and UPS bring their own tracking systems and technologies, but Amazon can’t afford to let its vendors go un-monitored.
In fact, in-house transaction costs are declining at the same speed as outsourced transaction costs. With the advent of software HR and CRM systems and other kinds of monitoring and management technologies, internal transaction costs are not as burdensome as they were in the past. It would be unwise to make the automatic assumption that in-house transaction costs are always higher than outsourced costs.
Actionable Insight So, what’s the answer for entrepreneurs? There’s no simple formula, just the admonition to be transaction cost savvy. In every situation where there are alternative scenarios, the savvy entrepreneur thinks through the transaction costs of each one, and makes a best estimate of the economic costs. He or she thinks about the present costs, the future ongoing monitoring costs, and the potential costs when there is a future adjustment to be made.
Always relate this economic calculation of transaction cost alternatives to the creation of customer value. What is the best alternative transactional mode or organizational mode to deliver value to the customer, today, tomorrow and a year from now? What is the cost of the resource control you need in order to deliver value, especially if customer preferences change and you want to change with them?
Additional Resources Transaction Cost Checklist (PDF): https://Mises.org/E4E_21_PDF
Buy Peter Klein’s book Organizing Entrepreneurial Judgment.
An article Peter wrote to commemorate Oliver Williamson’s Nobel Prize — he is the originator of “transaction cost economics,” which is closely related to today’s discussion topics, though not directly dealing with entrepreneurship.
A longer, more academic survey on transaction costs (PDF) — may be a useful reference.
Also, listeners may enjoy the comments on this blog post.
Dr. Keith Smith is an anesthesiologist and founder of both the Surgery Center of Oklahoma and the Free Market Medical Association. Surgery Center of Oklahoma has innovated in healthcare with a completely free market offering of transparent pricing with no hidden fees, with a radically patient-centric organization and different and better patient and doctor relationship protocols. Free Market Medical Association is a movement to encourage medical practitioners throughout the country to pursue a similar pathway of radical innovation. Dr. Smith took inspiration from Austrian Economics principles. Here are the seven principles he talks about on the Economics For Entrepreneurs podcast:
- Subjective Value This was the first Austrian principle that Dr. Smith learned from reading Menger and Mises. He applied subjective value thinking to the healthcare industry by asking, “Who is the customer?” and “Are health care industry participants focused on creating customer value?”
He realized that, since the patient is not paying the anesthesiologist or the surgeon, then there was no value exchange between the customer and the service provider. Therefore, there is no market relationship. The customer was not in a position to evaluate the quality and efficiency of the medical service that Surgery Center Of Oklahoma and its surgeons provided.
When a third party payer is paying the fees, the patient is not acting as the customer. The fee from the third party can never represent the right price — the one that properly reflect customer preferences — and much of what is dysfunctional in the health care system stems from this arrangement. The industry can not accommodate the fact that patients who wish to consume medical services value different aspects of the service in different ways. Some will pay any price to experience the value of immediate service: surgery today. Some will defer service to a later date to pay a lower price. Some want a surgeon that spends a lot of time with them before and after surgery. Some prefer speed and efficiency. All individuals create value in their own minds, and should be able to decide what price they will pay for that value. Subjective value theory guides Dr. Smith to run his surgery center to serve patients’ preferences.
- Preference Rankings The idea of preference rankings may sound theoretical, but Dr. Smith has found a practical way to make them a tool for building an organization.
When the patient and the surgeon are both customers of the surgery center, it can be hard to align the interests of both without conflict. Dr. Smith calls this desired outcome “accommodating all interests with boundaries”. Both the surgeons and the patients can make unreasonable demands that can’t both be accommodated in the service of good care. How to accommodate both? Just ask them what their preferences are and how they rank them. Many times, just having the conversation is a revelation — it reveals considerations to the patient or surgeon they had not appreciated before. For example, if a patient demands a local anesthetic and the doctor reveals a preference against it, the reasons for the surgeon’s ranking may bring new information to the patient and may change their preference.
Preference ranking provides an organizational tool to help Dr. Smith build his team of surgeons. A surgeon that frequently shows up late, or habitually takes an excessively long time for a procedure, may be revealing a preference for revenue over patient quality. By observing behavior, it becomes easy to identify a doctor (or a hospital) that is revenue focused compared to one that is truly focused on value, taking the long-term view and making every value exchange mutually beneficial. If a surgeon is observed acting in a way that is not in the patient’s best interest, Dr. Smith does not want him or her on the team. Asking preference ranking questions — what is important to you and how do you rank it? — is a good way to get to know someone you are considering for your team. It’s a troublesome thought process for some, and an enlightening one for others.
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Self-Examination Preference ranking can be applied in self-examination. Dr. Smith says, “I scour myself for inconsistencies”. He found one when he realized he was filing Medicare insurance claims that were paid with government funds which, he declares, is like “receiving stolen goods”. That, he realized, was inconsistent with his free market principles. And so he abandoned the practice and now treats Medicare patients at no cost. The acceptance of the market is the determinant of his business success — “to hug us or crush us”. Dr. Smith’s preference is to be consistent in his commitment to free market practices.
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The Errors of Interventionism The refusal to accept government money was just one step in expunging the corrupting and distorting effects of government intervention in the health care market. Dr. Smith examines every element of government intervention in the market and attempts to eliminate it from his business, to make sure his business does not benefit from it. He scrutinizes one situation after another and attempts to eliminate them all.
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Dynamic Flexibility. Austrian Capital Theory — and the Resource-Based View of the firm that derives from it — prescribes extreme flexibility of capital assets and resources to enable shuffling and recombining in response to changing consumer preferences. Dr. Smith describes the process of continuously looking for more knowledge, more learning and more flexibility as “radical entrepreneurship”. He looks for texts like Peter Klein’s The Capitalist And The Entrepreneur to provide new ideas and new initiatives. Continuous learning is part of Dr. Smith’s recipe, and he is always searching out readings that will change his mind.
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Time Preference Time preference is a core concept in Austrian economic theory. Entrepreneurship takes time. It requires patience, and the elevation of long-term goals over short term goals. It also requires foregoing present opportunities in order to pursue future benefit. What are you willing to forego in order to be an entrepreneur?
Dr. Smith found the most striking discussion — “jaw dropping” in Dr. Smith’s words — of time preference in Hans-Hermann Hoppe’s Democracy: The God That Failed (i.e., the relevant passage starts at the very beginning of Chapter 1).
He found an immediate application in the business model for Surgery Center Of Oklahoma. As surgeons get older, their time preference changes. They want to monetize their ownership position in the partnership — to “cash out”. This often leaves junior surgeons “holding the bag”, because the partnership (or an intervening VC) may buy the departing surgeon’s position, but this is paid for out of the future earnings of the remaining partners. Through his understanding of time preference, Dr. Smith was able to anticipate this situation and organize his surgery center like a law firm — no partner pays anything to join and receives no exit payment when they leave. They also don’t own the real estate. So there is no opportunity to monetize on exit, which “saved SCO as a business” and brought stability by de-fanging an activity that doctors are known for.
- The Austrian Way of Thinking As important as any principle of economics is the Austrian Way of Thinking: rigorous reasoning based on logic and a priori axioms; being aware of assumptions and always examining them; respect for how others value things; understanding the difference between risk and uncertainty, and looking uncertainty in the eye; and generally exerting more logic and less emotion in conducting business.
Economics is the study of human behavior. Humans move from A to B because they prefer B to A. Understanding the logic of human action — and the motivation behind it — provides a lens through which to observe what is going on around you and to see it more clearly, obscuring distractions and perceiving conflicts of interest you might not see without the lens. The Austrian Way of Thinking brings confidence, decisiveness and calm. Physicians — and anyone — can benefit.
Additional Resource Dr. Keith Smith's Austrian Approach to Innovation (PDF): https://Mises.org/E4E_20_PDF
Austrian Capital Theory (ACT) sounds arcane, academic, and complicated. In fact, it’s the key to modern organizational design, cutting edge business structures, and the high-response business models leading entrepreneurs deploy to win in today’s business environment. Hunter Hastings and Per Bylund discuss how to apply Austrian Capital Theory in modern organizational design, contemporary business structure, and a high response business model.
Show Notes Austrian economics recognizes that capital and resources are so varied and different today that agile entrepreneurs can combine them and recombine them in ways that are highly differentiated — even unique. Every firm is a capital structure that is in continuous flux, as the entrepreneur changes and adjusts to create new value in response to marketplace and environmental changes. Therefore, the whole economy is a changing, rapidly evolving capital structure, generating economic growth. It is the appreciation of the need to continually shuffle the firm’s capital combinations, and the mastery and agility in doing so, that marks the Austrian Entrepreneur. He or she is an orchestrator of capital, buying and selling capital goods and combining them with new and retrained workers to change production processes, scale up to new levels of efficiency, and to solve customers’ problems in new ways.
The purpose of the orchestration function is to achieve the highest return on capital by creating the most customer value. The value of capital is the future revenue streams it generates from customers, and revenues are a reflection of value created. Entrepreneurs examine every piece of capital, and every capital combination, to measure how much value creation it contributes. Could it do more? Can the entrepreneur render the capital more productive in maximizing value at the end of the production chain?
How can entrepreneurs assess whether their combination of capital assets is right? The managerial accounting of Austrian entrepreneurs is not identical to formal financial accounting. A conventional balance sheet is not going to tell the truth about the money-value of assets, since it is not based on assessing future revenue streams. And this year’s P&L is of little use since it is static and backward looking. How can entrepreneurs differentiate between assets that it merely feels good to own and assets that genuinely create consumer value and future revenue streams? It’s not easy, but there are two useful steps, both of which focus you single-mindedly on the consumer.
Root out those assets that clearly do not contribute directly to consumer value, or clearly contribute very little. An office building might be one such example. It’s nice to have a central office, but couldn’t your employees contribute as much from a remote location, so that you can eliminate the cost of centralization?Examine capital combinations that could contribute more if they are rearranged. A server + software + trained personnel is a productive combination. What if the entrepreneur could ditch the server and rent computing power from AWS? What if the savings could be reinvested in more training for the person or better software? Would this rearrangement contribute more to consumer value? Renting rather than owning assets is one way to add dynamic flexibility to the firm. The entrepreneur should focus the firm on what it alone can uniquely do for its consumers and customers. Outsource everything else. The firm is a necessary vehicle for the entrepreneur to take ideas to market to earn a profit. It is at its most efficient when it is 100% focused on what it does uniquely: its unique brand, its unique processes, its unique recipe, its unique design, its unique functional and emotional benefits for the consumer. Everything else should be stripped away. The necessary infrastructure can be rented or outsourced. If you own 10 computers and have 10 people sitting at them every day, it’s hard to identify what productivity you are getting out of each of them every day. If you don’t own them, and you are thinking rigorously about the future streams of consumer value your firm is producing, you won’t feel locked in to your current capital structure.
A “capital-lite” structure in no way reduces the market value of the firm — in fact, it can increase it. In the past, companies were valued based on the assets they owned, as captured on the balance sheet. But this valuation method was based on an assumption that the assets were owned because they produced consumer value and contributed to profits. What if the assets are not contributing to future profit? They become a liability. Firms like GE are finding this out today — they own a lot of non-contributing assets and face major transaction costs in shedding them.
There is no need to own consumer value-producing assets. You need to control then and have the rights to utilize them to produce value, but not to own them. In venture capital markets, it is common to see firms change hands at a price that represents a high multiple of revenues or of earnings, even if the traditional capital base is insignificant. Assets that don’t appear on the balance sheet, like brand and a loyal customer base, are more important than those that do.
Actionable Insight The Austrian Entrepreneur reviews combinations of capital and labor and non-capital resources at every moment, seeking ways to improve that combination for the consumer’s benefit. The single-minded focus is on consumers and their changing preferences and the consequent implications for responsive change in the capital structure of production.
Additional Resource Austrian Capital Theory at Work (PDF): https://Mises.org/E4E_19_PDF
Austrian Capital Theory holds that capital assets are heterogeneous and complementary. In business language, that means an entrepreneur can assemble set of assets that are special to his or her firm and combined in such a way that the combination is unique, or at least hard to copy. If the assets generate consumer value, and hence a revenue stream from consumer purchases, then the entrepreneurial firm can be said to have marketplace advantage—it is unique or advantaged in its creation of consumer value.
The Resource-Based View (RBV) of the firm came from this thinking. The marketplace advantage available to any firm results from its assembled resources (synonymous with assets for the purposes of our discussion). We talk to Professor Steven Phelan, Distinguished Professor at Fayetteville State University, an expert in this field.
Note: The conventional language of RBV is competitive advantage. At Economics For Entrepreneurs, we prefer the idea of the search for uniqueness, where the point of reference is the consumer rather than the competitor. Therefore, we’ll use terms like marketplace advantage and commercial advantage.
Show Notes Resource-based strategic thinking guides entrepreneurs in the identification, assembly and use of resources in unique (or at least differentiated) ways to create sustained marketplace advantage. The use of resources is how entrepreneurs create revenue flows from consumers. The money-value of the resources—and hence the market value of the firm—derives from these revenue flows. The goal is to align the resources as perfectly as possible with consumer wants and preferences. Entrepreneurs who combine consumer-valued resources in unique ways can establish an advantage in the marketplace. If their combination of resources is unique, or at the very least hard to copy, then the advantage is sustainable and the revenue flows can be anticipated to continue absent changes in consumer preferences.
What kind of resources are we talking about? All kinds, both tangible and intangible, and both physical capital and human capital. It’s the combination that counts. A handy acronym for the kinds of resources available for entrepreneurs to combine is PROFIT: Physical, Reputational, Organizational, Financial, Intellectual and Human, and Technological resources. It’s a good exercise to review your resources under each of these headings and question whether they are unique and hard to copy.
Reputational, Organizational and Intellectual (Human) resources are the most usual sources of uniqueness (in the VRIO framework, “unique” translates into valuable, rare, hard to copy / inimitable and non-substitutable).
Reputational resources can include brand, customer satisfaction levels and trust.
Organizational resources can include processes, methods, and culture, and also includes the bundles of resources we call capabilities.
Intellectual resources include people (always unique), teams, decision rights, as well as patents and recipes.
Sustainable advantage is reinforced when other firms can’t see inside the “black box” of the combination of resources and can’t reproduce the “secret sauce”. It might be the case that your Physical, Financial and Technological resources are not differentiated, or even rare. The “secret sauce” is in how you combine them, and especially how you combine them with Reputational, Organizational and Intellectual resources. If outsiders can’t see inside, and can’t decipher the combination or copy the recipe, you can separate yourself in the consumer’s perception as a unique choice.
How you deploy the resources can also be a source of advantage. Operational excellence can be differentiating and value-creating. If you can guarantee customers and suppliers that you’ll operate with excellence in all directions—on time, on budget, high responsiveness—you’ll create an advantage over other firms that don’t keep their promises. Think of this as a bundle of resources that you deploy really well. The business literature sometimes calls it “core competence”. High quality, consistent operations do not come easily. This capability is also a resource.
Dynamic flexibility can be thought of as a bundle of capabilities around detection of and action in response to the need for change. Austrian economics stresses marketplace dynamics and the role of entrepreneurs in detecting and responding to changes in consumers’ wants and preferences. Such agility does not come easily to the firm. It requires “sensing” the uneasiness of consumers and using empathic diagnosis to identify the source of the uneasiness, and creativity and imagination in rearranging resources to produce new offerings. Organizationally, the entrepreneur must make the change occur—ready the organization for the adjustment and orchestrate individuals and functions to shift. It’s a rare capability.
Implementing the resource-based strategy is a continuous activity. Winning entrepreneurs shuffle and reshuffle resources continuously. Professor Phelan urges entrepreneurs to ask this question every day: what can we do better? Ask it in every resource area of the PROFIT framework. Gather information that tells you where you need to improve or change (You can use a template like SWOT—Strengths, Weaknesses, Opportunities, Threats; but make sure your use of it is deeply analytical and not just a laundry list of what you do). And then execute the hard part of dynamic flexibility: taking rapid action. This is the advantage of small companies and entrepreneurs.
Additional Resource Resource-Based Theory of Entrepreneurship (PDF): https://Mises.org/E4E_18_PDF
Useful books mentioned by Professor Phelan Entrepreneurship Strategies and Resources by Marc J. DollingerThe E-Myth Revisited by Michael E. GerberCrossing The Chasm by Geoffrey A. Moore
Yousif Almoayyed runs a concrete business based in Bahrain, part of a family conglomerate of businesses. It’s a complex business, requiring the procurement of raw materials both locally and imported, the manufacture of products to exacting standards, the provision of on-time and efficient service and deliveries, relationship management, and cash flow management. The business involves high-cost capital goods and careful economic calculation of the revenue flows from those capital goods in an environment of fluctuating costs and market prices.
His university education was in engineering: math and computer science. He declined the opportunity for a business degree in order to learn on-the-job. Part of his self-directed business education was the reading and thoughtful analysis of Austrian Economics texts, and the practiced application of the principles gleaned from non-stop reading.
Show Notes By reading Austrian Economics texts and thinking about how to apply the learning, It’s possible to develop an “economic way” of seeing and thinking. Yousif’s reading plan was eclectic and broad-ranging. He first discovered Irwin Schiff’s How An Economy Grows And Why It Doesn’t. Then he found Bastiat, and heard Ron Paul mention Austrian Economics, so he signed up for Mises University, which he listened to in his car via iTunesU. Since then he’s read all the great texts, many downloaded free from Mises.org. His reading gave him principles, economic logic, and clarity and precision in vocabulary.
Looking through an economic lens results in a better understanding of people, their goals and motivations and the purpose of their actions. Now it is possible to look at people and understand why they do what they do. Economics teaches empathy — putting yourself in other people’s shoes to understand their motivations and therefore their actions. This analysis applies to customers, colleagues and employees. Yousif declared himself “surprised and shocked” at why he had not been taught this before.
For entrepreneurs, the core of economics is subjective value. Many people use the term “value” mistakenly and imprecisely. They equate money prices with value. But Austrians do not make this mistake, and by analyzing the subjective value preferences of customers and employees, it is possible to be more effective at motivating. To a customer, on-time delivery and operational efficiency have a value that can be reflected in higher price or longer cash flows through relationship strengthening. To an employee, convenient parking and recognition for extra effort can have more value than a pay raise. Your tennis coach tells you, “Keep your eye on the ball”. In business, it’s “Keep your eye on each individual’s subjective value preferences”.
Austrian economics provides a uniquely helpful perspective on pricing. Pricing is a particularly challenging subject for entrepreneurs. The Austrian perspective recognizes that, at any given moment, price is a kind of average of what many involved actors think it should be, i.e. it’s subjective. Some think it should be higher, some lower; some think it’s going to drop, some think it’s going to go up. At a point on time, all the actors settle on a number. Austrian economics teaches you to observe what all the actors are doing or hoping to do in the market at the time, and to analyze what’s motivating them. Many things influence price actors — including the supply and demand for the product or service, but also the supply and demand of money — but always in the specific market of your local set of exchanges and local actors.
Prices tell the truth. A lot of people won’t accept market prices. They deny the truth. If prices contradict what’s in the news, the news is fake. If a building owner fails to lower the rental prices of apartments because he things that would be going too low, and the building becomes one-third unoccupied, it is the prices that are telling the building owner the truth.
In Austrian economics, prices determine costs. The entrepreneur has some discretion to manage costs, but must meet the market price. Entrepreneurs must meet the market price in order to sell, and find ways of keeping costs below that level to make a profit. The entrepreneur can have some influence over costs e.g. via negotiating contracts based on volume, or speculating, or finding new suppliers.
Importantly, if market prices change, the entrepreneur’s cost must change. Subsequently, it’s important to understand that accounts look instantly different. What you did in the past is no longer an accurate indication of what you can do today. You can’t repeat old arrangements when future prices change. Prices change the way your accounts look in the past, present and future.
As a consequence, traditional accounting is mostly useless for entrepreneurs. Accountants do not really measure anything, at least not accurately. Many of their numbers are aggregated figures, or averages over arbitrary periods of time like quarters or months. Accounting takes something inherently dynamic and simplifies it and puts it into numbers for purposes of stewardship over capital. Accounts were originally simplified snapshots for owners who look periodically at what their managers are doing. Entrepreneurs who are actually running a business need to understand what is going on dynamically under the numbers. We need economics to understand “underneath the numbers”. Austrians are very careful with assumptions, and are sensitive to the many assumptions in accounting.
For example, asset prices may fluctuate. They are accounted for via straight line depreciation, which is calculated for deduction from income tax, and therefore is not necessarily accurate regarding the real world.
Austrians examine the ends of the people who devised the accounting systems.
Knowledge of Austrian Economics is the foundation for confidence and decisiveness. An entrepreneur can never have complete data or complete information. Austrian economics enables the entrepreneur to make confident decisions under these conditions of uncertainty. That’s because the Austrian lens focuses not on data but on more qualitative understanding. Austrian entrepreneurs utilize the principle of distributed knowledge from F.A. Hayek. Talk to salespeople. Talk to cab drivers. Observe behaviors. Derive indications. If those indications are pointing in a certain direction, reach a conclusion. Confidence, of course, comes from being right. So keep practicing the formation of entrepreneurial judgments. Call things before all the information is in. Review the outcome based on results. If there is contradictory information, don’t be hasty. Economics helps you build a picture of what all these indicators mean.
Supplementals Yousif mentions accounting as a field where Austrian Economics gives entrepreneurs a different perspective. See Thomas C. Taylor’s Accounting In The Austrian Tradition, as well as his interview on mises.org.
For a general view of Austrian Economics for Business, you might like this lecture video by Peter Klein.
David Nordfors is CEO and co-founder of IIIJ and the co-chair of the i4j — Innovation For Jobs — Summit together with Vint Cerf. He was previously co-founder and Executive Director of the Center for Innovation and Communication at Stanford University. He has served on World Economic forum Global Agenda Councils and was one of the WEF Innovation 100 in 2009.
Show Notes Will technological innovation kill or create jobs? It’s the wrong question. The right question is whether technology being used enough to innovate new ways of earning a living, to open new sources of income. The value proposition should be focused on the individual earner.
David predicts there is a huge opportunity for entrepreneurs to make people more valuable to each other. He calls this idea The People Centered Economy. It’s a research project, a book, a Summit and discussion group, and an innovation idea. Or, rather, an idea for a solution. The problem to be addressed is the fear that technological automation will destroy jobs. David wants to make sure technological innovation makes people more valuable to each other. We’ve illustrated David’s People Centered Economy in an infographic for you to download and share.
In his view, this is a disruption of the conventional economic approach — which he calls the Task-Centered Economy. In the Task-Centered Economy, producers pay workers to do tasks with little concern for making those people more valuable. If they can eliminate them through automation, they will. But on the other side of the economy, the consumption side, they want those people to buy the goods and services that are produced. Corporations are working hard to help people consume, but less hard to help them earn.
In the People-Centered Economy, entrepreneurs will work hard to make individuals more valuable to each other. Entrepreneurs are creative people who identify an unmet need felt by customers, and devise novel and profitable ways to meet that need. David says that the need among earners that is largely unmet is to “work with people you like, be valued by people you don’t know, in order to provide for people you love”. That’s a pretty good description of the collaborative entrepreneurial economy. Making people more valuable will be a new market for opportunity-seeking entrepreneurs. It may be one where entrepreneurs will be highly successful, because the difficulty for large corporations — who control much of the relevant technology — in switching to a PCE (people-centered economy) mode from a TCE (task-centered economy mode) is daunting for them.
David has developed a concept for the execution of PCE: Jobly.com. In his book, David describes a conceptual platform called Jobly.com. On one side of the platform are earners. Jobly applies A.I. to assess everything about the individual that’s available to know – probably more than they know about themselves – to profile them and assess their talents. Those talents may be latent or hidden. As an example, he uses people with synesthesia. They combine senses in an unusual way, for example, seeing colors when hearing music or a person’s voice. There may be no obvious way this talent can be applied in the job market to earn money.
But what if Jobly could also use A.I. to ascertain what unmet job needs can be met by this unusual talent. For example, HR can be viewed as an industry with 95% failure rate — only 5% of people say they have a job that both fits them and is engaging. What if a synesthetic could identify people who are in the “wrong” jobs — hear a marketer who’s “green”, and would be better placed in a technology job — and thereby improve the performance of an HR department with their hidden skills?
Jobly would match hidden talents to unrealized job needs so that both the earner and the employer become more valuable. Jobly could find a person with talents they don’t know about, and introduce them to an organization to solve a problem the organization didn’t know it had, creating the perfect job for both the individual and the organization.
David’s imagination of the future is that a good economy will be defined as people finding valuable things for each other to do. If people don’t find valuable things for each other to do, ultimately no-one does valuable things. Then we don’t have a very good economy. The customer is the earner. It’s the difference between EBay and Uber. EBay makes its sellers — earners — the most important people; they’re more important than buyers. Uber takes the opposite approach, making riders more important than drivers — and now drivers are dissatisfied because of eroding earning power. Uber may have to think about how to make its Drivers more valuable.
We’ve prepared a graphic to illustrate the evolution of the People-Centered Economy (Mises.org/E4E_16_PDF). We’d welcome any ideas you have regarding entrepreneurial initiatives to make people more valuable.
Jeremy Vesta is a partner in Vesta Holdings, and a manager of Harmony Beef, a greenfield start-up in the fresh beef industry. Fresh beef might be thought of as a commoditized industry. But new entrepreneurial thinking can bring profitable differentiation to all markets. Here are some highlights from our conversation.
Show Notes What’s the entrepreneurial response if you are operating in a commodity-like market? A fresh beef processor stands in the middle of the production chain, downstream from the unprocessed inputs and upstream relative to the distributors, retailers and consumers. Some abundant products and services that are inputs to finished consumer goods are deemed to be commodities and subject to price competition — lowest price gets the contract. Market conditions like these can be very challenging for entrepreneurs, apparently leaving little room for the kind of value creation or brand building that will generate higher prices and customer loyalty. What’s the right entrepreneurial response?
Operational excellence is a primary pillar of value provision in commodity markets. Jeremy’s first foundational principle for value creation in his industry — fresh beef — is operational excellence. It is often overlooked as a source of value by theorists, but not by customers. When they can count on exactness in meeting specifications, when their preferred timing is respected, when the quantities they ordered are the quantities that are delivered, customers translate the reliability of promises kept into trustworthiness, and the integrity of contractual precision into relationship strength. Operational excellence is often underestimated as a source of customer value.
The same is true further up the production chain. When an operator exhibits excellence to upstream suppliers and vendors, they are reassured that they are selling into a waste-free and efficient partnership, without operating friction or relationship tension.
An operator in a lightly differentiated market can provide the valuable service of transmitting market signals up and down the chain. Austrian economists say that the capital structure of an industry reflects the preferences of the end-consumer. Once customer and supplier relationships are established, the middle-of-the-production chain firm can provide a valuable market function as a curator, evaluator and transmitter of market signals. In Jeremy’s business, consumer signals pass through retailers as a request for “more products like that” or, conversely, as a non-purchase that shows up as “shrink” (perishable product that is unsold before its expiration date). Jeremy’s firm can pass these signals to the upstream suppliers to adjust their production practices. Similarly, social conversations in the marketplace about grass-fed beef, or organic beef, or hormone free / antibiotic free beef can be passed up the chain to producers willing to respond, and the resulting new products can be marketed as innovations by the retailer.
Careful and responsive market signal management enables increasingly sophisticated consumer, customer and product segmentation. True commodity markets, if there are such things, defy segmentation. The operator who senses the potential for market changes by curating market signals can create effective segmentation to increase differentiation and therefore profits. When the upstream producer provides more grass-fed beef in response to the market signals transmitted through Jeremy’s company, the supply side is newly segmented to Jeremy’s benefit. Then his company can supply the beef to selected retailers, restaurants and foodservice distributors who have expressed an interest in serving it to consumers, thus creating strong downstream segmentation and relationships. The capability to organize market signals, deduce evolutions in consumer preference, and to be a catalyst for innovation in the production chain is an important value-creation skill, even in (perhaps especially in) a lightly differentiated market.
The use of technology is another source of differentiation. Jeremy identified vacuum-packaging as a consumer-value creating technological advance in his industry. The product arrives at the consumer in a fresher condition and better protected, and provides the consumer more convenience as well as greater confidence in storing and handling. Jeremy’s company is an early adopter of such operational technologies, procuring the most advanced machinery and the latest componentry (such as high-tech bag material) to ensure the best functional performance (better / more complete vacuum) and therefore the greatest level of consumer emotional benefit (trust). Beef is still beef, but packaging and presentation are open pathways to greater customer satisfaction.
Most importantly, a firm can bring its own distinguishing values to bear in any market. Culture, values and integrity can’t be commoditized. Jeremy’s family chose the name Harmony for their beef company with great care and purposeful intent. Harmony up and down the production chain is built on trust and service. The company realizes more value when it exhibits core, true, genuine empathy. All market participants operate more efficiently when there is unquestioned trust. Each helps the other realize its goals. That doesn’t mean that there are never any problems or disputes, but integrity always defuses tensions, and trust always finds collaborative understanding. Setting high standards and adhering to a distinguished set of high values is beneficial for the whole production chain. Fairness pervades transactions. The market synchronizes when the counterparties in trades include care and trust in their dealings.
Find out more about Harmony Beef at HarmonyBeef.ca. Download the "Value Innovation Pathways" PDF (https://Mises.org/E4E_15_PDF).
The entrepreneurial life is good for the individual, the family, society and civilization. Whether your entrepreneurial undertaking is something small or something huge, or somewhere in between, doing something entrepreneurial, utilizing your own resources, benefits others and is therefore heroic.
Show Notes Successful entrepreneurs should not be called upon to “give back” to society. The entrepreneurs’ role itself is socially beneficial. They make money by producing goods and services that consumers value more than the money they pay to acquire them. Society — in the form of the market — has its own feedback loop to tell the entrepreneur whether or not value is being created for others: profit is the signal that society is experiencing value, and loss is the signal that the entrepreneur got it wrong and is not creating value. There is no need for a bureaucrat to tell us.
But you don’t need a social purpose or a change-the-world idea, or even a monetary goal to be an entrepreneur. Just get started. C Jay Engel started straight out of school. Entrepreneurship was stability; bread and butter. He had skills in project management and found that people needed those skills, and he developed a consulting business. He was able to try to expand in other areas, which took him into technology; successes and failures were part of the recipe, as was fun. He enjoyed himself and was able to develop as a person.
The pursuit of higher values can come later, when your entrepreneurial business matures and stabilizes. Initially, C Jay focused on what was immediately in front of him. Plans shift quickly and new directions open up, and agility is required. You can’t plan your entire entrepreneurial life at the outset. Now — still in his thirties — he is able to reflect on what he calls “grander things”, like the legacy he will leave to his kids. Not the financial one, but the kind of world he can contribute to, that they will live in. He likes to think that there are hundreds and thousands of entrepreneurs all over the world doing the same thing to help bring about that good world. It’s an exciting and inspiring spontaneous order: entrepreneurs making a better world by helping individuals.
Is entrepreneurship especially arduous? It can be. Think of Elon Musk. The task of getting people to Mars to establish a colony is pretty arduous. It’s less so if you’re setting up a consulting shop. But there is uncertainty to grapple with, and doing so requires a certain mindset. It’s a learning process, and trying different ways to handle uncertainty in the multiple different ways you’ll encounter it makes you a better, more developed person. Constant self-awareness helps you realize what you need to do to handle conditions of uncertainty.
Does that mean that a special set of personal attributes is required to be an entrepreneur? Is there a personality test? We’ve had a number of guests talk about elements of entrepreneurship, like a bias for action, risk mitigation, and brutal determination. But these are patterns of behavior more than they are personality traits. C Jay’s advice is: just do it. Examine yourself along the way and you’ll find out your strengths. And when you find that there are places where you can strengthen yourself (or your team), that’s what other people are for. You can’t be highly successful without engaging other people, so focus on that rather than on any so-called “weaknesses” you may be told you have.
Technology helps you assemble not only your team, but also a full set of entrepreneurial resources. The entrepreneurial economy is highly collaborative. Whether it is Upwork or LinkedIn or Alibaba or Amazon, technology can help you assemble a team, a full set of resources and a supply chain. You can find marketers and accountants and engineers and interconnect them all over the globe or locally, in a team. Team building and team motivation are core skills (and can be a limiting factor). Self-reliance does not mean the same thing as it did in the past. The rugged individual is not the driver of the market economy. In fact, the entrepreneurial economy is highly collaborative — self-supporting rather than self-reliant. Any capital you acquire depends on the entrepreneurs in the earlier stage who produced it for you, in anticipation of your needs. Price signals from other entrepreneurs guide you. No entrepreneur is alone. The invisible hand is actually visible — it’s the price mechanism connecting you to all the people and all the resources in the world.
How do we communicate this narrative to the world? The socialists are better at marketing than the entrepreneurs. Such harsh words are used about profit, and yet it is the social signal of approval. People who are benefiting from capitalism, like Hollywood celebrities and Silicon Valley billionaires, do not understand capitalism and decry it. What should entrepreneurs do? Just keep working at entrepreneurship. Keep making life better for customers and everyone else. It’s also healthy to reflect on how you are benefiting people around you. If you have a chance to say something or write something and share an idea then take it. Doing so is itself an act of entrepreneurship. Our message will emerge from the communication efforts of individuals.
C Jay Engel himself has started Austro Libertarian magazine. It’s a new publication located somewhere between the academic rigor of QJAE and the shorter articles of Mises Daily. Original content in longer form articles, in your choice of digital or a beautifully designed and printed physical magazine. For C Jay, starting a magazine is another example of economic action rather than political action.
Per Bylund talks to Hunter Hastings about the value-centric model for successful entrepreneurship, and we provide an infographic to help you apply the model to your own business.
Show Notes Subjective value is an important subject in economics — and even more so in entrepreneurship, where it is fundamental to what entrepreneurs do. It’s the critical factor in entrepreneurial success. Business schools talk about “creating value” and “value added” as if value creation were an objective process. But it’s not. And businesses can fail if they misunderstand value, because they can easily produce something for which there is no market.
Value is a felt experience, 100% inside the consumer’s head. Value is a satisfaction that consumers feel. It’s the result of an escape from or a relief from a felt uneasiness, or felt dissatisfaction. That’s often called a “consumer need” in business language, but unease or dissatisfaction are better words to describe what the consumer feels before the entrepreneur’s new solution is offered. Unease and dissatisfaction are hard to articulate, they are emotional conditions, they are affected by context and circumstance, and they can be inconsistent and idiosyncratic. The consumer feels, perhaps vaguely, that life could be better, or their current circumstances could be improved. Value is the feeling the consumer experiences in the period after having consumed the entrepreneur’s offering that relieves this vague feeling. They feel better – perhaps in a way that the entrepreneur never expected.
The consumer’s perception of value can change, in unanticipated ways, and very quickly. Take food as an example. Consumer needs are changing rapidly. There’s a new unease about ingredients and methods of production. It’s not exactly clear what the consumer “wants”, but their preferences are changing to include notions of holistic health and wellness, so that taste and calories and other attributes of food are less important to them. We can’t rely on consumers wanting today what they wanted yesterday. Just look at the problems big companies like Kraft-Heinz are experiencing as they try to keep up with this rapid and broad-based change in consumer preferences. And it is even harder to predict where the consumer is going next on this journey of change.
So, if value is perceived by the consumer, what do entrepreneurs really do? Do they create value, or add value, or something else? Per Bylund thinks of entrepreneurship as facilitating value. Entrepreneurs can’t create it and can’t add it. They design a value proposition based on their empathic understanding of what the consumer wants and of their sense of unease about their current circumstances, and they present this value proposition to the consumer. Then they must listen for and measure the consumer’s response to find out if the consumer is experiencing value.
Production must be designed with the consumer in mind. The consumer is the boss, and the production chain must reflect the consumer’s preferences and change with their evolving tastes. The economists refer to consumer sovereignty — the consumer determines what is value, and therefore which entrepreneurial initiatives are successful and which are not. The successful entrepreneur designs a production chain that can deliver value. In a very real sense, the physical and financial and human capital in the production process must be a reflection of the consumer’s preferences and desires. The consumer’s preferences determine the capital structure.
And since the consumer’s preferences are continuously changing, the successful entrepreneur practices a kind of capital dynamism that follows these changes and, to the extent possible, imagines where the consumer is headed, because production takes time and entrepreneurs are always concentrating on facilitating future value.
Advertising, marketing and communications are a fundamental part of the value proposition and not a supplemental part. The entrepreneur must tell a persuasive story about the value the consumer will experience. Advertising and marketing are ways of communicating to the consumer that there are new alternatives available to them — new ways to improve their circumstances and feel like life is better. Often, the entrepreneur is a pioneer, creatively interpreting the consumer’s need and developing a solution that the consumer might not have thought of on their own, but which they’ll embrace when they find out about it. Sort of like the Model T the consumers got in place of the “faster horses” they asked for in the (probably apocryphal) store about Henry Ford. Advertising and marketing tell the entrepreneur’s story, and they’re an important and integral part of the value proposition.
This consumer-first (or customer-first) process works in B2B businesses as well. When selling to or supplying a B2B customer, it’s important to know the customer’s individual preferences and needs, which are subjective — the need to feel satisfaction — in just the same way that the consumer’s needs are subjective. In fact, since the ultimate consumer determines what is valuable throughout the production chain, an entrepreneur who is knowledgeable about the B2B customer’s end consumer can establish an advantage. Being able to demonstrate (1) a deep knowledge of the end-consumer’s needs (especially when they are changing), and (2) how to bring the B2B customer’s position into greater alignment with those needs, makes the vendor-entrepreneur an especially important partner. The B2B customer will experience their own sense of satisfaction and value in the exchange.
The entrepreneur who adheres to a value-centric process has the greatest chance of success. The entrepreneur’s process of thinking must start at the consumer and work “backwards” to production. The entrepreneur must live inside the consumer’s mind, and employ empathy to understand the consumer’s subjective needs and wants. From an empathic diagnosis, the entrepreneur designs a product or service and a value proposition and takes it to the consumer when it is ready. By this time, the consumer may have changed, and so speed and agility are mandatory. It’s easier said than done. But it is critically important, especially for a new business or initiative. For established businesses, when the consumer changes, it’s extremely hard to change with them.
Use our free download of the value-centric process for entrepreneurs (https://Mises.org/E4E_13_PDF) to help you think about the stages of value facilitation.
In our ongoing project to build a solid bridge between the theory and practice of entrepreneurship, we explore the connection between organizational psychology and the entrepreneurial personality.
Lisa Stevenson studied I/O Psych as an undergrad, in connection with business courses, and became fascinated with it. I/O Psych is shorthand for Industrial and Organizational Psychology — the application of psychology in the workplace. Lisa went on to post-graduate studies and a Masters Degree in I/O Psych. She applied it in consulting companies, first as a recruiter and then as an organizational development consultant.
Show Notes The application of I/O Psych is aimed at improving people outcomes and people performance within firms. The discipline embraces talent and fit — does an organization have the right talent to get jobs and projects done now and in the future, and do the people with the right talents “fit” the firm’s values. Often, firms use I/O Psych to develop pro forma profiles and compare individual assessments to those profiles, looking to emphasize the most desired characteristics and avoid those that are unwanted.
One of the methods of I/O Psych is the application of self-assessment tools. There exists a wide range of psychology-based or psychology-inspired self-assessment questionnaires and surveys that are focused on assisting firms and their HR departments to evaluate and optimize their employee base. One particular application is the combination of different personality types in teams in an attempt to balance strengths and maximize collaborative output and productivity. One of the prominent self-assessment tools Lisa mentioned is MBTI (Myers Briggs Typology Indicator) — a popular free version of which is available at 16Personalities.com. Another is "Business Chemistry", the internal tool used at the global consulting firm Deloitte, where Lisa works in Talent and Development. You can take this self-assessment yourself at BusinessChemistry.Deloitte.com, and find the explanations and implications of their personality classifications. A third widely used self-assessment tool is StrengthsFinder from Gallup.
Can self-assessment help entrepreneurs to succeed? Lisa says yes — but not in the same way that corporations use self-assessment. The entrepreneurial role — whether (co-)founder / CEO or team member — is different. It requires adaptability, being able to do lots of things well, not just one thing; to earn new jobs and skills, including “dirty work”; to be deeply involved in all aspects of operations to understand and master how the entire business functions, not just one aspect of it. When she is hiring for entrepreneurial roles she looks for (1) a bias for action and (2) a willingness to take risk (such as learning a new skill or taking on a new task) combined with a skill at mitigating risk (learning fast, narrowing options quickly, reversing bad choices when new information requires it, without self-criticism). Entrepreneurial self-assessment is not concerned with strengths and weaknesses, but with knowing oneself candidly and acting on that information. There is an entrepreneurial personality based in bias for action and risk mitigation, but it’s not the same for every entrepreneur. It’s best to find your own balance. (At Economics For Entrepreneurs, we are developing a self-assessment that assesses behavioral traits rather than personality traits — you can take the first iteration here).
As an entrepreneur, Lisa applied the lessons of self-assessment both to herself and to her brand. Lisa started a growing jewelry brand called Rise Hawaii. Initially, it was based on her hobby of free diving and scuba diving. She would collect shells and sea glass and sell them to jewelers. She discovered that there were no jewelers making exactly the kind of jewelry she preferred personally — a combination of delicate elements with high-end precious metals. She started designing, then manufacturing — learning skills like dipping shells in molten gold — then selling on line and distributing to retail stores. Rise Hawaii is now a fast growing international brand selling online and through more than twenty retailers.
Personality analysis helped her in two ways. She understood her own personality from the self-assessments she had taken, and could observe her own behavior in stretching herself too thin in her business by trying to please every potential customer and meet every demand. By understanding the underlying personality traits, she was able to change behavior for the good of both her business and her best customers. She also applied a similar assessment technique to the personality of her brand. Lisa realized that, initially, she was trying too hard to emulate established "Hawaiian jewelry" branding adopted by others, but this did not reflect her authentic self. She consciously realigned her brand’s personality with her own. The result is a unique and sustainable brand positioning and a happy owner.
And self-assessment helps Lisa imagine her entrepreneurial future: growth through alignment with companies and causes exhibiting values she shares, including worthwhile purposes such as ocean conservation.
There’s a way for all entrepreneurs to benefit from self-assessment and self-awareness. Take one or more of the self-assessments accessible via the links provided here. Absorb the background information that’s provided. Use it to be self-aware: what do the results tell you about yourself? Did you learn anything new? Can you observe your own behavior and see personality traits at work? Are there any ways in which you are being inauthentic — behaving in ways that others want you to, rather than being true to yourself? What do the results tell you about your personal balance? Where does your profile need shoring up with new practices, new learning, or someone’s help? The key is to be aware, to understand yourself.
Links 16Personalities.comBusinessChemistry.Deloitte.comEntrepreneurial StrengthsFinderE4E Behavioral Self-AssessmentFind Rise Hawaii on Etsy at RiseHawaii and on Instagram at Rise.Hawaii.
How should entrepreneurs think about the economic concept of competition? Is there anything to learn? Is thinking about the concept useful for entrepreneurs running businesses? Hunter Hastings asks Per Bylund to steer us through this thicket.
Show Notes In mainstream economic theory, competition occurs between producers or suppliers of commodities. The good is pre-defined and undifferentiated, and competition is a matter of price and the production function. If this theory were looking for an example, it might find it in the gasoline market, where there are lots of gas stations with identical product, everyone has the same information, and price is the main means of competition. Economic theory calls this “perfect competition”, which is an ideal compared to “imperfect competition” (monopoly, duopoly, oligopoly, etc). It’s all pretty unrealistic and there’s nothing for an entrepreneur to learn.
Austrian economics sees competition as entrepreneurs competing for the customer’s dollar. The starting point is consumer sovereignty — the idea that the consumer (or the customer in B2B exchanges) is the one to exercise choice, and therefore determine what is purchased and, consequently, which brands, products and services are successful. An entrepreneur is competing with all the other ways a consumer could spend their dollar: by not buying at all, by buying a direct substitute, or by spending it in another category, or by deferring their purchase to a later time.
To succeed in this competitive environment, the entrepreneur should seek to create unique value. The Austrian logic of competition is value-centric. Value is subjective — it’s a perception of the consumer or customer. The entrepreneur competes for the consumer’s dollar by creating a value that the consumer can not realize from any other source — including non-consumption. The entrepreneur searches for uniqueness, to find a niche where he or she can serve the consumer in a way that no-one else has done before. This is what Peter Thiel calls a “monopoly” in his book Zero To One: a unique offering in a precise niche.
The way to compete is to develop a better empathic understanding of consumers’ needs. Every entrepreneur has the opportunity to be the best at developing an understanding of a target customer’s needs. In many cases, the competitive edge will be in choosing the right audience to serve — narrow enough that the empathic diagnosis is specific and precise and therefore more likely to yield an opportunity to serve the segment in a unique way. Generalizations and common denominators may not be precise enough and may cause the entrepreneur to miss precisely what it is about an audience’s needs that provides an opening for differentiation. Differentiation means a higher level of perceived value for that audience.
Positioning and telling a uniquely persuasive story are a big part of competitive value delivery. In so-called “perfect competition”, all players, producer and consumers, have the same information. Of course, the opposite is true in real life. One of the important differences in information lies in how value is positioned to the consumer, how the value story is told. Entrepreneurs compete to tell the best stories and communicate in the most persuasive ways.
In this way of thinking about competition, so-called “business strategy” is not particularly useful. Five year plans and specific organizational goals (like doubling sales) are not useful and there’s a high likelihood of failure. They represent the wrong focus. The right focus is “how can we increase value for the consumer” or “how can we be unique?” How can we satisfy consumers in ways that no-one else does? Dynamism means that all players are changing all the time, including consumers, and so entrepreneurs must be learning and adjusting all the time, and always trying to create new value.
Can strategy tools be useful? Strategy tools can be useful to help structure thinking and help you to be sure not to have overlooked some element you should have considered. The VRIO method helps you to think about assembling a unique set of resources to support a unique value delivery to customers. Modern entrepreneurship education offers a number of frameworks to help entrepreneurs in starting a business, like the Disciplined Entrepreneurship Canvas and the Lean Startup Canvas. They are both pretty good at starting with consumers and the value the entrepreneur can create for those consumers. We’ve re-created a few versions of the Lean Startup Canvas for you to download:
a version with explanatory notes, to help you better understand what each section represents and how it should be used;an annotated canvas that can be printed on regular letter-sized (8.5x11) printer paper;and a blank one that can also be printed, for you to complete yourself. Bottom line: Austrian Economics’ value-dominant approach provides better guidance for entrepreneurs than the formulas for strategic thinking that come from business school.
Start with the customer. Understand their needs, create value for them, and keep refreshing that value. In fact, this is a collaborative view of the market. Entrepreneurs share the desire to find a unique niche and establish a unique service, and they’re happy to compare notes and methods in order to help each other, which is one of our aims at Economics For Entrepreneurs.
Additional Resources The VRIO Method (PDF): https://Mises.org/E4E_10_PDF
Lean Startup Canvas, with notes (PDF): https://Mises.org/E4E_11_PDF
Lean Startup Canvas, horizontal (PDF): https://Mises.org/E4E_11_PDF_2
Lean Startup Canvas, blank (PDF): https://Mises.org/E4E_11_PDF_3
Alertness, Discovery and Resource-Based Strategy. Ed Pletner talks with Hunter Hastings about applying these economic concepts to start, grow, and manage a thriving and highly differentiated business.
Show Notes Entrepreneurial theory in Austrian Economics employs several terms to describe the entrepreneurial process and the exercise of entrepreneurial skills.
Alertness refers to the ability of some entrepreneurs to identify, and quickly gain profit from, marketplace opportunities to buy from one resource and sell to another in a way that benefits both and allows for a profit. Discovery refers to the process of applying empathic diagnosis to accurately identify unmet needs of potential customers and to rearrange resources to meet that need, enabling customer value and generating entrepreneurial profit. Capabilities-based strategy is the idea of identifying certain key resources — tangible or intangible — that enable a firm to establish a strong and potentially lasting competitive advantage in the marketplace. This approach to strategy is often packaged up in textbooks as the Resource Based View (RBV) of the firm. Ed Pletner started his entrepreneurial journey with a straightforward application of alertness.
Ed began as an eBay “trading assistant”, buying from one source (individuals or businesses that had something to sell) and selling to other individuals who wanted to buy, and taking a commission on the trade. With effort, energy and hard work, Ed quickly established that he could sell to large audience and develop a revenue-generating business without the need for a large overhead or expensive technology.
As his trading business expanded, Ed discovered ways in which to serve many large customers with a new service of electronics recycling.
Ed began buying his own electronic equipment for resale from garage sales and local swap meets. He describes this as a “great experience” of discovering both sides of the service equation – who wants to sell and why; who wants to buy and why; and what are the specific conditions necessary to complete the trade.
It all started with buying and selling technology hardware. At the beginning, Ed was moving it from garage to garage — a seller’s garage to his own, in order to store it before reselling it. Then the business became engaged with bigger quantities — warehouse to warehouse.
He couldn’t sell everything — some items had to be recycled or destroyed. It was at this point that the discovery process yielded the business opportunity of data destruction and electronics recycling.
From dynamic marketplace change, there emerged the customer need for secure and compliant data destruction as an integral element of electronics recycling. The problem to be solved was called E-waste.
We always encourage entrepreneurs to find a problem that customers want solved. Ed discovered e-waste. When hardware is recycled, there is always an associated amount of data: customer records, company data, financial records, health records, memos, emails etc., on hard drives, thumb drives, and all kinds of digital media. It has to be destroyed. And the customer needs to feel confident and assured that there is no failure or leakage in the destruction process, and that they can prove to regulators or auditors that they did the right thing and hired the right experts to avert any potential issues or claims.
Ed was able quickly to recognize the opportunity to become a trusted service provider in data destruction.
Ed invested in capabilities to enhance and strengthen his credentials in this emerging market that had a strong need for standards.
Ed understands subjective value. Value is, as he puts it, “in the eyes of the beholder”. And in this case, the beholders were the clients who had stringent guidelines to follow — HIPAA guidelines, or financial industry guidelines or contractual customer requirements — regarding how data is destroyed. It was most important to these clients to be able to retain a service that is compliant — that can provide proper certification of destruction and a third party audit. They are looking to avoid both legal and financial penalties and any reputational risk.
Ed invested in establishing his company, avritek, as a properly certified vendor. R2 Responsible Recycling is the industry environmental standard for electronics recycling. ISO 14001 and OHSAS 18001 are environmental and worker safety and health certifications. NAID (National Association of Information Destruction) is a location-based certification with onsite auditing for both paper and digital data destruction standards. Avritek has them all.
Ed has embraced the capabilities-based strategy approach wholeheartedly, always asking how he can expand his capabilities to serve clients better. How do we install a larger shredder to better serve large scale clients? Which ERP system shall we install to tie in all our processes and partner services? This is a lot different than spreadsheet based planning and budgeting. It’s all about delivering more value to clients via better capabilities.
Customer segmentation follows from commitment to capabilities. Avritek does not have to target customers. It aligns with them and synchronizes with them by understanding what they care about and providing the capabilities to enable them to exercise that care. In San Diego, where avritek is based, there are many biotech firms. They care deeply about data security, not only for compliance reasons but also because “they are in a caring industry”, as Ed puts it.
Interconnectivity opens up an international business footprint for the capable, service-oriented firm. Avritek is San Diego based. Many of its clients have offices and locations in multiple states and multiple countries. By partnering with similarly-credentialed electronics recycling companies, Avritek can provide a complete service to clients, along with a single point of invoicing, administration and relationship management. In this way, capabilities-based strategy is an excellent route to organic growth with high levels of capital efficiency.
Additional Resource Alertness, Discovery and Capabilites-Based Strategy (PDF): https://Mises.org/E4E_10_PDF
Decision-making can feel particularly challenging for entrepreneurs. Entrepreneurs face the unpredictability of the future with a limited set of resources, limited information, very little history of what works and what doesn’t, and few, if any, people to help. There’s no corporate research department and not much big data. Decision-making can be daunting. How can economics help?
Show Notes Economics helps us understand the process of decision-making, and how to enhance it with human creativity and wisdom rather than spreadsheets and analytics. The first step is to recognize and embrace what economists call uncertainty. Entrepreneurs face it all the time. We can’t know the future, or even the number of possibilities. The world is organic and human, and future outcomes depend on the interactions of millions of humans. No one can predict them. Don’t try. But don’t be intimidated by uncertainty.
Understand the difference between risk and uncertainty. Risk is a mathematically definable probability. When we roll a 6-sided die, we don’t know which number will come up but we can calculate the probabilities for each one of 6 possible outcomes. That’s a highly defined situation with a mathematical probability, as is insurance risk. Uncertainty is different — we can’t list the possible future outcomes or attach a probability to each one.
In uncertainty, think of decision-making as a continuous process, not a fork in the road. There is no need to fear decision making. It’s not a back-and-white choice, X or Y, right or wrong. Think of decisions as continuous; we decide, we try something out, we experiment, we get results, we adjust, we try again. Every piece of new information we obtain from experiments helps us make a more informed decision next time. Entrepreneurs are good at dealing with this continuous flow of decisions, and making adjustments as they go — like a basketball coach on the sideline. The system of decision making is far more important than any one single decision.
Peter Klein calls this process Entrepreneurial Judgment. Entrepreneurial judgment is reasoned, purposeful action regarding feasible outcomes. It’s not formal or mechanistic or mathematical, but nor is it blind guessing. The key is that it is the entrepreneur who makes the final decision. He or she is not executing decisions that others make. Entrepreneurs make their own reasoned judgment in a middle ground between guessing and mathematical certainty.
There is a systematic process to mitigate uncertainty. Dr. Klein defines the process as (1) defining what type of uncertainty you are facing (2) taking appropriate steps to narrow the scope of the particular type of uncertainty you are facing; (3) exercising judgment — i.e. making a decision and taking action — in a timely manner when uncertainty is reduced but not eliminated; (4) gathering feedback for your action and continuously repeating this process.
Environmental uncertainty is external to the entrepreneur and means that many possible outcomes could result from a decision. You plan to launch a new product. You don’t know how the competition will react, or how the consumer might change or what will happen to regulation. In this situation, entrepreneurs try to narrow the range of possible outcomes, using experience, history, testing and other means. For example, you could run a test of different price levels to ascertain which one generates the most purchases, and use the test results to narrow the possible outcomes.
Creative uncertainty is internal to the entrepreneur with a defined goal but many possible options of means to reach it. You want to sell a million units at $5, but don’t know which combination of messaging, media, and promotion is best to help achieve the goal. You narrow the range of possible options by hiring an expert marketing agency, instructing them to develop 6 alternatives, and choosing between the options based on consumer reactions.
Absolute uncertainty occurs when there is a wide range of possible outcomes, and a large set of possible options for action, in a dynamic environment of change. You want to start a company but you are not sure which consumer needs you are best placed to meet, or which of many options you would select to meet them. You have to find a way to narrow both the possible outcomes (which needs will I serve) and the possible options for action (what kind of a company will I launch). Dr. Klein used the example of Netflix. Reed Hastings wanted to start a tech company but wasn’t sure what kind — absolute uncertainty. He settled on direct delivery of VHS tapes, with moderate success, but at least he established a consumer need to fill. But then the technology environment changed, first to DVD’s (easier to ship) and then to streaming (better consumer solution but technologically very challenging). Netflix thought and re-thought the environmental uncertainty (changing technologies and consumer tastes) and the creative uncertainty (how would pricing, subscriptions, packaging etc affect outcomes?) in a continuous process of experimentation and recursion.
Entrepreneurial decision-making is evaluating and mitigating uncertainty. Narrow the range of your options and possible outcomes. Decide and act, and don’t be afraid to do so. Think of decision-making as a continuous process, one at which you can get better over time and with experience.
Additional Resources Entrepreneurial Decision-Making Under Uncertainty (PDF): https://Mises.org/E4E_09_PDF
The Types of Uncertainty Entrepreneurs Face (PDF): https://Mises.org/E4E_09_PDF_2
Hunter Hastings talks to Will Dinkel, CEO of Nova.ai, an intelligent platform for outbound sales and marketing — and a great example of AI as a tool for everyday tasks of everyday businesses of all kinds.
Show Notes AI has come a long way in a short time. Ten years ago, we always had to have a “human in the loop” for any task that could be made more productive with software. It could never be so productive as to not use human labor. And often that labor was very inefficiently deployed. Will cited the example of tracking labels and numbers on shipping containers — software could record the data, but humans still had to interpret it.
AI is available and relevant for entrepreneurs and small businesses today. Emerging technologies — including AI, Platforms, Apps and Global Exchanges — augment the capacity of individual entrepreneurs: AI is a business tool and a creative tool for entrepreneurs right now.
Outbound sales and marketing is a practical application of AI in a critical everyday activity. The specific area of application we talk about is personalization — which increases engagement and results. Personalization can generate as much as a 10X increase in sales effectiveness. Without AI it’s very labor intensive — 94.2% of the typical enterprise sales team’s budget is labor. With AI, personalization is very much less labor intensive, very effective, and potentially self-improving over time.
Personalization of sales messaging via AI is an example of bringing machine intelligence to empathy. In episode 5, Peter Klein explained the pivotal role of empathy in entrepreneurial success. With AI — in combination with the empathic entrepreneur — we can make empathy work for us more intelligently, more intensively and with greater analytical rigor.
Machine learning accumulates data over time and, via regression, uses it to make better decisions. When Netflix recommends “British mid-century dramas with a strong female lead” for your viewing enjoyment, it has accumulated your input data (searching, for example), and your output data (what you actually watch) and identified the most dominant co-varying themes in order to identify a recommendation you are highly likely to accept. Initially, the model needs a human in the loop to help it become accurate, but over time it can operate autonomously.
Nova.ai is an example of an application of AI that has become much more broadly capable over time at helping humans perform better. Initially, it was able to identify snippets of sentences and information that were effective in increasing outbound e-mail sales productivity by +40%. Now it can focus on the much broader role of the seller — in a process called Intelligent Customer Management — by sifting through all the data a salesperson has to deal with, identifying the major time sinks associated with it, and lifting the burden by providing analyses and recommendations for the most productive actions.
The future increase in AI productivity will come from it knowing more about the individual user. Currently, AI can sort through data intelligently, but it knows far less about the human user of the data. When that gap is closed, AI productivity will ascend to a new level. Imagine a nutrition bot that knows all your personal health and eating and exercise data. When scanning data in front of your eyes — like a menu or a deli counter — it will be able to make truly personalized, and perhaps life-extending, recommendations.
A.I. productivity will be available to all businesses, big and small. AI will be very egalitarian. Everyone can access it, and the upfront cost is low. In the first industrial revolution, capital intensiveness limited the access to opportunity. Not many had enough capital to build a railroad or a steel mill. In the era of AI, we can all access training in coding and AI and machine learning on Udemy or Coursera or one of many other learning platforms.
A good place to start is to open a Github account. Gitub is free at the basic level, and anyone can search for AI applications in any subject of interest. Everyone should have a fundamental programming education and Github is a great place to explore. Nova.ai is the place to find out about Intelligent Customer Management.
Additional Resource A.I. As Value Facilitation Through Personalization (PDF): https://Mises.org/E4E_08_PDF
Hunter Hastings talks with Per Bylund about Opportunity Costs. Why is this important? Because, for entrepreneurs, all costs are opportunity costs; and opportunity costs are the only costs. Opportunity cost is the core of economics, and to develop an understanding of how to apply economic principles to real life, it’s the place we must start.
Show Notes Opportunity cost is the fundamental trade-off. The value of any action or choice is defined by the value of what I am foregoing — of what I can’t do as a result of choosing. If I decide to make my product out of stainless steel, I can’t also make it out of aluminum. The value I create by choosing stainless steel must be greater than the value I gave up by not choosing aluminum.
We calculate opportunity cost as the NPV of different alternatives. The NPV of the second best choice is the opportunity cost of the first.
The entrepreneur must understand the mind of the consumer in order to see opportunity costs in the way the consumer sees them. Opportunity cost is a subjective evaluation on the consumer’s part. How do they look at alternatives when they are considering the entrepreneur’s offer? Would they assign greater value to the aluminum product compared to the stainless steel product? An entrepreneur needs to be able to answer that question in order to calculate how to design a good deal in the consumer’s eyes.
The way to do this is to solve an equation: consumer value = the value of what I am offering minus the customer’s perceived opportunity cost of acquiring it. We must understand what is the first alternative for the consumer (including doing nothing — not buying). That’s one part of the consumer’s opportunity cost. Second, what are the additional opportunity costs of buying — such as the difficulty of getting to the store to buy the product, or the difficulty of ascending the learning curve to use an app. These are the second component of opportunity cost for the consumer — the alternative is not to have to face these costs and may be preferable.
Use our Opportunity Cost Calculator.
It’s possible to segment consumers by understanding their attitudes to opportunity costs. Book buyers on amazon prefer the low cost and fast delivery. Their opportunity cost is going to the book store, where there is a limited selection and prices are higher. Book buyers who go to the brick and mortar store prefer mingling with other book buyers and perhaps getting a cup of coffee — experiences that are unavailable on amazon. For these consumers, the opportunity cost of foregoing such experiences on amazon is high — so high that it makes amazon’s low price unattractive. These attitudes are held by different kinds of book buyers.
The entrepreneur’s first opportunity cost is the value of choosing another career, such as a corporate job. Many entrepreneurs could make more money — and do so with more continuity and security — as a corporate employee. That’s the opportunity cost. But it may not compensate for the excitement and fulfillment of doing what you love as an entrepreneur. Be sure to calculate the opportunity costs carefully!
Once you’re an entrepreneur, every decision is a trade-off, and calculating opportunity cost is an everyday task it’s important to master. Every resource allocation decision is an opportunity cost decision. How much should I spend on product development, if that means less money for marketing and sales? Whom should I hire versus what tasks should I outsource? Once the decision is made the opportunity cost is locked in. This is especially critical for small and start-up businesses with limited resources and tough cash flow constraints. Always think in terms of opportunity costs when making decisions: what’s the alternative?
The allocation of time is often the most important opportunity cost of all. A classic example is engineering time spent perfecting the product versus getting a just-about-good-enough product to the consumer for evaluation and feedback. The engineering trade-off is that the product is not the best it can be. More time would help. The business trade-off is that customer feedback is the most important resource of all, especially negative feedback which tells you how to improve. Delaying it could be fatal. The entrepreneur must weigh these two alternative uses of time. That’s how the concept of the MVP (minimum viable product) and agile programming emerged. They’re both ways to make the best trade-offs of time allocated to the most important tasks.
The entrepreneur must always be thinking of trade-offs. What am I losing or foregoing by making this choice? That’s the opportunity cost. Calculate it, estimate it and put a value on it. Focus on what you are not doing in order to choose the right thing to do.
Additional Resource Opportunity Cost Calculator (PDF): https://Mises.org/E4E_07_PDF
The Green New Deal contains a wish list of progressive social and economic goals that come with a staggering price tag.
Original Article: "Study Estimates the Green New Deal to Cost $93 Trillion — That's a Conservative Estimate".
The real problem was the money supply inflation that happened during the boom phase. Combating deflation in the bust phase only superficially treats a symptom of the boom-bust cycle.
Original Article: "Central Banks Shouldn't Fight Deflation".
At Economics For Entrepreneurs, we believe that everyone can be an entrepreneur, should they choose to do so. It may take you some time to find exactly your best niche, and a few experiments may be in order. The right mindset, we propose, is to pursue your entrepreneurial goal with belief and commitment, while being sufficiently adaptive to make some adjustments along the path when new information and new learning becomes available.
This week we speak with Ricky Porco, a young CEO who already has several entrepreneurial experiences to his name. He’s co-founder of an innovative community-building platform, and of a software development company. He’s also been a marketing, sales, and do-it-all guy at a digital marketing agency; and now he runs a service company to help small businesses make the transition from paper to digital — that is, he’s an entrepreneur who supports entrepreneurs.
Show Notes Starting entrepreneurship early in life is an advantage. Ricky tells listeners how he started his entrepreneurial career in college, packing a lot of learning into a short period of time. It’s a permanent advantage he’s carried forward with him into every subsequent stage of his journey.
It might take you a few tries to understand what kind of entrepreneurship is best for you. You might expect to switch businesses two, three, four or more times, changing markets, organizations, and business models. Make sure you make your choices purposefully, and commit to active learning from each one.
You might even try life as an employee to learn by comparison. Ricky switched into the role of employee at one stage. He was able to observe how the boss he reported to struggled with management and growth, and learn from it, while gaining confidence in his own skills through his success as a rainmaker for this employer.
You quickly find out the importance of financial management. Ricky quickly found out that he and his co-founders were good a business model design, product development, marketing and sales, but a start-up is financially immature by definition and can easily run out of cash. Without sound and disciplined financial management, all the other skills and capabilities can count for nought.
And you also quickly find out that effective marketing is essential to every business. Some of Ricky’s clients see marketing as optional — “if there are funds left over”. The opposite is true: marketing is a fundamental requirement.
Organizational structure and design is a critical factor in success, and especially in opening information flows. The biggest threat to the entrepreneurial success of a firm is a clogged information flow, when employees or partners don’t have clear direction or timely data. This can easily happen in founder-centric companies and especially in family-owned businesses that tend to be hierarchical.
Digitization is the best opener of information flows: software is organization. One simple solution to the clogged information flow is digitization. Software solves the problem; there’s no hierarchy in Slack.
Additional Resource 8 Attributes of Austrian Entrepreneurs (PDF): https://Mises.org/E4E_06_PDF
Equalization of incomes can be accomplished only by moving down the road toward serfdom.
Original Article: "This Way Toward Equality".
Austrian economist Peter Klein talks with Bob about his unusual (for a Rothbardian) career path, including his time working for the Council of Economic Advisors to Bill Clinton. They discuss Klein’s work on entrepreneurship, and how his views differ from those of Israel Kirzner.
For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
Today we talk with Peter Klein about empathy—a critical tool in the entrepreneur’s toolbox. It’s through empathy that entrepreneurs can get into the customer’s mind, understand and identify their needs and wants from their perspective and in their perception. This is the skill that enables the design of new products, new services, new systems and new solutions. If the entrepreneur has exercised empathy well, the chances of success in the design process are high for the customer to say, “Yes! That’s what I need!” Is empathy a difficult skill to master? Not really. We all have it to some degree. It needs to be applied with a combination of subtlety and discipline.
Show Notes Empathy is a skill we learn from childhood. We’re taught as kids, when we say or do something that might be unkind or upsetting to another person, to “think about how they must feel”. The vernacular is to “walk in their shoes”. It’s the same essential skill we apply as entrepreneurs.
Entrepreneurs need to master the skill for an audience that might not be in their social circle and with whom they may not be familiar. You may be selling to car buyers, or cooking enthusiasts, or sports fans, or the procurement officer at a client. This kind of empathy is a little bit less natural and a little bit more learned.
It is entirely possible to learn entrepreneurial empathy and to get better at it. You can develop a process of reading and gathering data about the category or market you’re operating in, talking to actual and potential customers, conducting quantitative or qualitative surveys (like focus groups), analyzing the sentiments in social media conversations, or just talking to folks with a viewpoint. You can hire a consultant or an employee with highly developed customer empathy skills. But always, it’s your interpretation of the data that’s the key. What is motivating the customer, what is driving them, what is the feeling that’s at work?
There are plenty of tools. There are market research tools, analytical tools, and all kinds of methods you can use. Learn them on YouTube or an online course. Or use our Entrepreneurial Diagnosis Tool: the Contextual In-Depth Interview.
Think of yourself as a Doctor, performing a diagnosis. Often the patient can describe symptoms, but does not know the underlying cause, and certainly doesn’t know the cure. The doctor asks questions, performs some pattern recognition based on existing knowledge, and perhaps performs some tests to narrow down the possibilities. In the end, the doctor arrives at the diagnosis and the prescription based on skill.
The Doctor analogy extends even further to the cure you are trying to deliver to the customer. Your target customer is not so much looking for something new as they are seeking to solve some dissatisfaction. There is some feeling on their part — a little vague, perhaps, not too well articulated, but nevertheless genuinely felt — that something in their life could be better. Ludwig von Mises called it “felt uneasiness”, which is a wonderfully descriptive expression. As an entrepreneur, you are taking away an uneasiness. The result is a better feeling on the customer’s part — an end to that uneasiness.
This is what entrepreneurs do in a free market economy of mutual voluntary exchange. We persuade customers that they will feel better, be better off, experience more enjoyment, if they buy the product or service we are offering to them. They can be confident of that future feeling because of the empathy the entrepreneur has exercised in developing an understanding of them, their dissatisfactions and their unique individual preferences. The entrepreneurial system is best for everyone, because it’s based on empathy.
Additional Resource Entrepreneurial Diagnosis Tool (PDF): https://Mises.org/E4E_05_PDF
It’s a fallacy for an entrepreneur to believe in chasing the biggest possible audience or the largest possible market. Why? Because your business will get pulled in the direction of “all things to all people”, and you may end up pleasing none.
The opposite rule applies: identify and gather specialized knowledge, and apply it in a specialized market to a select group of customers. Aim to be the best in your specialization. To do so requires discipline, application, and—as we discovered when we talked to Bob Luddy—time.
Bob is the founder and CEO of CaptiveAire, a business specializing in commercial kitchen ventilation systems. It’s a fast growing business, now generating hundreds of millions of dollars in revenue and hailed by its customers as best-in-class. It didn’t get there overnight, and it didn’t get there without some difficult moments along the way. Bob shares his experience with us on Economics For Entrepreneurs.
Show Notes Bob Luddy’s case history represents an approach to starting an entrepreneurial business that is sometimes called Effectuation, illustrated in this handout. See also Bob’s book, Entrepreneurial Life: The Path from Startup to Market Leader.
Your first business may not be your ultimate business. Bob started in the fire suppression business. He aimed to be the best in that niche, but realized that there was a better opportunity in kitchen ventilation, so he made the switch. The new business was a slower build, but in a more fruitful market.
He felt a positive tipping point in year 9. He obtained a commercial bank loan — prior to that he had been short on capital. Now he felt he could accelerate growth. That didn’t mean he had “made it”, but that he was on slightly firmer footing. Nine years is a long time to find firmer footing — be patient! It takes a long time to build a great business.
Patient specialization is a critical component of success. So-called “serial entrepreneurs” never spend enough time to be the best at the business they’re engaged in. By being patient, Bob was able to identify weaknesses in the market on which he could capitalize: long lead-times (shorten them!), high prices (lower them!), imperfect performance (improve!), and poor service levels (invest in service!). These were innovations a new entrant could bring.
Be the best in your specialization — not all things to all people. Bob’s specialization methodology has been to create the highest industry standards for the products and services he sells, and then don’t deviate. Don’t make “wild” sales promises that are not standard. Keep to a tight range of products so as to drive down costs, and shorten execution times. Competitors who try to be “All things to all people” go out of business. Specialization is a basic economic concept that is key to success.
Systems thinking brings growth to specialization. Thinking like a customer means systems thinking: what is the complete solution the customer is seeking? Specialization does not mean being a tiny piece of the solution. By integrating the entire system, you become more valuable to the customer. The future of entrepreneurship is in integrating systems, and defining integration is the job of the entrepreneur. A business can keep growing by advancing towards greater integration.
Innovation is ephemeral — you never stop. Innovation is important, but don’t think of it as an event. It’s an activity that is continuous. Every single innovation will be competed away. You’ve just got to keep on doing it, and always be alert to new ideas, new combinations of existing ideas, and changes in customers wants and needs.
All decisions are subject to re-evaluation. None of us gets it right every time. Most decisions are made with incomplete information. But that’s necessary — an entrepreneur needs to make high velocity decisions. If they are wrong, own up to it, fix the consequences and re-evaluate based on new information.
The purpose of a business is profit. With no profit, there is no business, no jobs for employees, and no innovation. Make profit in a fair and moral way. And make profit in the long term, not necessarily maximizing profit in the short term. Everyone — the whole society — benefits.
Entrepreneurs don’t plan: they execute a vision. Entrepreneurs have a vision they are working towards. They have aspirational goals for sales or revenues. But they know they can’t plan the future. It’s hard to plan a month or even a day, let alone five years. What they can do is execute with excellence. The key question is, did you get it done today? As the world of business closes in on real time, execution is primary.
The winning entrepreneurial trait is brute determination. Sometimes, all you have is your own determination to succeed. You define what are the things that MUST be done, and you execute with no exceptions. Vision is good, but execution is hard. Doing the hard things, correctly and consistently, is what makes an entrepreneur.
Additional Resource Bob Luddy's Effectuation Process (PDF): https://Mises.org/E4E_04_PDF
[This is a chapter from The Problem of Production: A New Theory of the Firm.]
This book is about what is generally referred to as the ‘firm’, a phenomenon in the market that appears obvious but that remains difficult to explain. While there is a field of study referred to as the theory of the firm, there are in fact a number of noteworthy theories. All of these theories claim to explain the firm’s rationale, value, and purpose. But the theories tend to describe the firm in different ways. The discussion is further complicated as there are several different definitions of this seemingly elusive concept. As a result, our understanding for the economic reality of the firm is inhibited.
The purpose of this book is not to reconcile these theories or definitions, however, but to try a new approach and provide an explanation for the firm by looking at the market setting where we find firms. We start by constructing an economic model of the market as an elaborate yet dynamic system of production without firms. This, in turn, allows us to study the limitations of the economic system of production, and what means are available to overcome them; or, more precisely, how the market deals with this ‘problem of production’. The goal is to elaborate on an explanation for the firm by seeking its economic function within the extensive production apparatus of the specialised market.
This chapter positions this book in the extant literature on the economics of organisations and institutions. It does so by summarising and delineating two strands of the academic literature that are separate but should complement each other: strategic management (or, as it is sometimes referred to, organisational economics), especially the theory of the firm, and the Austrian school of economics. While they have things in common and have recently been approaching each other, we will here draw from both strands to produce a theory of the firm. Our theory is based on the Austrian conception of production in the dynamic market process and it takes market-based production and the evolving dynamic of the market process as its point of departure. The perspective is Austrian, but the object for our analysis is borrowed from strategic management. The discussion thereby indirectly attempts to reconcile these literatures by providing a theoretical explanation for particular phenomena in the overlapping space between them. This first chapter is intended to provide background by making the reader familiar with economic theorising on the firm and what the two aforementioned literatures have in common.
Theorising on the Firm Whereas firms are ubiquitous in the economy and therefore often assumed to be a natural component of the market, the concept of a ‘firm’ poses an interesting question relating to economising, organisation, and production. The question can be stated as simply ‘Why are there firms?’, but its simplicity is deceiving. The question requires both elaboration and contextualisation to make the problem clear. The ‘why’ in the question suggests that there must be a rationale for forming firms such that there is a distinct value of coordinating production specifically within firms, which directs our attention to the question of what possible alternatives to firm organising there could be. The commonly assumed alternative is a model of the market as predominantly decentralised exchange-based coordination of production. The theory of the firm literature aims to formulate an economic argument for firm organising in contrast to decentralised market exchange, and under what specific conditions this is of value and therefore can be the predicted outcome. Due to the importance placed on this distinction between firm and market, a significant and important subset of this literature stresses issues relating to the firm’s ‘boundaries’. A firm’s boundary denotes the point where the firm ends and the market begins (and vice versa), which indirectly suggests what makes the firm different from the market. The ‘why’ of the firm therefore relates to (if not requires) a definition of what constitutes a ‘firm’, since ‘why’ must point toward a certain ‘what’. Knowing the ‘why’ and ‘what’ should also provide insights necessary to investigate the ‘how’ of the firm, which is another important question at the core of the theory of the firm literature.
The questions of the firm’s why, what, and how are generally referred to as the Coasean questions of the firm since they were posed or implied in Ronald H. Coase’s ground-breaking, Nobel Prize-winning 1937 article ‘The Nature of the Firm’.R. H. Coase, 'The Nature of the Firm', Economica, 4:16 (1937), pp. 386-405. Coase was not the first to pose questions about the firm’s rationale, boundaries, and internal organisation, but his comparative framing was novel and the article’s approach has become starting point for the modern study of economic organisation and the firm. Coase’s basic question, which asserted a clear theoretical distinction between the firm as a planned hierarchy and the decentralised exchange in the market, was stated rather bluntly: ‘in view of the fact that it is usually argued that co-ordination will be done by the price mechanism, why is such organisation [the firm] necessary?’.Coase, 'The Nature of the Firm', p. 388. Indeed, as Coase points out, if the market economy is efficient there should be no need for and certainly no value in such alternative means to organise production. Coase answers the question by introducing a cost specific to market exchange — a marketing or transaction cost — that produces a cost-based rationale for organising hierarchies in the place of markets. The firm is according to the Coasean view a means to economise on the market’s transaction costs.
From our contemporary perspective, Coase’s article appears as the culmination of a vast literature on economic organisation and management of the firm in the 1920s and 1930s. This literature continued the earlier work by primarily Alfred Marshall, who discussed the abstract conception of a ‘representative firm’This highly abstract concept was criticised by Lionel Robbins, one of Coase’s professors at the London School of Economics, to whom the concept of ‘a long-period average business unit, representative of the organisation of a given line of production’ is both ‘superfluous’ and ‘misleading’. This concept, which ‘lurks in the obscurer corners of Book V [of Marshall’s Principles] like some pale visitant from the world of the unborn waiting in vain for the comforts of complete tangibility’, had nevertheless garnered ‘discernible’ influence in ‘certain recent discussions of applied economics’. L. C. Robbins, 'The Representative Firm', The Economic Journal, 38:151 (1928), pp. 387-404, pp. 391, 399, 387. and offered an extensive study of industrial organisation.See book IV, A. Marshall, Principles of Economics. 8th edition (1890) (New York: Macmillan, 1920). This line of research, to which Coase’s article was likely intended as a challenge but ended up making little if any impact,I have made the argument that Coase’s contribution should be considered a challenge to, and also attempt to undermine, this literature elsewhere. See P. L. Bylund, 'Ronald Coase's "Nature of the Firm" and the Argument for Economic Planning', Journal of the History of Economic Thought, 36:3 (2014), pp. 305-329. subsided within mainstream economics in the late 1930s. The economic study of the firm was not revived until Coase’s pioneering work was rediscovered in the late 1960s and early 1970s, primarily through the work of Oliver E. Williamson who adopted Coase’s comparative institutional analysis (‘firm vs. market’) as well as the concept of ‘transaction costs’. The rediscovery of the Coasean ‘make-or-buy’ perspective on coordination became the starting point for an extensive literature in economics aiming to explain firm organising, which developed over the course of some twenty years.Notable contributions to this literature include A. A. Alchian and H. Demsetz, 'Production, Information Costs and Economic Organization', American Economic Review, 62:5 (1972), pp. 777-795, S. J. Grossman and O. D. Hart, 'The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration', The Journal of Political Economy, 94:4 (1986), pp. 691-719, O. D. Hart, 'An Economist's Perspective on the Theory of the Firm', Columbia Law Review, (1989), pp. 1757-1774, M. C. Jensen and W. H. Meckling, 'Theory of the Firm: Managerial Behavior, Agency Costs, and Capital Structure', Journal of Financial Economics, 3:4 (1976), pp. 305-360, B. Klein, R. A. Crawford and A. A. Alchian, 'Vertical Integration, Apropriable Rents, and the Competitive Contracting Process', Journal of Law and Economics, 21:2 (1978), pp. 297-326, O. E. Williamson, Markets and Hierarchies, Analysis and Antitrust Implications: A Study in the Economics of Internal Organization (New York: Free Press, 1975), O. E. Williamson, The Economic Institutions of Capitalism (New York: Free Press, 1985). This literature is still core to the study of the firm.
Austrian Economics and the Firm The emergence and development of the literature on economic organisation in the 1920s and 1930s coincides with the Socialist Calculation Debate, one of the great debates in economics. The latter was prompted by the work of Austrian economist Ludwig von Mises, who argued that an economic system based on socialism was both theoretically and practically impossible.L. v. Mises, 'Economic Calculation In The Socialist Commonwealth', in Hayek (ed) Economic Calculation In The Socialist Commonwealth (London: George Routledge & Sons, 1935), pp. 87-130, L. v. Mises, Socialism: An Economic and Sociological Analysis (1936) (New Haven, CT: Yale University Press, 1951). For a connection between Mises’s and Coase’s arguments, see Bylund, 'Ronald Coase's "Nature of the Firm" and the Argument for Economic Planning'. Mises was a proponent of the Austrian or ‘causal-realist’ school of economics founded at the University of Vienna, which focuses on studying the real market through the lens of a deductive theoretical framework. The tradition’s focus on the market as it is, rather than — as in modern mainstream economics — highly formalised mathematical models with only occasional relevance to the real workings of the market, suggests it perhaps should have researched the firm. After all, markets both then and now are predominantly populated with firms; most economic activity takes place within or between such organisations. Yet, in contrast to neoclassical economics, which gave the topic a lot of attention in the 1960s, 1970s and 1980s, the Austrian school did not develop a theory of formal economic organisation, and even less a theory of the firm.
This appears as a conundrum but is also an opportunity. That it is an opportunity is evident from two recent trends in the literature related to the Austrian body of research, on the one hand, and the study of the firm, its governance and organisation on the other. One trend is the growing interest for issues relating to economic organisation from within the Austrian school and by Austrian scholars. Since the 1990s, articles and books have been published as part of the Austrian research program that propose approaches to and directions for developing an Austrian theory of the firm.Noteworthy examples include N. J. Foss and P. G. Klein, Organizing Entrepreneurial Judgment: A New Approach to the Firm (Cambridge, UK: Cambridge University Press, 2012), P. Lewin, Capital in Disequilibrium: The Role of Capital in a Changing World (London and New York: Routledge, 1999), F. E. Sautet, An entrepreneurial theory of the firm (Routledge, 2000). The other trend is evident by the (re)discovery of and then growing use and influence of Austrian economic concepts and theory in strategic management and entrepreneurship research.P. L. Bylund, 'Toward a Framework for Behavioral Strategy: What We Can Learn from Austrian Economics', in Das (ed) Toward a Framework for Behavioral Strategy: What We Can Learn from Austrian Economics Information Age Publishing, 2014), pp. 205-232, P. G. Klein and P. L. Bylund, 'The Place of Austrian Economics in Contemporary Entrepreneurship Research', Review of Austrian Economics, 27:3 (2014), pp. 259-279. These two trends, while addressing similar issues, have different starting points and approaches, and build off different theoretical frameworks. But, as we will see, they nevertheless have similar theory implications, however with different emphases, and therefore suggest a possible future convergence.
For scholars in management and entrepreneurship, Austrian economics has offered an opportunity to open new venues for research. While the formal models in mainstream economics, especially industrial organisation (IO), originally laid ground for the study of strategic management, they are deficient for producing predictions and advice in a dynamic world. The formalised economic approach offers little support for more practically oriented or realistic research aiming for understanding and aiding in the creation or management of real firms. In contrast, the Austrian view of the market as a dynamic, entrepreneurship-driven competitive discovery process, and its focus on realism in aiming to explain real empirical phenomena, has considerable potential to enhance research and practice in both management and entrepreneurship. As we shall see, modern research in these fields has already adopted several core Austrian concepts and insights.
The study of strategic management was originally an offshoot of the so-called Bain/Mason paradigm of industrial organization (IO). While IO focused on the overall efficiency of the economic system as compared to the perfectly competitive model, strategic management developed strategies for the individual firm to exploit the efficiency logic and so establish monopoly power through which it can earn above-normal returns.M. E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York, NY: Free Press, 1980), M. E. Porter, 'The Contributions of Industrial Organization to Strategic Management', The Academy of Management Review, 6:4 (1981), pp. 609-620, M. E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York, NY: Free Press, 1985). But the empirical market in which business leaders draft strategies and make decisions is scarcely similar to the perfectly competitive model. Also, in stark contrast to the model, real production is neither perfectly optimised nor instantaneous (which is often the case in formal economic models), and business decisions are always made under uncertain conditions. The market, in other words, is dynamic and uncertain, it is in a constant flux and is fundamentally less than perfectly foreseeable. Businesses consequently operate in a changing world — that is, disequilibrium — that is rather far from a stable equilibrium state, and this makes the formalised models describing maximising behaviour of rational actors with perfect information quite inapplicable in real business management.
It should therefore have been an obvious and expected development within strategic management to move toward adopting and analysing a more dynamic conception of the market and the firm. The change to focusing on the analysis of a more dynamic and ‘messier’ view of the market constituted a shift from the formal models of mainstream economics toward an Austrian conception of the market as a competitive and equilibrating process. As Robert Jacobson observed in the early 1990s, there are ‘relatively few strategy researchers [who] explicitly attribute or link their analysis to Austrian economics’, but ‘the influence of Austrian thinking is more widespread than this lack of attribution might suggest’. He continued by noting that much of the then-recent strategy research ‘fit[s] squarely into the Austrian school of thought’ and that this work even ‘can be seen as forming an “Austrian School of Strategy”’.R. Jacobson, 'The "Austrian" School of Strategy', The Academy of Management Review, 17:4 (1992), pp. 782-807, pp. 784, 802.
A similar shift has occurred in the study of entrepreneurship, though this field (at least the research done outside of economics departments) never adopted as fully the streamlined economic models on which strategic management was originally based. Entrepreneurship is here commonly perceived as some form of open-ended change, whether it is the fundamental ‘driving force of the whole market system’, as Mises puts it,L. v. Mises, Human Action: A Treatise on Economics. The Scholar's Edition (1949) (Auburn, AL: Ludwig von Mises Institute, 1998), p. 249. or simply the act of creating firms.Daniel F. Spulber, The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Firms, Markets, and Organizations (Cambridge: Cambridge University Press, 2008). As it constitutes a process of change, the concept and its impact on the market are profoundly difficult to express in formal notation. As a result, entrepreneurship could never rely on the models of modern economic theory as was the case in strategic management. This may be a reason why, as William J. Baumol noted, ‘[t]he theoretical firm is entrepreneurless — the Prince of Denmark has been expunged from the discussion of Hamlet’.W. J. Baumol, 'Entrepreneurship in Economic Theory', The American Economic Review, 58:2 (1968), pp. 64-71, p. 66.
Expunged is probably a proper description. Since at least the early 18th century studies in economic theory have placed the entrepreneur at the centre. Richard Cantillon, for instance, defines entrepreneurship as working for non-fixed income (and therefore the bearing of uncertainty)R. Cantillon, Essai sur la nature du commerce en général (1755) (London: Macmillan & Co, 1931). and saw in the entrepreneur the force that brings equilibrium to the market.M. N. Rothbard, An Austrian Perspective on the History of Economic Thought, Volume I: Economic Thought Before Adam Smith (Auburn AL: Ludwig von Mises Institute, 1995), p. 352. Adam Smith, commonly regarded the ‘father’ of economics, saw in the ‘undertaker’ an agent that transforms demand into supply.A. Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776). Jean-Baptiste Say saw the entrepreneur as a speculator who runs the firm for profit.J.-B. Say, A Treatise on Political Economy or the Production, Distribution and Consumption of Wealth (1821) (Auburn, Al.: Ludwig von Mises Institute, 2008), see also M. N. Rothbard, An Austrian Perspective on the History of Economic Thought, Volume II: Classical Economics (Auburn AL: Ludwig von Mises Institute, 1995), pp. 25-27. The common denominator of these classical approaches to entrepreneurship is that the concept is considered primarily in terms of the role or function it plays in the economy. Modern entrepreneurship, in contrast, has to a great extent approached entrepreneurship as an empirical phenomenon, in which entrepreneurship is measured as ‘self-employment’ or as the degree of non-concentration in an industry.See P. G. Klein, 'Opportunity discovery, entrepreneurial action, and economic organization', Strategic Entrepreneurship Journal, 2:3 (2008), pp. 175-190.
It was not until the work of Scott A. Shane and Sankaran Venkataraman,See especially S. A. Shane and S. Venkataraman, 'The promise of entrepreneurship as a field of research', Academy of Management Review, 25:1 (2000), pp. 217-226 and S. A. Shane, A General Theory of Entrepreneurship: The Individual-Opportunity Nexus (Cheltenham, UK: Edward Elgar, 2003). who suggested the study and implications of the entrepreneurial opportunity as common denominator for studies in entrepreneurship, that theorising without direct basis in empirical observation regained its foothold in the field of entrepreneurship. Shane and Venkataraman relied heavily on the work of Israel M. Kirzner in reformulating the study of entrepreneurship, and contrasted Kirzner’s ‘alert’ entrepreneur with a conception of Joseph A. Schumpeter’s ‘disruptive’ innovator-entrepreneur.I. M. Kirzner, Competition and Entrepreneurship (Chicago, IL: University of Chicago Press, 1973), J. A. Schumpeter, The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle (1911) (Cambridge, MA.: Harvard University Press, 1934). This has ultimately led to Austrian economics having a strong influence in entrepreneurship.
The use of Austrian concepts in strategic management is as prevalent as in entrepreneurship, but far from as explicitly attributed. Whereas entrepreneurship theory was built on an openly Austrian foundation, strategic management research only infrequently recognizes that many of the field’s core concepts have already been used, elaborated on and scrutinized by the Austrians. While there are indeed a number of studies in strategic management that explicitly use an Austrian approach or even adopt Austrian theory, the measurable relative influence of Austrian economics has not increased. Instead, concepts such as resource heterogeneity, uncertainty and dispersed knowledge — and their implications — are reinvented and drafted anew, and used as means to deal with problems arising due to the reliance on formal economic models. This may at times give a thoroughly strategic management flavour to these concepts that can seem to create a distinct paradigm, but it also subjects the field to costs as already developed theoretical concepts, which can be common knowledge in the Austrian tradition, are reinvented and suffer problems achieving consistency. The latter, in fact, is in line with a warning drafted by Jacobson, who cautioned that while Austrian economics is a mature theoretical framework and therefore both useful and valuable, it is also highly integrated due to its strictly deductive method; this means that ‘inconsistencies can arise when attempting to integrate other frameworks with Austrian paradigms’.Jacobson, 'The "Austrian" School of Strategy', p. 803. This may turn out to be a severe problem in strategic management as the field borrows, whether or not intentionally or even knowingly, several core concepts from Austrian economics, and it can equally become a problem in entrepreneurship theory as it originated as an application but not elaboration of Austrian theory. But, as we shall see in the next section, the same type of problem is latent also in Austrian theories of the firm.
Coase and the Austrians Austrian approaches to studying the firm face similar problems as those we just discussed with respect to theories in strategic management including Austrian concepts and constructs. The approach, however, is the obverse: they take Austrian theory as starting point and then add concepts, theoretical devices and reasoning from mainstream (non-Austrian) theories of the firm to it.P. L. Bylund, 'Division of Labor and the Firm: An Austrian Attempt at Explaining the Firm in the Market', Quarterly Journal of Austrian Economics, 14:2 (2011), pp. 188-215. In contrast to typical Austrian theorising then, which maintains consistency through strict deductive reasoning, Austrian approaches to the firm place mainstream conceptualisations within an Austrian ‘market process’ framework. In order to make the pieces fit, the framework is often made out to hinge on a single or couple of Austrian core concepts (such as knowledge, capital theory, entrepreneurship or uncertainty). Consequently, we see Austrian theories that discuss how concepts in mainstream economic theories of the firm, like transaction costs, incomplete contracting, monitoring costs and so on, relate to, can be combined through, are supported or otherwise further explained by utilising an approach that at least in part is or derives from Austrian thinking. By placing ‘bridging’ Austrian concepts at the core of the theory, which supposedly adds an explanatory dimension to existent mainstream theories, an argument is indirectly generated for the value of incorporating core components of Austrian economics in mainstream theory development. But doing so could also introduce inconsistencies. The product is in any case a theoretical amalgamation that appears to be mainstream in many ways and therefore builds on strengths perceived in the already established theories, but is presented with a distinctly Austrian flavour.
Whereas these approaches purport to indicate steps toward an integrated framework that can explain economic organisation on Austrian terms, they predominantly attempt to achieve this goal by relying on the unorthodox method of ‘combining’ Austrian with decidedly non-Austrian theoretical constructs. As these constructs have different histories, are from different bodies of theory and commonly are formulated using very distinct (and, at least to some extent, incommensurable) assumptions and reasoning, they risk appearing more as a jumble of concepts inspired or held together by an Austrian-style market process argument than an integrated theory. As I concluded elsewhere, ‘the existing [Austrian] attempts fail to convincingly explain why there are firms because they are too narrowly focused on specific characteristics rather than on the firm in the market’.Bylund, 'Division of Labor and the Firm: An Austrian Attempt at Explaining the Firm in the Market', p. 191 It should, in fact, be difficult to imagine an Austrian approach to explaining economic organisation that does not see the firm as having or supplying a distinct and important function to the integrated market system in which it is thoroughly embedded. The firm should be both affected by and effectuate change in the market process. In this sense, the firm cannot be seen as ‘only’ a governance choice for certain types of transactions or applicable under a certain set of conditions or in specific situations (as several theories suggest), but should — considering the firm’s relative omnipresence in the market — play a more substantial role in how the market process works. The firm, seen from an Austrian point of view, should provide a function that fits in the broader scheme of things.
At this point it may be appropriate to address the question of how we define a ‘firm’. But this is exactly the problem with existing theories of economic organisation, whether they are Austrian or mainstream — there is no established definition of the phenomenon, so common in the market, that we refer to as a ‘firm’. Instead, the theoretical literature suggests (at least) four distinct definitions or rationales for the firm: as a technological necessity, as having a nature that is distinct from the market, as a means for avoiding costs of using the price mechanism, or as an accumulated collection of resources.Sautet, An entrepreneurial theory of the firm, pp. 5-6. As can easily be seen, there is no reason to assume that all four rationales are necessarily and always present where there is a firm, which makes the situation theoretically unsatisfying. If we for a moment assume that firms are more than simple ‘legal fictions’,Jensen, et al., 'Theory of the Firm: Managerial Behavior, Agency Costs, and Capital Structure'. by which we mean that economic organisation provides an actual and real economic function regardless of legal status, it should be clear that the empirical observation that firms are ubiquitous in advanced markets cannot properly guide the development of Austrian theory. This is not to say that empirical observations are unimportant, but quite the opposite. The fact that business firms are practically ‘everywhere’ should to theorists of the firm indicate that there may be more to this phenomenon than suggested by either of the simple rationales relied on in the extant literature, and that it therefore could play a more important role in the market process than, for example, offering a means for avoiding some costs of market transacting. Cost minimisation through choosing the ‘cheaper’ means of coordination can of course be a benefit of the firm, as is Coase’s argument, but the full out adoption of the mainstream market/hierarchy duality as one’s theoretical point of departure does not necessarily follow from this statement.
Despite this, many Austrian theories adopt Coase’s transaction cost theory of the firm, or in any case its argument or assumptions, as starting point. While it is true that Coase introduced the comparative institutional analysis of economic organisation in a nice way, there is reason to think that Coase’s framework is incompatible with Austrian theory. His theory of the firm was intended as a defence of economic planning, and it was in support of planning in the market (Coase’s conception of the firm) that he introduced the concept of transaction costs — a kind of cost affecting market exchange yet that somehow exists outside of economic actors’ opportunity cost assessments and therefore have no effect on efficient resource allocation.Bylund, 'Ronald Coase's "Nature of the Firm" and the Argument for Economic Planning', see also, H. Demsetz, 'R. H. Coase and the Neoclassical Model of the Economic System', Journal of Law and Economics, 54:4 (2011), pp. S7-S13. Coase’s point was that the market is ‘costly’ because resources are heterogeneous and market coordination is not rationally planned, and it follows from this that rational planning (by definition unaffected by this cost) would tend to be less costly. Coase explains that this is the reason such a ‘large sphere’ of the Western market economies are not coordinated through market exchange but are instead planned within firms, and contrasts this ‘decentralised planning’ through firms in the market with the centralised economic planning in Soviet Russia (as Coase notes, Lenin had said the country would ‘be run as one big factory’).
Setting the political connotations aside, Coase’s economic argument stands in stark contrast to how Austrian economists understand the market and how they conceive of capital heterogeneity and the implications thereof. To Austrians, as to Coase, it is ultimately the fact that resources in production are heterogeneous, produced and non-permanent that makes economic planning costly (if not impossible). But Austrians would argue, along the lines of Mises’s argument against socialist economic planning, that this is what makes the market an unbeatable (though still, it must be emphasised, imperfect) coordination mechanism for advanced specialised production — not the other way around. It is Coase’s decidedly un-Austrian framework that allows him to conclude that ‘planning’ is superior to and therefore a multitude firms are formed to supersede the market’s price mechanism.
Whereas Coase’s analytical approach of comparative institutionalism is rightly accepted and appreciated by Austrians, it is difficult to see why the rest of his argument should be. Rather than using a theoretically streamlined but otherwise realistic ‘imaginary construction’ (the common method in Austrian theorising) to isolate causal links and interdependencies in the real economy, Coase’s assumptions intentionally do away with any structural differences so that only the means of coordination remains to distinguish the firm from the market. The conclusion that the choice (which to Coase appears to be made by the economy rather than by an actual actor) of coordinating force between price mechanism and manager is a matter of selecting the least costly alternative is neither interesting nor important — it follows directly from the stated assumptions. This is an important difference between Coase’s analysis and the deductive theoretical framework of Austrian economics. Coase relies on a set of strong assumptions without obvious grounding in theory, whereas the Austrian approach incorporates assumptions within a causal-realist framework that provides a bulwark against arbitrariness.
An Austrian Theory of Economic Organisation Coase’s theory ultimately challenged the theory of economic organisation at the time and thereby the body of literature in economic organisation that developed in the 1920s and 1930s. While inspired by E. Austin G. Robinson, an influential Cambridge economist who had written on the logic of industrial organisation,See e.g., E. A. G. Robinson, The Structure of Competitive Industry (London: Nisbet, 1931), for a discussion on Robinson's influence on Coase, see L. R. Jacobsen, 'On Robinson, Coase and "The Nature of the Firm"', Journal of the History of Economic Thought, 30:1 (2008), pp. 65-80. See also E. A. G. Robinson, 'The Problem of Management and the Size of Firms', The Economic Journal, 44:174 (1934), pp. 242-257. Coase’s approach deviated from Robinson’s in one important respect: he assumed that the firm’s internal organisation is practically a carbon copy of the market’s allocation of resources,Indeed, Coase argued that the ‘object of the organization was to reproduce market conditions’, that is to say ‘to reproduce [its] distribution of factors … within the business unit’. R. H. Coase, 'The Nature of the Firm: Origin', Journal of Law, Economics & Organization, 4:1 (1988), pp. 3-17, p. 4. which facilitated his marginal transaction analysis and allowed him to conclude that there is a strict cost rationale for the firm. The common starting point in the literature at the time, in contrast, was that the firm is defined contra the market by its more intensive division of labour. This difference means that the boundary of the firm, according to Coase’s theory, is the result of a simple cost comparison between different means for allocating resources, whereas ‘pre-Coaseans’ like Robinson derived organisational boundaries from real differences in productivity through resource heterogeneity and specialisation intensiveness.
The latter view was further developed in the works of Edith Penrose,For Robinson's influence, see L. R. Jacobsen, 'On Robinson, Penrose, and the resource-based view', European Journal of the History of Economic Thought, 20:1 (2011), pp. 125-147, see also E. T. Penrose, The Theory of the Growth of the Firm (New York: John Wiley and Sons, 1959). who with mentoring assistance by Austrian economist Fritz Machlup,C. M. Connell, 'Fritz Machlup's Methodology and The Theory of the Growth of the Firm', Quarterly Journal of Austrian Economics, 10:4 (2007), pp. 300-312. authored an influential book on the evolution and growth of firms. The modern resource-based view of the firm, which applies a strict strategic management perspective on the value creation and value capture problems that arise due to resource heterogeneity, is based on Penrose’s non-Coasean approach as derived from the work of Robinson and Machlup. As will emerge through the discussion in subsequent chapters, this legacy of Robinson — and the classical economics approach to the study of the firm that it was based on — should be a much more appropriate starting point for developing a dynamic theory of the firm. Not only is this particular approach evolutionary and dynamic in the same sense that Austrian economics provides a framework for studying and understanding the market as a process, but it already includes several concepts that are compatible with the Austrian approach.
Nevertheless, an Austrian theory of the firm should probably not assume it as a starting point. Considering the deductive and integrative nature of Austrian theory, it would be a mistake to do more than take inspiration from other schools of thought — especially if they are based on different (or even incommensurable) assumptions. Despite how it is commonly approached, the economic theory of the firm is not a specialisation, but an elaboration and extension of the existent body of economic theory aimed at providing an answer specifically to the question of economic organisation. This answer cannot, obviously, contradict the theoretical framework, but can suggest a potential theoretical challenge to existing emphases or applications. In order to be true, a deductive theoretical framework and all its parts need to constitute a consistent whole; what remains, therefore, for Austrian theory to properly provide an answer to the so-called Coasean questions of the firm’s rationale, boundaries, and internal organisation is to extend the theory by applying it on and emphasising the particular issues that pertain to organisation. Indeed, as Mises notes, ‘[t]here is no specialization [in economics], as all problems are linked with one another. In dealing with any part of the body of knowledge one deals actually with the whole’.Mises, Human Action: A Treatise on Economics. The Scholar's Edition: 869 The point of departure for producing an Austrian theory of economic organisation, therefore, must be the existent body of Austrian theory and consequently the Austrian understanding for what constitutes and drives the market process. It follows that an Austrian theory of the firm should be based on or, at a minimum, be related to core Austrian concepts such as knowledge, capital theory, entrepreneurship and uncertainty. It should also fit with the theoretical framework — and in fact constitute a missing piece of the puzzle.
As finding and theorising on this piece is the task for this book, our focus must first and foremost be on what specific problem the firm can solve in the market process, by which we mean that organising certain economic activity within the firm must have a value for those involved in the firm as well as the market process as a whole. The former is a question of how the firm attracts labour and capital factors, and the latter addresses the overall value of the structure to the market as such. It is not sufficient to address either of these aspects without also addressing the other ones, as it is not sufficient to address either of the Coasean questions separately, since what then emerges as a potential solution may not fit with the overall theoretical framework. The take-home here is that the theory of economic organisation must be built on yet be ultimately delimited (if not restricted) by the theory of the market.
It should be noted that existing approaches to explaining the firm from an Austrian perspective usefully adopt a similar problem-focused methodology. From our perspective, however, they do so in a very limited sense by phrasing the question to be answered in terms of a gap in the theoretical framework rather than a real economic problem. The integrated economic function of organisation for market actors in the market process becomes an implication rather than a core contribution of the theory. Granted, this allows for the approaches to focus primarily or even exclusively on a specific concept or sub-theoretical orientation (such as capital theory or entrepreneurial discovery or judgement) while purporting to — at least indirectly — inquire into the nature of relationships that exist in the market (or, if we wish, between firms and markets). But the approach in effect emphasises trees at the cost of failing to appreciate the extent of — or even see — the forest. But the nature of economics is such that we are unlikely to fully understand the tree, as a phenomenon that arises within an economic or market context, without first considering the tree as embedded within and part of the forest. In other words, we have to deal with the market embeddedness of the firm in order to understand it, and we therefore need to target its function within the broader market context. This is the point of departure for this book.
The discussion above indicates not only that there is a seemingly unoccupied space for a theory to explain the firm from the point of view of the market process, but also that there are several theories, approaches, and frameworks that we can draw from. While a new theory of the firm can provide important insights, and it is indeed the purpose of this book to draft one, it is unnecessary to adopt a completely different approach and ‘reinvent the wheel’ completely. Yet to take the firm’s embeddedness seriously, it is necessary to derive the firm’s function from limitations that the market suffers without it. In this sense, we start from the beginning by discussing the market process and how it functions without firms. We look specifically at production as the core activity within the market process, and then elaborate on whether market production is subject to a fundamental problem or shortcoming, which can potentially be solved by entrepreneurs only through economic organising. The next chapter discusses the market as a dynamic process.
At Economics For Entrepreneurs, we are going to combine theory and thought leadership about how entrepreneurship works, with practical advice and shared experience from those who have achieved entrepreneurial success. This week we feature Per Bylund. He is an economist who observes what entrepreneurs actually do, rather than analyzing the statistics of GDP growth and macro-economic trends. He’s a research fellow in entrepreneurship at Mises Institute, a teacher of entrepreneurship at Oklahoma State University, a writer of books about firm-level economics and of a regular series of articles in Entrepreneur magazine, and he himself has been a serial entrepreneur. He has a lot to share.
Show Notes Economics can’t help entrepreneurs much by talking in abstractions about economic growth and economic systems. That’s not what you as an individual entrepreneur are engaged in. You are trying to make a living, and you are trying to create value for others via new or different services. Economics can help with applications of sound principles that help entrepreneurs build better-performing businesses.
What you are doing as an entrepreneur is not for you. It’s for the customer. They decide what is value. It’s not enough to generate an idea. The entrepreneur must ask, with objective honesty, is this valuable? For whom? How is it valuable? Value is subjective in the customer’s mind, so you have to empathize, penetrate that mind and understand it in the customer’s terms.
So don’t start at the wrong end of the process. Don’t be thinking: I want to produce something. How much can I produce it for and sell it at a profit? Rather, you should be thinking: who is out there looking for a value; what is valuable to them?
Price is determined by the customer. You can only sell a product or service for a price that is lower than its value, and value is determined entirely by the customer.
Similarly, you don’t “make a sale” to the customer. You make it a no-brainer for the customer to buy because you offer a better product or service than they’ve got today, and one that is better value for them.
Customer centricity, or customer obsession is a good path. Listen to customers, and learn what they are looking for, and what represents value to them.
Always be thinking about how to meet the future. Customer wants and needs and circumstances and preferences are always changing. Anticipating the change is the stock-in-trade of the entrepreneur. That’s not necessarily the same as innovating. You can create new value by anticipating future needs. Listen to people and look for trends.
Everyone can be an entrepreneur and it’s a very fulfilling experience. Entrepreneurship is aspirational. It’s something you do for customers, and making people better off is very rewarding. They’ll buy your products and services only if they feel that it’s a benefit for them. If you are successful, you’ve helped them. And to be successful, you must be doing something you are good at, which is another source of reward.
Additional Resources Customer Journey Mapping (PDF): https://Mises.org/E4E_03_PDF
How to Use the Customer Journey Map (PDF): https://Mises.org/E4E_03_PDF_2
In Economics For Entrepreneurs, we will attempt to bring you some usable tools that represent a way to apply economic principles to your business to help you to greater success. Economists talk about individuals embracing values as a guidepost to the right behavior and the right choices. An example of such a value might be Family Security. An individual who holds this value in high esteem will make certain choices about their career, for example, perhaps emphasizing stability over frequent change. Another individual who prefers an exciting life might make the choice of more change, excited by the possibilities it brings. How can entrepreneurs diagnose and understand these idiosyncratic choices and take cognizance and advantage of them in business? This week we talk with Trini Amador, who is an entrepreneur who advises some of the biggest corporations in the world on these mysteries, and has built a highly successful values-based brand of his own.
Show Notes People adopt values as a guide to their behavior and a signpost for prioritizing their preferences and choices. For example, a sense of achievement might be a value for one individual to pursue, and in as many circumstances as they feel are applicable, they’ll ask themselves, “Will this choice or action bring me a sense of accomplishment?
There are many possible values; individuals tend to be most motivated by their “highest values”. Entrepreneurs who can identify these highest values in their customers, and can develop an understanding of how to appeal to them, can be especially successful in designing value propositions and service offerings.
The way for entrepreneurs to understand how to appeal to consumers’ highest values is to think about climbing up the values ladder to reach the top. Their first encounter with your business will be at the bottom rung — the service or product you are offering. Their first question will be, what’s the benefit for me? If they see a functional benefit, they’ll ask themselves if it makes them feel good — proud, comfortable, energized, whatever feeling is relevant. If they experience an emotional benefit, they’ll ask if your offering fits with their highest value — that’s what makes them a devoted and loyal customer.
The tool to help your business climb the values ladder is the Mean-End Chain. We posted a simple example with Episode #1.
When you’ve constructed a Means-Ends chain for your target customer, you can begin to populate a brand framework. People are loyal to brands, and they often pay a premium price. A brand can be a person (you) or a business (yours) or a product or a service. Trini explains how to populate the brand framework to make your brand relevant to the target audience and differentiated by making a unique promise that you keep every time.
These are the brand building tools utilized by the world’s most successful brands. Trini delivers the insider’s knowledge.
Additional Resources Rokeach Values (PDF): https://Mises.org/E4E_02_PDF
The Use of Terminal and Instrumental Values In Understanding Consumer Motivations (PDF): https://Mises.org/E4E_02_PDF_2
There are some economic principles that can help entrepreneurs in their business-building endeavors. One is the understanding of ends and means. What ends (goals, objectives) are your customers pursuing, and how do they choose the means to achieve those ends? The customer is in charge of choosing ends, and the entrepreneur takes charge of offering the most attractive and valuable means. How do entrepreneurs solve that equation? We asked Peter Klein. Peter is Professor of Entrepreneurship at Baylor University’s Hankamer School of Business. He is also Senior Research Fellow at Baylor's Baugh Center for Entrepreneurship and Free Enterprise and Adjunct Professor of Strategy and Management at the Norwegian School of Economics. He knows ends and means.
Show Notes Economics helps entrepreneurs in a very practical sense by shining a very bright light on human motivation. In economic terms, people act. They do things. And when they do things, they always have purpose in mind. They are goal oriented. The entrepreneur’s job is to figure out how to help customers achieve a goal that they already have in mind.
Thinking about this principle in simple terms helps entrepreneurs develop a deep understanding of customer value chains. Why for example, do people choose to drink coffee? It doesn’t just happen. People raise a coffee cup to their lips because they want to enjoy the taste. Or maybe to give themselves a caffeine boost. Or perhaps they are drinking coffee in a social context and they want to enjoy the shared experience. Economists are always thinking about the customer’s goal in taking a certain action — and entrepreneurs can benefit from thinking the same way.
How and why do people decide on their ends? Economists — and entrepreneurs — don’t judge. We just want to find out what ends the customer is pursuing. And how behavior might change if circumstances change — for example, if prices rise, the customer might buy less or stop buying altogether.
How can entrepreneurs find out about what motivates customers to pursue certain ends and use certain means? By immersing themselves in a market — like the consumer market for coffee as a beverage — and thinking about it from all angles: psychology, economics, history, culture, fashion, supply chain, marketing. Like Howard Schultz observing coffee shop behavior in Milan as a precursor to launching Starbucks in the US. He deduced from his observations what Americans might derive from a similar experience if he provided it.
How do entrepreneurs develop the appropriate skills and knowledge? Not from reading books, that’s for sure. It’s instinct plus tools. The tool discussed in this episode is the Means-Ends Chain (see also the How-To-Use-It tool). It’s the tool that helps entrepreneurs understand that they are not selling — and the customer is not buying — coffee, but an experience.
The skillful entrepreneur links the proximate product — the coffee — to the desired experience — the “third place” experience as Starbucks calls it — in a convincing and persuasive manner. This requires exploration and experiment to get it right. It’s never obvious.
That’s why economists refer to uncertainty — it’s the situation all entrepreneurs face. You never know the future outcome until you try. The entrepreneur must be flexible in exploring the customer’s ends and means. Uncertainty rules.
Entrepreneurs exercise judgment, and try to develop insights, but can never achieve certainty. Data might help but it’s not infallible. Eventually, the entrepreneur must decide to “go for it” without certainty of being right. It’s the “plunge” decision. Learning, big data, and surveys are inputs, but they can’t make the decision; only a human can.
Experience can help. In the US, the average age of the first-time entrepreneur is mid to late 40s. Experience in an industry and lived experience are helpful. And intergenerational sharing of experience — like finding a mentor — can also contribute the experience you don’t have.
Entrepreneurship is not rocket science. Know your market, know your customers, and trust your judgment and your instincts.
Additional Resources The Means-Ends Chain Tool (PDF): https://Mises.org/E4E_01_PDF
The How-To-Use-It Tool (PDF): https://Mises.org/E4E_01_PDF_2
The Mises Institute is launching a new podcast with the title Economics For Entrepreneurs. Why should you listen?
The entrepreneur is the central hero in the dynamic order of Austrian Economics. Mises referred to entrepreneurs as "the driving force of the whole market system".Human Action, Scholar’s Edition, LvMI, Ch XIV. Jesus Huerta de Soto points to the unique role the theory of entrepreneurship plays in Austrian Economics.
Neoclassical economists... overlook the co-ordinating force that Austrians attribute to entrepreneurship. The entrepreneurial process….is a dynamic, never-ending process which constantly spreads and furthers the advancement of civilization.Jesus Huerta de Soto, The Austrian School.
Mises and de Soto were writing about economic roles. In Economics For Entrepreneurs, we are focused on the flesh-and-blood individuals who tackle the entrepreneurial task every day. The entrepreneurs who detect consumer and customer dissatisfactions and imagine — then produce — solutions for those dissatisfactions. The entrepreneurs who serve others by creating new value and, as a result, create the most just, moral and beneficent society for all, while creating a life of purpose and meaning for themselves.
We want to contribute knowledge and insight to that process. We want entrepreneurs to be successful. We’d like everyone to be an entrepreneur.
How is our podcast going to help? It’s a three step process. The first resource for successful entrepreneurs is understanding the laws of economics. If you have clear insight and a rigorous practical application of these laws, you have a competitive advantage over others. We’ll talk to the leading economic thinkers about the exactly how economic principles are best applied in business.
The second resource is the set of tools to apply these principles, and we’ll describe and, where possible, provide those tools for entrepreneurs to use. They can range from frameworks and processes to tools for planning and brand building. Some will make you better at specific tasks, others will augment your individual capacity, so you can be more effective.
The third resource is your imagination. We can’t provide that, but we can stimulate it. As you listen to both up-and-coming and established entrepreneurial practitioners, we think your imagination will be unleashed in multiple new directions.
The laws of economics, the tools for practical application, plus your imagination. We think that’s a winning formula.
Moreover, there is a world-changing innovation at work to which we can all contribute. If we are able to interconnect a worldwide group of entrepreneurs, the people who are the creators of new value in society, we will be able to unleash a wave of collaborative genius to change the world for the better. One entrepreneur can be smart, and one innovation can create value and one firm can grow revenues and profit. If they all share their learning and share the new information they create, and everyone acts on that learning at speed and scale, then we get to a new horizon of value creation. It’s what Austrians call spontaneous order, the driving dynamic of entrepreneurial human action, the never-ending process that constantly spreads and furthers the advancement of civilization.
We hope you will join us at Economics For Entrepreneurs. We’ll be on on iTunes, Google Play, Stitcher, Soundcloud, and via RSS; plus, Mises.org and HunterHastings.com.
ABSTRACT:
Hoffmann (2018) attempts to reconstruct a typology of risks deemed more accurate and useful to both economists and risk managers than currently received views on the subject within mainstream economics/finance and Austrian economics. This comment argues that his criticisms of the Misesian approach and his case for an alternative are unconvincing. We explain weaknesses in his criticisms of the Misesian approach and outline some problems with his constructive task of building up the alternative.
KEYWORDS: Austrian economics, risk, uncertainty, complexity, probability JEL CLASSIFICATION: B4, C1 Dr. Xavier Méra (xmera@uco.fr) is Assistant Professor of Economics at Université Catholique de l’Ouest in Angers, France.
Quarterly Journal of Austrian Economics 21, no. 3 (Fall 2018) full issue, click here.
I. INTRODUCTION Drawing on the general literature on risk and uncertainty, as well as Mises, Knight and Weaver, Hoffmann (2018) attempts to reconstruct a typology of risks deemed more accurate and useful to both economists and risk managers than currently received views on the subject within mainstream economics/finance and Austrian economics. In particular, the author emphasizes what his approach and the Knightian/Misesian one have in common and where they differ. Formally, this is done by identifying two “research gaps” in the Misesian literature—a lack of conceptual clarity in dealing with risk and uncertainty (1) and a lack of justification for the view that classical probability theory is irrelevant when dealing with human action (2)—and trying to close them.
In what follows, we focus on some reasons why both his criticisms of the Misesian approach and his case for an alternative strike us as unconvincing, although this is not to deny that the paper is thought provoking and displays valuable information. First, we explain why his criticisms of the Misesian approach appear to us as weak, and second, we outline some issues with his constructive task of building up the alternative.
II. WEAKNESSES IN THE CRITICISMS OF KNIGHT/MISES While Hoffmann (pp. 2–3) delves into some epistemological considerations, in order to make some proposals regarding the requirements of a proper definition of risk, he nevertheless neglects to identify what could be the epistemological grounding for the Misesian position, as if it did not have any, before telling us about the two research gaps that allegedly characterize it. It is true, as the author suggests, that Mises is less than perfectly explicit regarding the proper scope of application of classical probability theory. However, the impression left that the traditional dichotomy of risk and uncertainty could be considered as an ad hoc piece of theorizing, somehow independent of the praxeological edifice and its justifications, is unwarranted. On the contrary, as can be inferred from Mises’s discussions, as well as Hoppe’s (2007) defense and elaboration of it that the author refers to without ever mentioning why Hoppe thinks Mises is right, Mises’s views on this particular topic are arguably grounded in his general epistemology. If they are flawed, ultimately it must then be either that Mises’s epistemological views are wrong, or that he inconsistently applies them to the particular questions under consideration (or a combination of both). But the author provides no assessment of the sort. It seems obvious to this commentator, in any case, that the author is on shaky grounds when identifying some research gaps in Mises’s approach without first paying some attention to those considerations.
At the risk of oversimplifying, the Misesian approach on probability, risk and uncertainty that the author describes, can be defended along the following lines:
The distinction between risk and uncertainty and their fields of application mirrors the methodological dualism Mises advocated between the natural sciences on the one hand and economics on the other and derives from it.This, incidentally, helps explain why Knight’s views came to be typically associated with the Austrian school after Mises systematized and refined the theory of knowledge and the corresponding method used by the Austrian economists, and as the Chicago school became unambiguously positivist. According to Mises and his followers, sound economics has to be structured as statements logically derived from and implied in the so-called axiom of action (the “logic of action” or “praxeology”). Action has to be understood as purposeful behavior. It implies the necessity of choice regarding the use of some scarce means to arrive at some ends. All the categories of goods, value, cost, profit and loss, etc. are implied in this insight which is considered by Mises as valid knowledge derived a priori of experience, via discursive reasoning. The axiom is self-evident in the sense that one cannot deny it without performative contradiction since any attempt would have to be an action itself, using some means to arrive at some end, etc.
One implication of the axiom is that action in general and therefore any production process takes time and that the future must be uncertain to the actor. For there would be no choice to make if future courses of events were known in advance in a world of complete certainty (Mises, 1949, p. 105). Actors must lack perfect foresight then. When acting, they must rely on their more or less probable knowledge about the world.
Now, for our purpose here, a relevant implication is, as Hoppe (1995, p. 78) puts it, that “action presupposes a causally structured observational reality but the reality of action which we can understand as requiring such structure, is not itself causally structured.” Action itself is not causally structured since it is purpose-directed. The actor chooses to use scarce means in some ways instead of some other ways to arrive at some ends and by necessity, chooses to abandon or postpone the fulfillment of other ends. On the other hand, action presupposes the “constancy principle,” “time invariant operating causes” in the actor’s environment, or a “causally structured” physical reality in which action takes place. In Mises’s words, “causality is a category of action.” The reason is that the very idea of action implies interference in the actor’s environment in order to produce a preferred state of affairs compared to the course of events without such an action. Success and errors must be ever present possibilities as long as there is action, and being able to conceive of a course of events and its successful deviation initiated by an actor means he can grasp some relationships between things which stay constant over time. There cannot be any meaningful concept of success and error, planning and therefore action under complete randomness or indeterminacy in the actor’s environment. The range of applicability of teleology and causality must therefore be clear and are determined a priori. Action has to be categorized teleologically, as purpose-directed, and the non-acting entities in the actor’s environment must be categorized causally (Mises, 1949, p. 107; Hoppe, 1995, pp. 77–81).
Now the insight here is that there are two categorically different realms of phenomena and that different methods are required to learn about them accordingly. On the one hand, the actor will have a less than complete knowledge of causally structured natural phenomena. On the other hand, he will lack knowledge of his own and other people future actions. As for the methods, there is no way one could identify fundamental laws of action by treating it as some causally structured movements of bodies that one has to experiment with to find the cause and effect relationships a posteriori, and there cannot be a priori knowledge of specific causal relations apart from the fact that they are causally structured.
In the realm of natural phenomena, the constancy principle allows us to project past observations regarding peculiar cause and effect relationships into the future. In other words, actors can hypothesize some specific time invariant causes at work and test their views thanks to experiments. The more tests are made, the more the relationships can be confirmed or discarded. That is how natural sciences proceed, of course. At some point, it becomes known with practical if not absolute certainty that combining two atoms of hydrogen and one atom of oxygen produces a molecule of water. Or, some engineers are able to build and operate high speed rail networks which work most of the time without significant technical failure. Now, sometimes observations of natural phenomena do not shed light on all the relevant cause and effect relations, but still allow actors to discover some regularity that can be expressed in terms of a numerical probability distribution. That is what Mises (1949, p. 107) refers to when discussing “frequency” or “class probability.”
The important consideration here is that the very possibility of being able to identify a class and the related probability distribution of some event presupposes that it is ruled by causality. No quantitative constant can be expected as a rule from an acting entity. That is why frequency or class probability can strictly be applied only in the field of natural sciences and that is why Knight’s concept of risk should apply to this realm only.
Now, not every event can fit the “ruled by causality” category. People act—people choose, that is—and choices cannot be predicted on the basis of time-invariant causal laws. A particular action is not the automatic answer to an external stimulus but the deliberate employment of chosen means to reach chosen ends. Different actors or even the same actors facing the same situation at different times can make different choices. Therefore, there can be no question of grouping some acts in a class of supposedly homogeneous events (Mises, 1949, pp. 110–113). This is the realm of “case probability.” This is why Knight’s concept of uncertainty should apply to actions only.
One may also refer to Hoppe’s (2007) elaboration of why action is intractable by frequency theory. In a nutshell, we may typically “know of no rule how to distinguish one bottle from another as far as breakage is concerned,” (Hoppe [2007, p. 14], referring to the manufacturing of beers in a factory for instance) so that a class may meaningfully be identified and probability calculus applied. However, understanding (verstehen) via verbal communication with other actors puts us “in a position to precisely distinguish one actor from any other actor and one action of a given actor from any other” (Hoppe, 2007, p. 17). Hence, as Knight puts it, in most cases in daily life, “there is no valid basis of any kind for classifying instances.” That is, “the essential and outstanding fact is that the ‘instance’ in question is so entirely unique that there are no others or not a sufficient number to make it possible to tabulate enough like it to form a basis for any inference of value about any real probability in the case we are interested in” (Knight, 1921, p. 226). Should a particular manufacturer expand production? With no valid basis for classification, limited knowledge of the possible outcomes and no calculation of the sort insurance deals with being possible, actors must then resort to “intuitive judgment” and “estimates” in “any typical business decision.” Being irreducible to fixed costs, they permanently leave room for errors in judgment, hence the existence of profits and losses.These errors should not be confused with technical failures, when one’s technological recipes do not work, which essentially have to do with our grasp of the laws of nature. Typical business decisions being based on such estimates, failure to forecast future prices and quantities is perfectly normal and results in bidding up factors of production “too much” or “not enough” in relation to their marginal productivity.
Now perhaps that approach is flawed, but where is it exactly? Why is the identification of risk with the frequency interpretation of probability naïve, in light of Mises’s whole system? Is it, for instance, that his methodological dualism is wrong? Shall we get rid of the whole edifice? If not, why not? What shall we keep, why, and how does that affect our treatment of risk or uncertainty? Unfortunately, the author does not give us a clue, since he does not treat Mises’s take on risk and uncertainty as a part of a larger system. Instead, the author takes another route. He occasionally alludes to other paradigms or builds his case for another framework and in light of it, incorporates elements of Misesian thought which fit and rejects those who supposedly do not. This is not necessarily problematic, although a possibly enlightening discussion of the above considerations is lost in the shortcut. If one refers to or builds an alternative paradigm, demonstrates it to be the truth on the matter, one may spare oneself a thorough analysis of the Misesian—or any other—view on uncertainty and risk and its relationship to Mises’s epistemology and simply point out that this view must be wrong to the extent that it deviates from the said truth.
An example of such an “external” critique of the Misesian approach is when Hoffmann (2018, p. 21) claims he is justified in asserting that, “we can reason about human action and choices probabilistically” as Luce and Raiffa (1957, pp. 19–23) show or, referring approvingly to Hájek (2011), that the frequency interpretation of probability is flawed anyway, so that the Misesian identification of risk with the frequency interpretation of probability is naïve. Apart from the fact that it is hardly obvious how both claims could be held at the same time, the problem is that the author does not tell us what are the objections exactly, and why we should consider them as valid.As a matter of fact, a cursory look at the relevant section in Luce and Raiffa’s book, called “Individual decision making under risk,” reveals that its authors do not assign numerical probabilities to human acts at all. The probabilities discussed there are those of the outcomes of a gambling game such as a lottery!,Yes, one can point toward objections in the literature to virtually any view under the sun, but if merely pointing out that stance A runs counter to stance B was deemed decisive to make a case for stance A, one could have as well demonstrated that stance A is wrong by pointing out that stance B exists. And if one can “prove” one thing and its opposite by the very same procedure, this should say something about the procedure.
III. WEAKNESSES OF THE ALTERNATIVE PARADIGM More constructively, Hoffmann (2018, pp. 11–14) lays down the foundations of an alternative paradigm, by providing the reader with four requirements that a sound definition of “risk” should meet, and tries to sort out what is right and wrong in the Misesian approach, in light of that new framework. The requirements are (1) that “risk should be defined in such a way that it can be distinguished between risk per se (what risk is) and how risk is measured, described or managed”; (2) “risk should be defined in such a way that it can be distinguished between what risk is and how risk is perceived as well as that the definition does not presuppose an interpretation of either objective or subjective risk”; (3) “risk should be defined in such a way that it is helpful to the decision-maker in lieu of misguiding her in many cases, and, thereby, the risk definition should capture the main pre-theoretic intuitions about risk”; and as a weaker requirement (4) “Risk should be defined in such a way that it does not divert attention away from systemic effects that have an impact on not only the actor, but also on other actors.” While these requirements sound by and large reasonable, the main issue is the following: the author tells us that their notion of risk (in a broad sense, or “risk I”) is introduced “in a deductive manner by postulating four requirements that a risk notion should meet.” Yet what is the epistemological status of those postulates? As far as the present writer can see and for our purposes here, it is clear that, at least, the Misesian treatment of probability, risk and uncertainty, can be thought of as grounded in an identifiable epistemology. It is far less clear that the alternative proposed by the author has such firm grounding.
In addition, why does the risk definition provided actually suit those requirements? It is hardly obvious that it does and that it fills research gap I, as intended, for it is quite close to Mises’s notion of probability (except for the uncommon inclusion of desirable outcomes) which allegedly does not: risk is “the real or realistic possibility of a positive or negative event the occurrence of which is not certain, or expectable but only more or less likely. However, the probability that the positive or negative event will occur does not have to be known or be subject to exact numerical specification.” (Hoffmann, 2018, p. 16). In fact, it turns out that the concept includes as subcategories the familiar Knightian concepts of risk in the narrow sense (later called Risk II) that the author finds problematic in other sections of the paper, and uncertainty: “Thus, the term ‘risk’ is not used as an antonym to ‘uncertainty,’ as is customary in decision theory, but rather as a generic concept that covers both ‘risk in a narrower sense’ (what Knight calls measurable uncertainty) and ‘uncertainty.’” (Hoffmann, 2018, pp. 16–17) What is the improvement then?
Now it is true that further elaborations of the author reveal that he deals with additional distinctions, Knightian risk and uncertainty being one among others. This is another consideration that leads him to disagree with Mises on the scope of classical probability theory. For not only human action could sometimes be made tractable by it. When it is not, when we deal with (deep) uncertainty instead of risk narrowly understood, this would not so much be because of some feature inherent to human action but because we are in the presence of what Weaver (1948) calls “organized complexity.” In other words, we are “dealing simultaneously with a sizable number of factors which are interrelated to form an organic whole. Interactions and the resulting interdependence lead to emergence, i.e., to the spontaneous appearance of features that cannot be traced to the character of the individual system parts and, therefore, cannot be fully captured in probability statistics nor sufficiently reduced to a simple formula.” (Hoffmann, 2018, p. 22) Again here, it is unclear what is the epistemological status of the proposal, it is unclear why we are supposed to adopt Weaver’s view. But even if we do not dive into the deep waters of epistemology, it should be clear that the proposal is not as plausible as the author wishes it to be. For we can conceive of situations in which we deal with human choices without organized complexity. For instance, the range of possible choices of a shipwreck survivor alone on a desert island or in a lifeboat would be very limited and there would be no interaction to speak of (at least no interactions between human actors). Yet, if what makes some choices intractable by probability theory is organized complexity, would that not mean that we can predict the choices of this person, using classical probability theory? Now the author would have to tell us how we could do so.
IV. CONCLUSION Aside from some apparent internal inconsistencies, the main problem with the author’s thesis is the lack of a systematic analysis of how both the praxeological treatment of risk and uncertainty on the one hand and his own on the other are or can come to be known and validated. His apparent eclecticism leaves his approach with shaky foundations.
ABSTRACT: Whenever risk managers are confronted with deep uncertainty and organized complexity, probabilistic inference methods which claim crisp inputs and precise results cannot be used effectively. This is a thesis of this paper which we derive from a systemic viewpoint and discuss in the context of praxeology. More specifically, our contribution to the literature of Austrian Economics is twofold. First, after revisiting the Knightian nomenclature of risk vs. uncertainty, which according to Hoppe (2007) is similar to Ludwig von Mises’s work on the subject matter, we present our own conception of risk which differs from their notion. Second, we follow Hoppe (2007) in assessing the arguments provided by Knight and Mises against the possibility of applying probability theory in the area of human action, but reach a different, more nuanced conclusion. In particular, we outline a case which parts ways with the praxeological approach.
KEYWORDS: Austrian economics, risk, uncertainty, complexity, probability JEL CLASSIFICATION: B4, C1 Dr. Christian Hugo Hoffmann (choffmann@ethz.ch) is a postdoc at the Chair of Entrepreneurial Risks at the Swiss Federal Institute of Technology in Zurich (ETH), Switzerland.
Quarterly Journal of Austrian Economics 21, no. 3 (Fall 2018) full issue, click here.
It is high time, however, that we take our ignorance more seriously. – (Friedrich A. Hayek, 1967)
- INTRODUCTION This paper characterizes and discusses different concepts of risk and seeks to define a proper meaning of the term in the realm of economics and finance. The purpose is not only to simply deepen our conceptual knowledge, but to, and this is particularly relevant to Austrianism, identify and examine the potential of going beyond the mere and rigid dichotomy of risk vs. uncertainty which Knight and Ludwig von Mises rely on. This is achieved by exploring if and how far systematization can be deemed possible in the non-probabilistic realm of uncertainty. Even though at the end we will also differentiate between Knightian risk and uncertainty (so to speak), it is important to note that we only endorse a single concept of risk which is different from Knightian risk and which will be baptized Risk I (section 5). We introduce Risk I in a deductive manner by postulating four requirements that a risk notion should meet (section 4). Prior to that, we review the literature (section 2) and turn the spotlight to Knight’s and Mises’ angle on risk (section 3). We close this paper in section 6 and 7 where we detail lessons from the taxonomy of risk we are proposing for Austrianism.
The absence of an accepted and appropriate definition of risk in the literature is not simply an abstract academic ivory tower issue. For example, risks in and to economic and financial systems are regarded as triggers of global financial crises (Schwarcz, 2008, pp. 193–249; Kelly, 1995, pp. 221ff.). Having lucid definitions is a fundamental requirement for management and modeling (Fouque and Langsam, 2013, p. xxviii). Without a well-thought notion of (financial) risk and approaches for measuring and managing the amount and nature of the risks, it would be difficult to effectively target indispensable (e.g., mitigating) action without running the real risk of doing more harm than good.
- THE NOTION OF RISK IN THE LITERATURE In non-technical contexts and contexts of common parlance, the word “risk” refers, often rather vaguely, to situations in which it is possible but not certain that some undesirable event will occur (Hansson, 2011; Heinemann, 2014).The origin of the concept of risk is not clear. Etymologically, the term is, among other things, derived from the Greek word “rhiza” which can be translated with “cliff”, supporting the above negative mode of explanation, and from the Latin vulgar expression “risicare” / “resecare”, meaning “to run into danger” or “to wage / to hazard”. Cf. Heinemann, 2014, p. 59.a More precisely, the philosopher Sven O. Hansson distinguishes five particularly important and more specialized uses and meanings of the term, which are widely used across academic disciplines and/or in everyday language (Hansson, 2011).
(1) risk = an unwanted event which may or may not occur.
An example of this usage is: “The risk of a financial collapse is vast.”
(2) risk = the cause of an unwanted event which may or may not occur.
An example of this usage is: “Subprime lending is a major risk for the emergence of a housing bubble.” Both (1) and (2) are qualitative senses of risk. The word also has quantitative meanings, of which the following is the oldest one:
(3) risk = the probability of an unwanted event which may or may not occur.
This usage is exemplified by the following statement: “The risk that a financial collapse will occur within the next five years is about 70%.”
(4) risk = the statistical expectation value of an unwanted event which may or may not occur.
The expectation value of a possible negative event is the product of its probability and some measure of its severity. It is common to use the total amount of monetary costs as a measure of the severity of a financial crash. With this measure of severity, the “risk” (in sense 4) laden with a potential financial collapse is equal to the statistically expected number of monetary costs; i.e., for example, 70% (building on the example from (3)) times USD 10T results in USD 7T of expected overall costs of a global financial crisis. Other measures of severity give rise to other measures of risk.“Although expectation values have been calculated since the 17th century, the use of the term ‘risk’ in this sense is relatively new. It was introduced into risk analysis in the influential Reactor Safety Study, WASH-1400, (Rasmussen, 1975).” (Hansson, 2011). Today, Hansson (2011) regards it as the standard technical meaning of the term “risk” in many disciplines. Some risk analysts even think that it is the only correct usage of the term (ibid.).
(5) risk = the fact that a decision is made under conditions of known probabilities (“decision under risk” as opposed to “decision under uncertainty”).“Most presentations of decision theory work from Luce and Raiffa’s (1957) [building on Knight, 1921; C.H.] classic distinction between situations of certainty (when the consequences of actions are known), risk (when the probability of each possible consequence of an action is known, but not which will be the actual one) and uncertainty (when these probabilities are unknown)” (Bradley and Drechsler, 2014, p. 1229). See footnote 28 for an example.
All concepts of risk have in common what philosophers call contingency, the distinction between possible and actual events or possible and chosen action (Renn, 2008, p. 1). In addition to these five common meanings of “risk”, according to Hansson (2011), there are several other more technical meanings, which are well-established in specialized fields of inquiry. With regard to economic and particularly relevant analyses for the purposes of this study, nota bene that the current debate on risk resembles a Babylonian confusion of tongues. The present situation is characterized by many weakly justified and inconsistent concepts about risk (Aven, 2012, p. 33). Some of the many different definitions that are circulating are triaged and a subsumption system for them is given in Table 1. The purpose of this overview is to lay out the variety of material risk notions, rather than to claim that the categories proposed are exhaustive or mutually exclusive.
Table 1: Classification system for risk definitions and characterization of different risk definition categories.x: yes, o: no, x?: answer depending on the meaning of the terms or it is not specified. A similar, but not fully satisfactory summary is found in Aven (2012, p. 37).
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In light of this ambiguity, the next section pays special attention to how the term “risk” has been coined by the Austrian school of economics, by Ludwig von Mises and Frank Knight in particular.
- THE NOTION OF RISK IN AUSTRIANISM Hoppe (2007) deserves credit for investigating a systematic, yet rarely noted similarity in the works of Knight (1921) and Mises (1949), namely in terms of their stance on risk, uncertainty and (the scope of) probability (theory).However, cf. also Rothbard (1962, pp. 498–501). However, the similarity concerns more than he spells out. Hoppe’s conclusion is not sufficiently satisfying because it remains incomplete when he simply notes that both Knight and Mises share a similar critical view on the limitations of mathematical probability theory, which would not prove to be useful in our daily endeavors of predicting human action (Hoppe, 2007, p. 19). Leaving that for the moment, Hoppe fails to discuss an intriguing shortcoming from which both oeuvres suffer. Knight (1921, ch. 7 and 8) and Mises (1949, ch. 6) treat the notions of uncertainty and probability, which are a primary concern of praxeology, but both treatments lack some conceptual clarity. To be precise, we do not disagree with Hoppe’s or Knight’s / Mises’s critical attitude towards the applicability of numerical or Kolmogorovian probability theory. Rather, the aforementioned lack of conceptual clarity on risk notions refers to a naïve identification of risk with (a frequency interpretation of) probability both Knight and Mises succumb to and which is not critically appraised by Hoppe.
Knight (1921, pp. 223f.) spots empirical-statistical probabilities and defines them as “insurable” contingencies or “risk.” Mises concurs with him (Hoppe, 2007, p. 11). Yet, why is this approach naïve? In section 4, we will call it problematic because it does not meet the first, second and third of four requirements which we will establish regarding an appropriate concept of risk. On top of that, the frequency interpretation of probability itself is laden with inconsistencies (cf. Hájek, 2011 for a synopsis). Therefore, by anticipating the reasoning underlying criteria 1 to 3 in section 4 and by pointing to the objections to frequentism in the literature, we are justified in stating the first of two research gaps.
Research Gap I: Poor conceptualization of the term “risk” as well as knowledge deficits concerning the conceptual relationships between “risk,” “uncertainty,” and “probability” in a finance and economics context.
Mises (1949, pp. 107ff.) actually does not even single out “risk” as a terminus technicus in this connection of elaborating on the interpretations of probability. Instead, he first comments rather vaguely:A precise definition includes the logical operator “if, and only if”, which is missing in how Mises introduces “probability.”
A statement is probable if our knowledge concerning its content is deficient. We do not know everything which would be required for a definite decision between true and not true. But, on the other hand, we do know something about it; we are in a position to say more than simply non liquet or ignoramus. (Mises, 1949, p. 207).
Within this wide, general, and under-determined class of probabilistic statements, Mises then distinguishes two categorically distinct subclasses. The first one—probability narrowly understood and permitting the application of the probability calculus—bears the signature of his brother Richard, who first and foremost coined the objective concept of probability (Mises, 1939), and is called “class probability”:Moreover, that Mises (1949) shows himself in complete agreement with his brother (Mises, 1939) in this regard, entails that he deliberately uses “random” to mean “chancy,” which is problematic (cf. Eagle, 2012).
Class probability means: We know or assume to know, with regard to the problem concerned, everything about the behavior of a whole class of events or phenomena; but about the actual singular events or phenomena we know nothing but that they are elements of this class. (Mises, 1949, p. 207).
On the other hand, Knight (1921, pp. 223f., 226, 231f.) calls the other sort of contingency (i.e., probabilities which are not a priori or empirical-statistical) “true uncertainty” and describes it as an estimate or intuitive judgment. For example, business decisions “deal with situations which are far too unique, generally speaking, for any sort of statistical tabulation to have any value for guidance. The conception of an objectively measurable probability or chance is simply inapplicable.” (Knight, 1921, p. 231). Almost three decades later, Mises (1949, p. 110) adds that true uncertainty or case probability, which is how he refers to it, means:
We know, with regard to a particular event, some of the factors which determine its outcome; but there are other determining factors about which we know nothing. Case probability has nothing in common with class probability but the incompleteness of our knowledge. In every other regard the two are entirely different. (Mises, 1949, p. 110).
In particular, while the probability calculus is only applicable to ‘genuine’ classes or collectives (hence the name class probability), case probability is about individual, unique, and non-repeatable cases/events “which as such—i.e., with regard to the problem in question—are not members of any class” (Mises, 1949, p. 111). Thus, they lie outside the scope of classical probability theory. Yet, what kinds of events must be considered as instances of case probability according to Mises? He provides the reader with the following initial answer:
The field for the application of the former [class or frequency probability] is the field of the natural sciences, entirely ruled by causality; the field for the application of the latter [case probability] is the field of the sciences of human action, entirely ruled by teleology. (Mises, 1949, p. 107).
It follows that “human action is the source of ‘true,’ nonquantifiable (Knightian) uncertainty” (Hoppe, 2007, p. 11). We share Hoppe’s observation that, unfortunately, Mises (1949) is less than outspoken in elucidating why human actions (choices) are intractable by probability theory (in the frequency interpretation) (ibid.). Moreover, we claim however that Hoppe’s intended main contribution in his paper, namely to render the reason why choices are intractable by the frequency interpretation of probability explicit based on the Misesian framework, is insufficient and provide evidence in section 6. To put it in a nutshell already, we will not accept Hoppe’s rationale because we reject the Misesian framework for this particular purpose. Instead, we will bring forward Proposition II and, thereby, ground the matter of the scope and limitations of probability theory on questions on complexity in lieu of human action. For now, we acknowledge
Research Gap II: Lack of understanding of whyhuman action and choices lie outside the scope of classical (Kolmogorovian) probability theory.
We address those two research gaps in the following. Section 6 seeks to close research gap II although the proposition that human action per se cannot be captured by probability statistics turns out to be untenable. Section 5 targets research gap I and the very next chapter constitutes a necessary stepping stone in this direction. Put differently, some notes on the epistemology of risk are in order first to escape possible snares before we deduce our own definition of risk.
- THE EPISTEMOLOGY OF RISK When there is a risk, there must be something that is unknown or has an unknown outcome. Therefore, knowledge about risk is knowledge about lack of knowledge (Hansson, 2011). This combination of knowledge and lack thereof contributes to making issues of risk difficult to grasp from an epistemological point of view.
Second, it is sensible to acknowledge that risk not simply refers to something unknown, but to draw a conceptual framework distinguishing between the known, the unknown, and the unknowable (“KuU” as it is labeled by Diebold et al., 2010). Accordingly, Kuritzkes and Schürmann (2010, p. 104) call a risk known (K) if it can be identified and quantified ex ante; unknown (u) if it belongs to a collective of risks that can be identified but not meaningfully quantified at present;The unknown might, therefore, also be knowable insofar as there (will) exist mechanisms that allow transforming the unknown into the known. These mechanisms can be either known or unknown. It is often unknown whether a risk or circumstance is a “knowable unknown” or an “unknowable unknown”, which might remind the reader of Donald Rumsfeld’s dictum of known and unknown unknowns—another demarcation line. and unknowable (U) if the existence of the risk or set of risks is not anticipatable, let alone quantifiable, ex ante. Nota bene: there is no sharp definitional line to be drawn between these classes, maybe leaving the KuU classes lying along a continuum of knowledge.
Third, things are even more confusing because even “known” risks (in the sense of Kuritzkes and Schürmann, 2010) contain uncertainty: “[…] as recent evidence coming from the financial markets painfully shows, the view according to which a ‘known probability distribution’ contains no uncertainty is not quite right” (Fedel et al., 2011, p. 1147).Ellsberg (1961) speaks of the ambiguity of a piece of information. The authors strengthen their assertion as follows (Fedel et al., 2011, p. 1147): Suppose a die is being rolled. One thing is to be uncertain about the face that will eventually show up (a “known” risk). One quite different thing is to be uncertain about whether the die is fair or unbiased (is the ostensibly known risk really known?) (Fedel et al., 2011, p. 1147). In other words, we can rather naturally differentiate between first order and second order uncertainty, respectively. In the former case, we are uncertain about some (presently unknown) state of affairs. In the latter, we are uncertain about our uncertainty, i.e., second order uncertainty refers to the assessment that an agent makes about her own uncertainty (Fedel et al., 2011, pp. 1147f.).In principle, even higher orders of uncertainty are conceivable.
Finally, fourth, Hansson (2011) observes that a major problem in the epistemology of risk, a problem which is paid special attention to in this study, is how to deal with the severe limitations that characterize our knowledge of the behavior of unique complex systems that are essential for estimates of risk (e.g., modern financial systems). Such systems contain components and so many, potentially shifting, interactions between them that it is in practice unpredictable (Hansson, 2011).
These four points already presage that the relationship between the concepts “risk,” “knowledge,” and “uncertainty” seems to be wide-ranging, multi-layered and elusive. Hereafter, we try to cope with these issues and, further, to establish four explicit conditions for defining a proper, i.e., a more useful and a consistent,Following Rothschild and Stiglitz (1970, pp. 226f.), it is, of course, impossible to prove that one definition is better than another. Instead, they point out that definitions are chosen for their usefulness as well as their consistency. notion of risk.
Condition 1: Risk should be defined in such a way that it can be distinguished between risk per se (what risk is) and how risk is measured, described or managed (Aven, 2012, p. 33; Bradley and Drechsler, 2014, p. 1226).
Rationale: This condition is important because there exist perspectives on risk in which this distinction is not made (see Table 1 and cf., e.g., Beck, 1992, p. 21; Hansson, 2007, p. 27). Like MacKenzie (2006, pp. 143–179), George Soros (2008, p. 3) notes how “our understanding of the world in which we live is inherently imperfect because we are part of the world we seek to understand” and he focuses on “how our knowledge of the world is interdependent with our measurements of it” (Blyth, 2010, p. 460).An impressive example of how knowledge is interwoven with our measurement tools can be taken from fractal geometry: Intuitively, we would assume that a question like “How long is the coast of Britain?” is well-defined and can be answered clearly and precisely by pointing to a certain fact. However, by adding to the observations by Lewis Richardson (1881–1953), Mandelbrot (1967) shows that the length of a coastline, a self-similar curve or fractal object, depends on the scale at which it is measured (which has become known as the ‘coastline paradox’). In principle, every (measurement or description or management) tool in use (which could be based on stochastic models) should be treated as such. Every such tool has its limitations and these must be given due attention. By a distinction between risk as a concept, and its descriptions or assessments “we will more easily look for what is missing between the overall concept and the tool” (Aven, 2012, p. 42). By the same token, if a proper framework clarifying the disparity between the overall risk concept, and how it is being measured or operationalized etc. is not established, it is difficult to know what to look for and how to make improvements in these tools (Aven, 2012, p. 42). In addition to that, it is a central principle of systems science, which in turn is in consonance with the Austrian line of thought,For example, Mises (1949, p. 874) places the learning of economics within the context of systems thinking and the “interconnectedness of all phenomena of action” at the core of systems thinking. to examine issues from multiple perspectives—“to expand the boundaries of our mental models” (Sterman, 2000, p. 32)—and, as a consequence, the risk concept should not be illuminated by one theoretical perspective only (e.g., mere probabilistic underpinnings); it should not be founded on one single measurement tool. Because in the various scientific environments, application areas or specific contexts, there might not be one best way to measure/describe risk. This appears to be, therefore, a reasonable and uncontroversial premise which can be further strengthened by an analogy to the Austrian debate on the single concept “utility” that has been operationalized in different ways. One camp around Böhm-Bawerk would maintain a cardinal understanding of utility, namely that the utility of goods can be measured and expressed as a multiple of a unit. By contrast, Čuhel, Mises, and many more would defend an ordinal understanding of utility (Moscati, 2015). Thus, once we allow for the distinction between utility and its measurement, we enable both and potentially other parties to talk sense about utility from different angles, to elaborate on different facets of the broad notion, and so forth (be it a cardinal utility function or an ordinal understanding).
Application to Knightian/Misesian framework: When Knight (or Mises, for that matter) identifies risk with (a frequency interpretation of) probability, he does not pass this test because then it is not differentiated between the notion (i.e., risk and hence probability) and its operationalization (i.e., the probability measure).
The second condition purports the following:
Condition 2: Risk should be defined in such a way that it can be distinguished between what risk is and how risk is perceived (Aven, 2012, p. 34)According to Aven (2012), this premise is not in line with cultural theory and constructivism (cf. also Jasanoff, 1999; Wynne, 1992; and critical comments in Rosa, 1998). Beck (1992, p. 55), for example, writes that “because risks are risks in knowledge, perceptions of risks and risk are not different things, but one and the same.” as well as that the definition does not presuppose an interpretation of either objective or subjective risk (Hansson, 2011).
Rationale: There is a major debate among risk professionals about the nature of risks: are risks social or subjective constructions (human ideas about reality, a feature of the agent’s informational state) or real-world, objective phenomena (representations of reality, a feature of the world itself;). Willett (1901) and Hansson (2011), for example, speak up for a strong objective component of risk: “If a person does not know whether or not the grass snake is poisonous, then she is in a state of uncertainty with respect to its ability to poison her. However, since this species has no poison there is no risk to be poisoned by it” (Hansson, 2011). On the other hand, it is obvious to others that risks constitute mental models (Renn, 2008, p. 2). They are not veritable phenomena, but originate in the human mind (Renn, 2008, p. 2). As Ewald (1991, p. 199) notes: “Nothing is a risk in itself; there is no risk in reality. […] [A]nything can be a risk; it all depends on how one analyses the danger, considers the event.” The definitional framework should, hence, try to “avoid the naïve realism of risk as a purely objective category, as well as the relativistic perspective of making all risk judgments subjective reflections of powerPower, for example, to the extent that what counts as a risk to someone may be an act of God to someone else, resigned to his fate (Bernstein, 1996b). and interests” (Renn, 2008, p. 3).
Application to Knightian/Misesian framework: Needless to restate the well-known objections to objective probabilities (e.g., cf. Hájek, 2011 for an overview), but interestingly, since Knight and Mises embrace a frequentism-based notion of probability, they also seem to endorse a purely objective interpretation of “risk.” Thus, their framework does not pass this second test either. At least, some more clarification would be required because, on the other hand, subjectivism is considered a central pillar for economists of the Austrian School (e.g., Spitznagel, 2013, pp. 21, 76). Or maybe it simply follows then that an agnostic position should be taken as Condition 2 suggests it.
There are at least two more requirements for a good risk definition.
Condition 3: Risk should be defined in such a way that it is helpful to the decision-maker in lieu of misguiding her in many cases (Aven, 2012, p. 42), and, thereby, the risk definition should capture the main pre-theoretic intuitions about risk (Rothschild and Stiglitz, 1970, p. 227).
Rationale: At first glance, this condition might sound trivial, but it must not be forgotten that risk cannot be confined to the ivory tower of scholarly deliberations. Even though it might be a theoretical and abstract concept, risk has forged a direct link with real-life management of challenges and actual decision-making. It has a direct impact upon our life and the orientation along decision-making and human action is key for Austrianism (Mises, 1949) as well. Speaking for the banking context, banks, taxpayers, governments lost a lot of money (and much more; e.g., credibility) because risk managers (in a broad sense) ignored or misjudged risks, miscalculated the uncertainties or had too much confidence in their ability to master dangerous situations (FCIC, 2011). Ultimately, only time and feedback from the economic practice can tell whether or not this premise is fulfilled.
Application to Knightian/Misesian framework: Some proposals such as R = P V OU, i.e., the framework of Mises, 1949 and Knight, 1921 (see Table 1), do not fulfill this criterion because, to put it in the words of Aven (2012, p. 41), “referring to risk only when we have objective distributions would mean we exclude the risk concept from most situations of interest.” Thus, this risk concept would not prove helpful in many or most cases of decision-making.
In conjunction to this third premise, opening the debate to a wider (namely, to a non-academic) audience, one can also see the following ethical demand.
Condition 4: Risk should be defined in such a way that it does not divert attention away from systemic effects that have an impact on not only the actor, but also on other actors (Rehmann-Sutter, 1998, p. 120).
Rationale: The school of Austrian economics also emphasizes the importance of systemic effects that are usually associated with (very) low-frequency events in a high-dimensional space—cf. for example, Spitznagel, 2012: “The Austrians and the Swan: Birds of a Different Feather.” Yet, Rehmann-Sutter (1998, p. 122) goes one step further and bemoans the fact that in some economic concepts of risk, “there is only one personal position: the decision-maker,” whereas most risks are not individual but rather social (Sen, 1986, pp. 158f.), i.e., there might be negative consequences for others from “taking risks.” He adds, however, that we have difficulty in adequately including those other persons (e.g., taxpayers in our context) affected by the consequences of the (risk management) decision (of a bank) in the decision-making process, where the concept of risk is worked out in reality (Rehmann-Sutter, 1998, p. 122). “These other participants are abstract; attention is diverted away from them. These participants are conceptually hidden” (Rehmann-Sutter, 1998, p. 122).
Application: We cannot regard this critique as fundamental in terms of the economic risk concepts taken into consideration in Table 1—e.g., the definition R = EV does not entail a narrow reading of the consequences. Therefore, we consider 4 as a weak condition which can in principle be met by every risk definition. In other words, condition 4 is more about the interpretation of the definition than about the risk definition itself. Nevertheless, an important lesson can be learned from that admonition, among the most prominent of which was drawn by Kristin Shrader-Frechette.
Shrader-Frechette (1991) points to the unease we feel when we are using a concept which was elaborated for optimization of entrepreneurial behavior in an unpredictable market to describe interventions into the (financial) system with potential or actual adverse effects to other persons and institutions. What is prima facie rational might secunda facie not be rational if a feedback view of the world is adopted (Sterman, 2000). Since only those risks enter standard probabilistic risk measurement procedures that (directly!) affect the respective organizations, risk managers or traders etc. often do not see a direct connection between their actions and other actors (Garsten and Hasselström, 2003, p. 259) or with significant changes in the financial system or even the global economy, which, in the end, bounce back on the individual institutions themselves.
For now, a first bottom line is that, unfortunately, many extant definitions of risk do not even meet the first two basic requirements (see Table 1, rows 3 and 7). In terms of Table 1, only risk in the sense of uncertainty (R = U) and risk as the real or realistic possibility of a negative, (very) rare and uncertain event with serious or even extreme consequences (R = U&C) remain in the game. Since seeing risk as uncertainty can be considered a special case of U&C, the latter seems to be the most promising candidate whereas the other risk concepts presented do not only turn out to not have some desirable properties, but also suffer from other shortcomings. For example, the especially in a banking context relevant identification of risk with volatility or the variance of returns (R = V) is clearly unsatisfactory: “We can construct distributions that have identical variance but with which we would associate very different degrees of ‘riskiness’ – and risk, as the saying goes, is one word but is not one number” (Rebonato, 2007, p. 237; cf. also Rootzén and Klüppelberg, 1999); “[i]n any case, anyone looking for a single number to represent risk is inviting disaster” (Taleb et al., 2009, p. 80; cf. also Power, 2007, p. 121).
Before we shed some more light on U&C, it makes sense to first look closer at another example, namely the field of the risk definition R = P V OU where Mises (1949) and Knight (1921) made one of the first large-scale distinctions between risk and uncertainty, for what became known as ‘Knightian risk’ (= measurable uncertainty) and ‘Knightian uncertainty.’ Albeit there might be good reasons for regarding Knight’s original argument for distinguishing between risk and uncertainty as going astray (see condition 3),Taleb and Pilpel (2004) and Aven (2012), for example, argue that we should leave the Knightian nomenclature once and for all: “[…] the distinction is irrelevant, actually misleading, since, outside of laboratory experiments, the operator does not know beforehand if he is in a situation of ‘Knightian risk’” (Taleb and Pilpel, 2004, p. 4). it is nevertheless important to bear it in mind due to several reasons.
First, it is very puzzling to see how different economists, risk experts and others have reacted to Knight’s oeuvre, how they interpreted it and what conclusions have been drawn. A good example is that while both the critical finance community (e.g., Stout, 2012; Bhidé, 2010; Aven and Renn, 2009; Power, 2007; or Taleb and Pilpel, 2004), on the one hand, and the economic (imperialistic) mainstream (Friedman, 1976; Ellsberg, 1961; Savage, 1954) on the other, consider Knight’s distinction between risk and uncertainty as invalid because his risk perspective is too narrow, the interests of these two groups are diametrically opposed to each other: Whereas the former repels probability based definitions of risk (“risk as a concept should not be founded on one specific measurement tool [such as probability—C.H.],” Aven, 2012, p. 42) in favor of uncertainty, the latter maintains that Knightian risk, i.e. risk measured by probability, would prevail instead of “uncertainty” (“for a ‘rational’ man all uncertainties can be reduced to risks [because it is believed that we may treat people as if they assigned numerical probabilities to every conceivable event—C.H.],” Ellsberg, 1961, p. 645).However, the agent’s acting as if the representation is true of her does not make it true of her. Cf. Hájek, 2009, p. 238.
Second, Knight’s seminal work might, therefore, be seen as very influential or even path-breaking for the more recent history of economic thought (Heinemann, 2014, pp. 61f.; Aven, 2012, p. 41; Esposito, 2011, p. 32) and as laying the grounds for a common meaning of “risk” (Hansson, 2011), especially relevant in economics and decision theory (Luce and Raiffa, 1957). Indeed, the tie between risk and probability is seen as so strong that only few seem to question it: “Risk can only be found in situations that have to be described by probabilities” (Granger, 2010, p. 32). Moreover, Knight (1921) introduced a simple but fundamental classification of the information challenges faced in banks’ risk management, between Knightian risks which can be successfully addressed with statistical tools (Value at Risk, Expected Shortfall, etc.), and Knightian uncertainties which cannot (Brose et al., 2014, p. 369). Good risk management, thus, calls for toolkits that handle both Knightian risk and uncertainty (Brose et al., 2014, p. 369).
Hence, third, it is important to have a risk concept based on probability models to be able to participate in, and contribute to, the discourse of risk if a great number of participants and economists or people interested in risk management in banking, in particular, should be reached. Since such a definition of risk (which will be baptized Risk II) would not do justice to the requirements set above (e.g., the first condition), however, it will not be the one which is pursued and embraced in this study after all.
Hence, it would be premature to simply and uncritically take on Taleb and Pilpel’s (2004) or Aven’s (2012) position of pleading in favor of leaving the Knightian nomenclature once and for all. Instead, our strategy is twofold. We first conclude that the kind of definitions by Heinemann (2014), Steigleder (2012), Aven and Renn (2009), etc. are the most appropriate before we approve a narrow notion of risk that is compatible with how risk discussions are commonly held.
- UNDERSTANDING RISK As an answer to research gap I, risk, in this paper, is paraphrased broadly asThese first two passages are taken from Steigleder (2012, p. 4).
… the real or realistic possibility of a positive or negative event the occurrence of which is not certain, or expectableWe follow Steigleder (2012, p. 4) in calling an event expectable here “if it is known to be a normal and common consequence of certain circumstances or actions. Whenever an event that is expectable in this sense does not occur, that is something abnormal and needs explanation.” but only more or less likely. However, the probability that the positive or negative event will occur does not have to be known or be subject to exact numerical specification.
Thus, the term “risk” is not used as an antonym to “uncertainty”, as is customary in decision theory, but rather as a generic concept that covers both “risk in a narrower sense” (what Knight, 1921, calls measurable uncertainty) and “uncertainty”. This is because we frequently lack a sufficient basis to determine the probabilities with any precision (Greenbaum, 2015, p. 165) as it will be clarified below.
This broad notion of risk is designated by Risk I. Structurally, risk in this sense captures:
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What can happen?
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Answering this question requires the identification or description of consequences or outcomes of an activity.
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Is it more or less likely to happen (in contrast to how likely is that to happen)?
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Attention is directed to rather rare or systemic events in this piece for reasons that become transparent below.
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If it does happen, what is the impact?
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Answering this question requires the evaluation of consequences which are rather serious or even extreme. Otherwise, risks would turn out to be immaterial.
We thereby follow the call of Das et al. (2013, p. 715) that risk management research will have to dig deeper “in going from more frequency oriented ‘if’ questions to a more severity oriented ‘what if’ approach, and this at several levels”. In this particular treatise, the focus lies on (very) low-frequency events in a high-dimensional space or, in particular, on low-frequency, high-severity (monetary) losses for several reasons. For example, pushing natural phenomena to an extreme unveils truths that are ensconced under normal circumstances. As stressed in Johansen and Sornette (2001) and following the 16th century philosopher Francis Bacon, the scientific appeal of extreme and systemic events is that it is in such moments that a complex system offers glimpses into the true nature of the underlying fundamental forces that drive it (Johnson et al., 2012, p. 3).
Accordingly, the need to address unexpected, abnormal or extreme outcomes, rather than the expected, normal or average outcomes is a very important challenge in risk management (McNeil et al., 2005, p. 20; Malevergne and Sornette, 2006, p. 79; Greenbaum, 2015, p. 164); because improving the comprehension (of the distribution) of extreme values, which cannot be dismissed as outliers because, cumulatively, their impact in the long term is dramatic, is of paramount importance (Mandelbrot and Taleb, 2010).The need for a response to this challenge also became very clear in the wake of the LTCM case in 1998 (McNeil et al., 2005, p. 20). John Meriwether, the founder of the hedge fund, clearly learned from this experience of extreme financial turbulence; he is quoted as saying: “With globalization increasing, you’ll see more crises. Our whole focus is on extremes now—what’s the worst that can happen to you in any situation—because we never want to go through that again.” (Wall Street Journal, 2000).
Benoît Mandelbrot uses a nice metaphor for illustration’s sake (cf. also Churchman, 1968, p. 17): “For centuries, shipbuilders have put care into the design of their hulls and sails. They know that, in most cases, the sea is moderate. But they also know that typhoons arise and hurricanes happen. They design not just for the 95 percent of sailing days when the weather is clement, but also for the other 5 percent, when storms blow and their skill is tested.” (Mandelbrot and Hudson, 2008, p. 24). And he adds: The risk managers and investors of the world are, at the moment, like a mariner who “builds his vessel for speed, capacity, and comfort—giving little thought to stability and strength. To launch such a ship across the ocean in typhoon season is to do serious harm.” (Mandelbrot and Hudson, 2008, p. 276).
Clearly, this does not mean that (very) low-probability risk events matter simply because they have a very low probability. For example, there is some probability that a pink elephant will fall from the sky. But such a risk does not affect managerial decisions in economic and financial systems (such as banks). The known or unknown risks that matter for our purposes are, of course, those that, had senior or top management been aware of them, would have resulted in different actions (Stulz, 2008, p. 64)—e.g., the bursting of a pricing bubble or an escalating political conflict etc.
Second, a narrow concept of risk is invoked (Risk II); it is basically circumscribed by two key variables, the severity of the consequence and its probability of occurrence,The probability of occurrence or at least the subjective probability must be less than 1 and more than 0, otherwise there would be certainty about the event or the possible outcomes of an action. (Going back to Lewis [1980], the principle that, roughly, one’s prior subjective probabilities conditional on the objective chances should equal the objective chances is called the principal principle.) Moreover, the probability should be seen in relation to a fixed and well-defined period of time. For the concept of probability including objective and subjective probabilities, in general, cf. Hájek (2011). and it presupposes that possible/significant consequences and the corresponding values of severity and probabilities are known.For readers well versed in economic theories of decision sciences, it should be added that, depending on the particular theory, probabilities are not always assigned to the consequences of action alternatives (e.g., Jeffrey, 1983), but also, for example and actually more often, to so-called states of the world (e.g., Savage, 1954).2 Risk II encompasses Hansson’s (2011) risk definitions 3 to 5The risk formula “Risk = probability * measure of severity (e.g., utility, monetary unit, etc.)” directly follows from the Risk II concept (Hansson’s fourth definition). Since Risk II presupposes known probabilities (with 0 < p < 1), decisions under “risk” are made, and not decisions under conditions of “uncertainty” (Hansson’s fifth definition). And, finally, seeing risk as probability (third definition) can be considered a special case of Risk II and it can be regarded as a special and rare case of the broad risk definition (Risk I). Figure 1 depicts the conceptual relationships between Risk I, Risk II, and uncertainty, and can be viewed as our proposal to close research gap I.
Figure 1: Two relevant risk concepts: Risk I encompasses Risk II and uncertainty.A similar illustration (but insufficient explanation of the concepts) is found in Heinemann (2014, p. 61).
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Risk II is rather hypothetical or an exception and this case is basically constructed only to participate in regular risk discussions (see above, p. 15).See above: “Hence, it is third in turn important to have a risk concept based on probability models to be able to participate in, and contribute to, the discourse of risk if a great number of participants and economists or people interested in risk management in banking, in particular, should be reached. Since such a definition of risk (which will be baptized Risk II) would not do justice to the requirements set above (e.g., the first condition), however, it will not be the one which is pursued and embraced in this study after all.” Apart from the different orders of uncertainty (Fedel et al., 2011, p. 1147; Ellsberg, 1961), different types of uncertainty need to be taken into account. In Figure 1, we distinguish three qualitatively different types of uncertainty: (a) what decision theorists or philosophers might call state uncertainty, (b) what they might call option uncertainty and/or state space uncertainty, and (c) what corresponds to ethical uncertainty, a form of normative uncertainty (cf. Bradley and Drechsler, 2014). On top of that, many different kinds of risk (business risk, social risk, economic risk, etc., Kaplan and Garrick, 1981, p. 11) or categories of risk (market, credit, operational risk, etc.) are discussed in the literature and many more classification systems are introduced. We argue, however, that, even though some of the taxonomies offered for bank risks or for knowledge (or the lack thereof) are persuasive, e.g., the conceptual framework “KuU” by Diebold et al. (2010), at least the silo-treatment of risks should be overcome. Instead of devoting much attention to different forms of risk, the focus lies here on R = U&C in general. The broad concept of risk is chosen as a form of description since it is not a priori clear for concrete risks at issue whether or not the probabilities and potential consequences as well as their severity are known. Knight’s (Mises’s) important distinction between risk and uncertainty is esteemed by separating Risk II from uncertainty. This differentiation is, in some cases, indispensable for the discourse of risk (management) in banking because different implications arise: The risk perspective chosen strongly influences the way risk is analyzed and, hence, it may have serious effects on risk management and decision-making (Aven, 2012, p. 42). However, much of what we today call risk management is “uncertainty management” in Knightian terms, i.e., courageous efforts to manage ‘risk objects’ for which probability and outcome data are, at a point in time, unavailable or defective (Power, 2007, p. 26; Willke et al., 2013, p. 9).
- A TAXONOMY OF UNCERTAINTY: SCALES OF MEASUREMENT AND QUANTITATIVE VS. QUALITATIVE PROBABILITIES It is a commonplace that we must not undertake impermissible transformations on the data we wish to analyze, nor must we make interval statements on ordinal data, in particular (Flood and Carson, 1993, pp. 41f.).We differentiate among four types of scales: nominal, ordinal, interval and ratio. According to Tal (2015, 3.2), “[n]ominal scales represent objects as belonging to classes that have no particular order, e.g., male and female. Ordinal scales represent order but no further algebraic structure” and admit of any transformation function as long as it is monotonic and increasing. Celsius is an example of interval scales: “they represent equality or inequality among intervals of temperature, but not ratios of temperature, because their zero points are arbitrary. The Kelvin scale, by contrast, is a ratio scale, as are the familiar scales representing mass in kilograms, length in meters and duration in seconds.” This classification was further refined to distinguish between linear and logarithmic interval scales and between ratio scales with and without a natural unit (Tal, 2015, 3.2.). “Ratio scales with a natural unit, such as those used for counting discrete objects and for representing probabilities, were named ‘absolute’ scales” (Tal, 2015, 3.2.). We agree with Mises (1949, p. 113) that there is a form of uncertainty, which he calls case probability and we will call deep uncertainty, and which does not lend itself to classical probability-based methods: “Case probability is not open to any kind of numerical evaluation” (Mises, 1949, p. 113). On this basis, we hypothesize that when we as risk modelers are in a state of deep uncertainty about some future data or events, then we can perform, not a cardinal, but an ordinal ‘measurement’ of that risks only.It is an open issue whether the representation of magnitudes on ordinal scales should count as measurement at all (Tal, 2015). In other words freely adapted from the logician and philosopher W.V.O. Quine, cardinalists’ overpopulated universe offends the aesthetic sense of us who have a taste for desert landscapes. Their aspiration after pedantic preciseness abets a breeding ground for disorderly mathematical operations on data and risks that necessitate modesty.
Proposition 1: Deep uncertainty or case probability does not admit of degrees, but is a merely comparative notion.
However, we do not agree with Mises (1949) about the scope of case probability vs. deep uncertainty. While he claims that “[c]ase probability is a particular feature of our dealing with problems of human action” (Mises, 1949, p. 111) and, thus, that human action and choices lie outside the scope of classical (Kolmogorovian) probability theory, Mises remains short on providing us with a sufficient reason for this assertion (see research gap II).
Our strategy by contrast is twofold: We suggest that the class of human choices and actions is both too broad and too narrow for capturing uncertainty statements that cannot be expressed in probabilistic terms. It is too broad because we can reason about human action and choices probabilistically (see “decision-making under risk,” Luce and Raiffa, 1957, or Table 1 [the column in the middle] below). Admittedly, it can be argued that all decisions are made “under uncertainty” if one abstracts from clear-cut and idealized textbook cases, but if a decision problem is treated as a decision “under risk” (e.g., the probability of rain is 70 percent [according to the weather forecast]; shall I take an umbrella to work?), this does not mean, as Hansson (2011) clarifies, that “the decision in question is made under conditions of completely known probabilities. Rather, it means that a choice has been made to simplify the description of this decision problem by treating it as a case of known probabilities. This is often a highly useful idealization in decision theory” yet it is, at the same time, important to distinguish between those probabilities that can be treated as known and those that are genuinely uncertain.
The class of human choices and actions is also too narrow because what some (not all) human actions and choices intractable by probability theory is organized complexity (Weaver, 1948), as we argue below, and organized complexity characterizes many different systems, not only human action.
Proposition 2: Deep uncertainty emerges from highly organized and dynamic complexity.
In a classic and massively referenced article, Weaver (1948) distinguishes three significant ranges of complexity, which considerably differ from each other in the mathematical treatment they require. He offers a classification that separates simple, few-variable problems (or a small number of significant factors) of ‘organized simplicity’ at the one end from the ‘disorganized complexity’ of numerous-variable problems at the other, where the variables exhibit a high level of random behavior. This leaves ‘organized complexity’ sitting between the two extremes. The importance of this middle region does, however, not depend primarily on the fact that the number of variables involved is moderate—large compared to two, but small compared to the number of atoms in a pinch of salt. The hallmark of problems of organized and dynamic complexity lies in the fact that these problems, as contrasted with the disorganized situations where statistical or probabilistic methods hold the key, show the essential feature of organization (Weaver, 1948, p. 539). This in turn involves dealing simultaneously with a sizable number of factors which are interrelated to form an organic whole. Interactions and the resulting interdependence lead to emergence, i.e., to the spontaneous appearance of features that cannot be traced to the character of the individual system parts (Anderson, 1972), and, therefore, cannot be fully captured in probability statistics nor sufficiently reduced to a simple formula. Something more is needed than mathematical analysis or the mathematics of averages (Weaver, 1948, p. 540; Huberman and Hogg, 1986, p. 376).
Weaver (1948, p. 539) lists examples of problems of organized complexity where in each case a substantial number of relevant variables is involved that are varying simultaneously, and in subtly interconnected ways. In particular, the economic, but not only the realm of human action, is viewed as being within the realm of organized complexity (Klir, 1991, p. 119). Table 1 resumes the relationship between Weaver’s notions of complexity and the suitability of stochastic methods in terms of the respective status of probabilistic statements. It paves the way for bringing risk and its non-probabilistic form (deep uncertainty) as well as complexity, the latter as an answer to research gap II, together in one single scheme.
Table 2: A suggested taxonomy of uncertainties and complexities based on Weaver (1948).
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Figure 2: The disassembly of complexity: The unifying framework.
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We share the same ground with Mises (1949) and Knight (1921) when we are very wary about the predominance of probability statistics in the realm of economics and finance which is more characterized by case probability, that we presented as a merely comparative notion (Proposition 1), than by class probability. However, many outcomes of this study are not in accordance with the praxeological approach. In light of the two research gaps we singled out, we would like to highlight two instances:
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“Risk” should be grasped as Risk I, not Risk II.
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Not human vs. non-human action (or, phrased positively, human action vs. natural sciences, cf. Mises 1949: 107) decides on the applicability of probability theory, but a system’s degree of organized complexity where deep uncertainty arises from (Proposition 2).
If this study stimulates further controversy of how to conceive risk and identify the limitations of probability theory, as such debate is considered very important for the development of the risk fields (Aven, 2012, p. 34), it will already have served a useful purpose.
ABSTRACT: Murray Rothbard developed the concept of decision-making rent as a return to a kind of unhirable labor performed by the entrepreneur in his role as owner and ultimate decision-maker of the firm. Rothbard conceived owner’s rent as separate from profit and loss and the decision-making function as concerned with productive organization and technique, which is distinct from the function of forecasting uncertain future market conditions. Vlad Topan (2012) disputes Rothbard’s position and contends that ownership rent does not exist because decision-making ability is meaningless in the absence of uncertainty. In this paper, I argue that Topan’s critique rests on fundamental misconceptions about the nature of entrepreneurship in Austrian economics.
KEYWORDS: decision-making ability, decision-making rents, ownership function, entrepreneurship, firm JEL CLASSIFICATION: D20, D21, L20, L21, L26 Joseph T. Salerno (jsalerno@mises.org) is Academic Vice President of the Mises Institute.
I am indebted to David Gordon, Carmen Dorobăț, Matthew McCaffrey, and Mark Thornton for their very helpful comments and suggestions, which clarified and improved the argument of the paper. Responsibility for remaining errors or obscurities is mine alone.
Quarterly Journal of Austrian Economics 21, no. 3 (Fall 2018) full issue, click here.
Vlad Topan’s “Note on Rothbardian Decision-Making Rents” (2012) is a welcome and thoughtful addition to a neglected topic in the Austrian theory of entrepreneurship: what Murray Rothbard (2009) has dubbed the “decision-making” or “ownership” function of the capitalist-entrepreneur. This productive function had been recognized and discussed by Carl Menger, Eugen von Böhm-Bawerk, and Ludwig von Mises before Rothbard. Unfortunately, after the publication of Man, Economy, and State in 1962, the concept dropped out of the Austrian literature until the present author traced out the development of this concept in Austrian writings in his article, “The Entrepreneur: Real and Imagined” (Salerno, 2008).
The main thrust of Topan’s note is to deny Rothbard’s claim that there exists a specific form of income that is a return to the ultimate decision-making function of capitalist-entrepreneurs as property owners and is separate and distinct from their interest return as capital-investors and pure profit (or loss) return as entrepreneurial uncertainty bearers. In particular, Topan disputes Rothbard’s claim that the ownership function and its correlative income of decision-making rent has any place in the equilibrium conditions of the evenly rotating economy (ERE).
Despite the great degree of care and ingenuity that Topan puts into constructing his case, I believe that it rests on two fundamental errors.
First, Topan conflates Mises’s imaginary construct of the pure entrepreneur with what Mises (1998, p. 256) called the “entrepreneur-promoter” or simply “promoter.” The former, according to Mises (1998, pp. 253–254) is not a human actor but a single “definite function” that is embodied in “an imaginary figure” who is “propertyless” and whose only function is to bear risk. As such, for Mises the pure entrepreneur is a “methodological makeshift” designed to enable the economist to analytically isolate profit (and loss) from the interest earned on capital, both of which are inextricably bound together in the net income received by business owners and investors in the real world. In sharp contrast, Mises’s entrepreneur-promoter is a real actor who owns capital and puts it at risk by purchasing factors of production that he judges are undervalued relative to the prospective value of the future product they will yield. He is then obliged to efficiently combine these factors according to a technical plan in a time-consuming productive venture that he must oversee to completion. Indeed, Mises (pp. 254, 302) pointed out that it is not possible to think through the concept of a pure entrepreneur who owns no capital to a logical conclusion and he explicitly warned against the “error” of confusing the pure entrepreneur with the entrepreneur “in a living and operating market economy.”Rothbard (1997, p. 249) recognized and adamantly rejected Mises’s concept of the pure entrepreneur, “which treat[s] the entrepreneur as an entirely separate entity, and not just as the forecasting aspect of the activities of the capitalist or laborer.” In his own treatise, Rothbard (2009, p. 510) avoided the construct when analyzing the nature and causes of profit as a return to the function of uncertainty-bearing and spoke of “the active entrepreneurial element in the real world [that] is due to the presence of uncertainty.” Rothbard (2011, p. 285) also noted that Israel Kirzner’s conception of the pure entrepreneur, who owns no capital and earns profits essentially by arbitraging price differences, finds “a certain amount of textual justification in Mises.”
Topan (2012, pp. 76–77), however, ignores the distinction drawn by Mises between the two types of entrepreneur and, at the outset of his note, selects six quotations from Mises’s and Rothbard’s works which, because they are presented out of context, emphasize uncertainty-bearing while either completely ignoring or downplaying the role of ownership in the definition of the entrepreneur. In addition, at least four of these quotations refer specifically to the pure entrepreneur as Mises defined the term. Thus, for example, Mises (1998, p. 254) is quoted by Topan (p. 76) as follows: “The term entrepreneur as used by catallactic theory means: acting man exclusively seen from the aspect of the uncertainty inherent in every action.” But in the sentence immediately before the sentence quoted by Topan, Mises referred to this one-dimensional delineation of the function of the entrepreneur as being embodied in “an imaginary figure” that is a “methodological makeshift.” Moreover, in the very next paragraph following the one containing the quoted sentence, Mises (1998, p. 254) carefully demonstrated that this “imaginary construction of a pure entrepreneur” involves a logical contradiction, because he owns no property and, therefore, bears no risk!As Mises (1998, p. 254) described him,This [pure] entrepreneur does not own any capital. The capital required for his entrepreneurial activities is lent to him by the capitalists in the form of money loans.... Nevertheless, he remains propertyless for the amount of his assets is balanced by the amount of his liabilities. If he succeeds, the net profit is his, if he fails the loss must fall upon the capitalists, who have lent him the funds. Such an entrepreneur would, in fact be an employee of the capitalists who speculates on their account and takes a 100 per cent share in the net profits without being concerned about the losses.
The second quotation that Topan (76–77) draws from Mises (1998, p. 288) likewise refers to the pure entrepreneur and not the entrepreneur-promoter:
Like every acting man, the entrepreneur is always a speculator. He deals with uncertain conditions of the future. His success or failure depends on the correctness of his anticipation of uncertain events. If he fails in his understanding of things to come, he is doomed. The only source from which an entrepreneur’s profits stem is his ability to anticipate better than other people the future demand of consumers.
In the paragraph immediately preceding the one in which this passage appears, Mises (1998, p. 288) made it clear that he was here focusing exclusively on entrepreneurial profit and loss and how changes in the data bring about differences between the selling prices of products on the one hand and the sum of the prices of their factor inputs on the other. At the same time, he explicitly abstracted from how such changes “affect the sellers of labor and those of original nature-given factors of production and of the capitalists as money-lenders.” In other words, Mises was once again describing the pure function of entrepreneurship and not the integral, flesh-and-blood entrepreneur. Likewise, in two of the three passages that Topan (p. 77) quotes from Rothbard, Rothbard is clearly referring to the function of “entrepeneurship” or what he calls the “active entrepreneurial element” and not to the real property-owning capitalist-entrepreneur.
Topan’s first error leads to and is compounded by a second error. Jumbling up two different concepts of the entrepreneur at the start of his note and overemphasizing the single function of uncertainty-bearing predisposes Topan to ignore the distinct decision-making function that is inextricably bound up with the choice of the organization and technical combination of heterogeneous capital goods and labor factors, particularly management. Thus Topan (p. 79) argues:
Specifically, by introducing this additional distinct function of ownership and its subsequent (supplementary) form of remuneration/income, [Rothbard] ends up separating—something considered as a shortcoming in Kirzner—ownership from entrepreneurship. If this is not so, and if it is still the ownership function that also receives the profit/loss residuum, then we have a function with two incomes, a situation which violates the “one function—one income” principle implied in the theory of distribution. Not to mention the emptying of the catallactic function of the entrepreneur, that would remain without an income share.
This assertion betrays Topan’s single-minded focus on the function of the disembodied pure entrepreneur to the exclusion of the real person of the capitalist-entrepreneur who embodies a number of conceptually distinct “catallactic functions.” For Rothbard and Mises the “one function—one income principle implied in the theory of distribution” is not violated by recognition of a decision-making rent that accrues to the entrepreneur qua property owner. Nor does Rothbard, a la Kirzner, “separate ownership from entrepreneurship” by identifying a separate property-owning function, as Topan (p. 79) claims. For all three functions of the capitalist-entrepreneur involve property. The capitalist function is advancing property in the form of wages and rents to the factors of production; the specifically entrepreneurial function is choosing the factors and allocating them to the production of property in definite forms that are anticipated to facilitate the achievement of ends chosen in light of forecasts of uncertain future market conditions; and the decision-making or ownership function involves supervising and organizing the various elements of productive property into a coherent structure of means, i.e. the firm, according to known techniques in order to achieve the chosen ends in the most efficient way possible.
Let us clarify the argument by analyzing the concrete data that must inform the analysis of the functions and corresponding incomes of the capitalist-entrepreneur. Indeed, by noting that some entrepreneurs earn profits while others suffer losses, Topan implicitly recognizes that it is a datum of everyday experience and of human history that people differ greatly in their capacities to anticipate and adjust their actions to changes in the world that affect their ends and means. Without inserting this subsidiary empirical postulate into the chain of praxeological reasoning, it would be impossible to account for the fact that some individuals are better entrepreneurs than others.As Mises (1998, p. 256) put it, economics must take into account “the promoter concept” because “it refers to a datum that is a general characteristic of human nature.... This is the fact that various individuals do not react to a change in conditions with the same quickness and in the same way.... There are in the market pacemakers and others who only imitate the procedures of their more agile fellow citizens.” Topan presumably would agree too that praxeology must recognize the obvious fact that people have different time preferences and therefore that they save and invest different proportions of their incomes, accumulate greater or less capital and receive unequal amounts of interest payments in the real world and in the ERE. Topan would also surely grant that economic theory must proceed on the empirical observation that individuals vary in their skills, aptitudes, energy, motivation, and productivity with respect to different types of labor and therefore receive unequal wage rates in the real world and that such wage inequalities would persist in the ERE.
Topan inexplicably seems to balk, however, at incorporating into economic theory the mundane observation that business owners differ markedly in their levels of technical knowledge, mental and physical energy, clarity of memory, strength of purpose, supervisory abilities, communications skills, aptitude for calculating and interpreting financial data, etc. But surely these differences affect the quality of the decisions capitalist-entrepreneurs make in choosing and combining the concrete elements of their property into an integrated structure of means in order to achieve their ends, even if they all correctly forecast the value of these ends. It is these qualities that cause people to differ in what Rothbard (2009, p. 602) calls “for want of a better term... the decision-making function or ownership function.” As this function is described in the long passage Topan (2012, pp. 78–79) quotes from Rothbard, it is clear that it has nothing to do with uncertainty per se. Rather it deals with the ultimate technical, supervisory, and organizational decisions that a capitalist-entrepreneur alone must make with respect to the disposition of his productive property. It may help to clarify this concept by describing it in the familiar context of everyday life before addressing it in a business environment.
Suppose that someone is throwing a large party with a certain theme and ambience that she anticipates would greatly please her guests. She has formed a creative overall vision of the prospective party—the future “product” or end—and is aware of the concrete means necessary to realize her vision. But to prepare for the party rationally and efficiently, the hostess must use her existing knowledge, skills, and abilities in many diverse areas: menu selection; food preparation, including both the knowledge of recipes and the skills to execute them; selection of wines and other beverages that complement the meal; location, layout, and decoration of the “space” for the party; the timing of the food and beverage service; the music that best comports with the guests’ diverse tastes and with the theme of the party; the optimum number, selection, and seating arrangement of guests; the suggested dress; the crafting of attractive and informative party invitations and so on. The hostess also must attend to mundane matters like the sufficiency of bathroom facilities and toilet items, the adequacy of parking, and the proper sequestering of her children and pets.
In addition the hostess must actively supervise and make continual decisions relating to the coordination of the overall “flow” of the party as it proceeds, whether or not she decides to “outsource” one or more tasks to a party planner, caterers, a professional DJ, or bartender. These hired “managers” do not spontaneously coordinate their actions with one another and with the hostess’s overarching plan for the party. Moreover, she requires the interviewing skills and psychological insight necessary to accurately assess the technical competencies and work ethic of the personnel she is considering, as well as the leadership skills to motivate those she hires to engage with her in realizing her vision for the party.
To take a simple example, the party would turn out very differently depending on whether the hostess: suffered from a chronic illness and needed to take a nap midway through the party; were prone to overindulging in alcoholic beverages; were easily flustered by mishaps; or were healthy, vital, resilient and remained alert to every aspect of the party.
The point is that given the same resources and using the same standard of success, parties hosted by different people with varying knowledge, skills, aptitudes, capacities for mental focus and physical stamina would vary in success, even if they all could foresee exactly how the party would turn out as a result of their decisions. In other words, the variations in success of different hostesses need not be due exclusively to uncertainty-bearing, that is, anticipating and visualizing guests’ reactions to the theme and ambience of party; they may just as well be caused by disparities in their “ultimate decision-making ability” as owners of property.
We may even extend our fanciful party example to the ERE. Individuals of given but different decision-making abilities would host parties at regular intervals, purely as social events and not for monetary gain. Each would throw the same parties over and over again and the regularity of their purchases of party supplies would not upset market supply and demand conditions.There is nothing preventing economists from extending the ERE to an analysis of household activities because it is a mental construct of their own making. As Mises (1998, p. 248) pointed out, the ERE is consistent with many different assumptions so long as they do not disturb supply and demand conditions. Thus, he wrote, “Only such change as do not affect the configuration of price-determining factors may be considered in its [the ERE’s] frame…. We are free to assume that infants are born, grow old, and finally die, provided that total population figures and the number of people in every age group remain constant.” Elsewhere Mises (2003, p. 16) remarked:A theory of action could conceivably be constructed on the assumption that men lacked the possibility of understanding one another by means of symbols, or on the assumption that men—immortal and eternally young—were indifferent in every respect to the passage of time and therefore did not consider it in their action. The axioms of the theory could conceivably be framed in such universal terms as to embrace these and all other possibilities…. We forgo these possibilities because conditions that do not correspond to those we encounter in our action interest us only in so far as thinking through their implications in imaginary constructions [e.g., the ERE] enables us to further our knowledge of action under given conditions. [Emphasis added.] They would all know the future perfectly but some would be renowned as great hosts or hostesses, others as relatively inferior ones. However, all those who host dinner parties would of course enjoy a surplus of satisfaction gained over satisfaction sacrificed in the foreclosure of other consumption opportunities to use the resources devoted to the party. As with spending on all consumption activities, the marginal utility of the end chosen would exceed that of the end foregone. Furthermore, these psychic “rents” to party hosts would persist in the ERE, although there would be no monetary or other objective expression of them and no method of comparing their magnitudes between different people.
What is true of owners of property in the service of extra-catallactic ends is also true of business owners. Now, given that the differences in decision-making abilities among individuals in household and business activities are a datum of human action—although these abilities admittedly may develop over time in the real world of change as a result of practice, experience, or formal instruction—we are free to assume that they exist and are frozen in the ERE. In business, the differential monetary rents to decision-making ability derive especially from owners’ organizational skills, technical knowledge and psychological insight although more mundane qualities such as health, physical energy, and aptitude for financial calculation may also affect such rents. Surely these personal qualities influence how successful the owner of the firm is in organizing and adapting the diverse yet complementary elements of his property to his entrepreneurial forecasts of future market conditions. Furthermore, the owner is unable to divest himself of the ultimate decision-making function even if he delegates most or all decisions about technology, organization and personnel to hired managers and technicians. This is not to deny, of course, that to the extent that the owner performs routine technical or straightforward managerial tasks that can be performed by hired labor, he is functioning as a pure laborer rather than as an owner making ultimate decisions about his property and is earning normal wages rather than special ownership rents.
In a neglected article published in 1935, M. M. Bober (1935) presented an enlightening discussion of the entrepreneur-owner’s crucial and undivestible function, while recognizing that it would continue under static conditions and earn a rent. Bober’s aim in the article was to connect the short-run and long-run analysis of the size of the firm and explain the U-shape of the long-run average cost curve by identifying the factor that remained fixed even in the long-run. This factor was the ultimate decision-maker or the “entrepreneur,” whom Bober (1935, pp. 81, 83) characterized as the “fixed factor at the apex of the whole structure” of the firm whose “personality and... power [becomes] diffused over a wide area” as the firm grows in size. Bober continued:
That some managerial operations can be delegated admits of no doubt; but there remains a solid substratum of activities that must emanate from one final source of authority and responsibility, and not only under dynamic conditions but under static conditions as well.... Officers and foremen die or resign, and new ones are to be selected; security issues mature, and the problem of financing reappears; short-term loans are recurrently made, and dealings with bankers are involved.... There is also the important problem of supervision, and the greater the differentiation and delegation of powers the more vital is the problem. Furthermore, it is difficult to assume that the bearer of final responsibility can afford to play hide and seek with static conditions, disappearing from the scene or relaxing in the tasks while static conditions prevail, and assuming the helm only when the industry is undergoing alterations.
Bober (1935, p. 83) also saw that entrepreneurs of “infra-marginal” firms earn differential rents depending on their abilities and these rents exceed the rent that “will suffice to attract into the industry the marginal entrepreneur.”Unfortunately, Bober (1935, pp. 83–84) was under the influence of the perfect competition doctrine. And, although he did recognize the distinction between static and dynamic conditions, he mixed up profit and decision rent. He also treated the latter as a cost to the firm just like differential rents to hirable factors, despite the fact that he seemed to discern that the ultimate decision-making function was unhirable.
Let me now turn to an analysis of Topan’s specific critique of Rothbard’s concept of decision-making rents. Citing several passages from Rothbard’s work, Topan (2012, p. 80) comments, “Rothbard seems to assimilate... the income of decision-making to a type of wage, and to view decision-making ability as some sort of labor.” But Topan (2012, pp. 80–81) notices a “tension” in Rothbard’s use of the concept. The tension arises, according to Topan, because on the one hand, decision-making is “logically antecedent” to labor but on the other it is a “special type of labor” requiring “some unique ability or talent.” But I suggest that this tension is merely semantic and not substantive. In suggesting a name for the function, Rothbard (2009, p. 610), as we saw, was not completely comfortable with the term “decision-making,” prefacing his suggestion with “for want of a better term,” and then offering “property-owning” as a possible alternative designation. Furthermore, in the passages that Topan (2012, pp. 82–83) cites as evidence to support his point, Rothbard repeatedly and clearly characterizes the decision-making function as “a certain kind of labor,” “an attribute of a labor factor” and the return to this factor as “wages of decision-making.” Viewed in context, there is no tension in Rothbard’s concept of the decision-making function. It is a unique kind of labor factor that is not separable from property ownership and therefore can never be hired.Topan (2012, p. 85) is therefore simply wrong in his claim that Rothbard rejects the idea that the decision-making function is “a special subcategory [of labor], special enough so that it deserves a separate and dedicated catallactic function, together with a form of income.” The passage in Rothbard (2009, p. 565) that Topan cites to support his claim clearly refers to the illicit distinction between the workers and the managers of the firm, both of whom are “hired by its owners.” (Emphasis added). In contrast to hirable labor, technically it has no market and, hence, no implicit wage, which is why Rothbard (2010, pp. 602–603) formally dubs its return a “rent” rather than a “wage.”Rothbard (2009, p. 559) draws the distinction between wage and rent as follows: “A wage is the term describing the payment for the unit service of a labor factor. A wage, therefore, is a special case of rent; it is labor’s ‘hire’.” (Emphases in the original.)
Topan raises an important point when he notes that, according to Rothbard’s analysis, the rent of any factor employed in production must be positive to induce its owner to participate in production. But what, asks Topan (2012, p. 84), is being rewarded by these positive rents when a firm’s owner qua entrepreneur suffers losses as a result of erroneous judgment of future market conditions? Does the decision per se generate a positive rent, even though it is an “uninspired decision” penalized by entrepreneurial losses? Topan answers in the negative and concludes that the Rothbardian concept of decision-making must imply “successful decision-making.”
As we saw above, however, for Rothbard, the owner’s “decision-making function” does not involve entrepreneurial decisions made under uncertainty. In fact, it is the application of a special type of labor, the oversight and stewardship of one’s productive property used by the owner or hired labor for a specific purpose. These decisions are not to be deemed successful or unsuccessful, but, like all “decisions” to expend labor of any kind, better or worse in terms of the physical quantity and quality of the product. In this sense, employing the same ingredients, recipe, cooking utensils, and kitchen appliances, my wife makes better “decisions” than I do in baking cookies. This outcome has nothing to do with uncertainty of the future but to existing differences between our baking skills. To extend the example to the market realm, a bakery owner deciding between employing me or my wife as a baker would need the technical expertise and insight to judge the present differential between our baking skills. If he hires my wife, his decision will generate higher owner’s rent than if he hires me.
Topan’s attempt to subsume the decision-making function and owner’s rent under entrepreneurship and profit may be criticized from another angle. Suppose that due to gross technical ineptitude the owner of specific means of production is unable to bring his product to the market. For example, the bakery owner above hires a baker whose cakes fail to rise and cookies turn out too hard to chew and the output is disposed of as waste. Surely in this case the failure is purely technical and there would be no question of earning a profit or loss because there is no product supplied on the market and entrepreneurial forecasting does not enter into the matter.I am indebted to David Gordon for this point.
Topan (2012, pp. 84–85) further argues that supposing that rents, like profits, can be positive or negative—as they would be if they were judged by the binary criterion of successful/unsuccessful—then the relationship between rents and profits would be unclear because both pertain to ownership. If decision-making alone pertains to ownership, Topan contends, then entrepreneurship as uncertainty bearing would be an empty concept. Alternatively, if the decision-making function is bound up with uncertainty-bearing, then, contrary to Rothbard’s view, nothing remains of the function in the ERE, from which uncertainty has been banished.
Topan’s arguments on these points betray a failure to fully grasp Rothbard’s rent theory. Rothbard (2009, pp. 559, 571–572, 694) maintains that only rents of factors actually used in production, whether marginal or supramarginal, must be positive. Submarginal factors like desert land, mines with the least accessible ore deposits, or potential laborers who suffer from severe mental or physical disabilities would earn zero rents in the ERE. Likewise, business owners who are inadequate as decision-making stewards of their productive property would incur such high production costs that their firm’s return in the ERE would fall short of the natural rate of interest. Such firms, of course, would not be in business in equilibrium. There would thus be submarginal decision-makers who are earning zero—never negative—rents in the ERE precisely because they are not operating firms.As Rothbard (2010, p. 603) points, out, even marginal firms operating in the ERE earn positive decision rents:[T]he marginal land earns some rent, even if ‘close to’ zero. Similarly, the marginal firm earns some rent of decision-making ability. We can never say quantitatively how much it will be, only that it will be less than the corresponding ‘decision rents’ of the supramarginal firms.
For Rothbard, then, decision-making rents in the ERE, like the rents of land and hirable labor factors, are completely independent of entrepreneurial profits under dynamic conditions. While Rothbard does not explicitly discuss the variation of pure profit and owner’s rent in the real world of uncertainty, Mises did so in some detail. Like Rothbard, Mises (1998, p. 288) maintained that the uncertainty-bearing and ownership functions are conceptually separate and distinct, warning, “One must not confuse entrepreneurial profit and loss with other factors affecting the entrepreneur’s proceeds.” He thus distinguished the “specific entrepreneurial function” which involves “determining the employment of the factors of production” from the entrepreneur’s personal “technological ability” including his “ability to hire adequate helpers.”
For Mises, therefore, “specific entrepreneurial profit or loss” is not influenced by the quality of the owner’s technological ability, which differs between owners and earns higher or lower “wage rates or quasi-wage rates.”Note that Mises, too, is reluctant to apply the unqualified term “wage-rates” to the entrepreneur’s undivestible technical function. For example, entrepreneurs of inferior technical ability in the bottling industry will experience more bottles bursting per given quantity filled in their plants than in more efficiently run plants. However, as Mises (1998, p. 189) pointed out, this reduces physical output and raises production costs, but “does not affect entrepreneurial profit and loss.” According to Mises, the owner’s knowledge of productive techniques is better or worse, but not uncertain. Thus Mises (1998, pp. 189–190) argued that if the risks of accidents are insurable, they
...do not introduce uncertainty into the conduct of the technological processes. If an entrepreneur neglects to deal with them duly, he gives proof of his technological insufficiency. The losses thus incurred are to be debited to bad techniques applied, not to his entrepreneurial function.... [T]he specific entrepreneurial profits and losses are not produced by the quantity of physical output.... What produces them is the extent to which the entrepreneur has succeeded or failed in anticipating the future—necessarily uncertain—state of the market.
In the real world, then, owners of going concerns always earn decision rents, which are part of the composite return to capitalist-entrepreneurs intermingled with profit and interest. Contrary to Topan, to recognize that pure profit and ownership rent together determine the success or failure of the firm under dynamic conditions is not to deny that they are functionally independent of one another. Mises (1998, pp. 289–290) is especially emphatic on this point:
The elimination of those entrepreneurs who fail to give their enterprises the adequate degree of technological efficiency or whose technological ignorance vitiates their cost calculation is effected on the market in the same way in which those deficient in the performance of the specific entrepreneurial functions are eliminated. It may happen that an entrepreneur is so successful in his specific entrepreneurial function that he can compensate losses caused by technological failure. It may also happen that an entrepreneur can counterbalance losses due to failure in his entrepreneurial function by the advantages derived from his technological superiority or from the differential rent yielded by the higher productivity of the factors of production he employs.... The technologically more efficient entrepreneur earns higher wage rates or quasi-wage rates than the less efficient in the same way that the more efficient worker earns more than the less efficient.
In sum, although owner’s rent of an operating firm is always positive, a firm may fail because either: the rents may be insufficient to offset entrepreneurial losses; or the inferiority of decision-making ability compared to that of other owner-entrepreneurs in the industry may result in a relatively high cost structure that wipes out any pure profit and drives the firm’s net return below the natural interest rate. We thus must reject Topan’s claim that Rothbard’s concept of decision making refers “to uncertainty bearing and overcoming.” His contention is based on confounding specifically entrepreneurial “decision making,” which refers to adjusting production to uncertain future market conditions, with “decision making” aimed at efficiently supervising and coordinating his existing property in light of his present production plan.
Topan (2012, p. 86) makes one final attempt to eradicate the owner’s decision-making as an independent category of economic theory by subsuming it under “entrepreneurial judgments,” which he asserts “must be as specific as possible.” By this he means that such judgments should be understood as “referring to particular circumstances of time, place and persons from the future.” But here Topan all but concedes the point. Owner’s decision making, in Rothbard’s and Mises’s view, refers to judgments of present labor skills, productive techniques, and organizational structures, as noted above.
Topan (2012, p. 87) recognizes that if the ownership function is completely eliminated from economic theory, as he advocates, then he must provide an alternative explanation for the ubiquitous phenomena of high-cost versus low-cost firms. He suggests but downplays the possibility of entrepreneurial errors because these would generate cost differences “of a rather ephemeral nature.” The “more lasting” inter-firm cost differences, he attributes to different preferences for non-pecuniary income among “skillful entrepreneurs” who may, for example, choose an inferior location for their enterprise because of its proximity to their home. But, here again, Topan is admitting owner’s rent into his analysis by the back door. For, unless the entrepreneur is purchasing the land for speculative purchases, his choice of the site is based on his technical knowledge of what constitutes a superior or inferior location for the production of a specific good to be sold on an uncertain future market. He would thus be trading off part of his decision rents rather than entrepreneurial profits for the psychic benefits of a short and pleasant commute to work.
In conclusion, I do not believe that Topan has succeeded in establishing his case that Rothbard’s concepts of the ownership function and its corresponding income of decision-making rent have no place in economic theory. On the contrary, these concepts are essential to comprehending the role of the capitalist-entrepreneur in real-world markets.
Translator’s Note: This review of Frank Fetter’s textbook by Joseph A. Schumpeter was brought to my attention by Dr. Matthew McCaffrey of the University of Manchester, who suggested a translation. It was originally published in German in volume 17 of the leading Austrian journal in economics in the early 20th century: Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung (Journal of Economics, Social Policy and Administration). The journal was edited by some of the most eminent economists of Austria at that time, namely, Eugen von Böhm-Bawerk (1851–1914), Theodor von Inama-Sternegg (1843–1908), who had passed away shortly before the publication of volume 17, as well as Eugen von Philippovich (1858–1917), Ernst von Plener (1841–1923) and Friedrich Freiherr von Wieser (1851–1926). The discussion of Fetter’s text is part of a series of nine book reviews by Schumpeter contained in this volume. In them, he discussed new publications in the English, French and German literatures, including E. R. A. Seligman’s Principles of Economics, William Stanley Jevons’s unfinished, posthumously published Principles of Economics, A Fragment of a Treatise on the industrial mechanism of Society and other Papers, Léon Polier’s L’idée du juste salaire (The Idea of the Just Wage), and H. von Leesen’s German language biography of Frédéric Bastiat.
The review of Fetter’s Principles is the last one of this series, and is also the most laudatory. Schumpeter emphasizes that the book is more than merely a textbook, and he highlights the close connection between Fetter’s theory and the economics of the Austrian school. The review is therefore of interest from the vantage point of the history of economic thought. In particular, Schumpeter recognizes the importance of Fetter’s classification of entrepreneurial activity—the “enterpriser’s function” in Fetter’s words—as just another form of labor. Without going into any detail, Schumpeter hints at the extremely important social implications suggested by this view, but then proceeds to provide a brief rejection of this position from the perspective of pure economic theory.
Karl-Friedrich Israel
Review 9: Frank A. Fetter, The Principles of Economics, with Applications to Practical ProblemsNew York: The Century Co. (1905)Joseph A. SchumpeterZeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung, Band 17, pp. 415-420 (1908).
This book surely deserves special attention, not only as a textbook that is rich in content, but also as a scientific achievement. Once again, the focus lies on theory, which is entirely based on the phenomenon of value. This is clearly brought to the reader’s attention already by the structure of the book, which is oriented towards value. As such the endeavor is to be appreciated, since, if one is to base it on only one principle, it means a step towards the unification of the edifice of our science. However, by analyzing still other things besides pure theory within the same system—if one tries to fit everything into the same scheme—one is expecting too much of this value foundation. The first part [of the book] is entitled “The Value of Material Things” and provides a doctrine of needs, an introduction to the law of marginal utility, and other basic aspects in much the same way as most “psychological” economists would present them. These outlines, which are very attractive and clear, strike a chord with those of the proponents of the Austrian school. Indeed, Fetter is much closer to the latter than the other American theorists.
The law of diminishing returns takes a back seat and appears almost solely as a formal concession to American practice when it is given a special chapter in the section on fundamental concepts. Similarly, it is merely a terminological measure without any substantive significance when the author expands the term rent to every physical and value gain. In connection to the latter we should point to the elegant term “psychic income,” which surely deserves further use. Here, we would like to complain about just one point. The term is defined as a form of total utility, given by the product of the quantity of a good that an economic agent owns and its marginal utility. This notion of total utility can be found quite frequently in the works of notably non-mathematical theorists. It is based on the assumption that, in any given moment, all units of the good are valued equally according to their marginal utility, and hence that the total value of all available units is given by the sum of the equal values of each unit, just like the total quantity is given by the sum of the units. But this is certainly an erroneous belief. From the fact that all of the single units available at the same time are valued equally, it does not follow that the value of several of these units is equal to the sum of their single values. Instead, when it comes to the value of several units, needs of higher intensity become important that do not influence marginal utility as such, which is only determined by the least urgent need, and each time presupposes the satisfaction of the more urgent ones. This, however, is contested when we deal with larger quantities, and when evaluating the latter this needs to be taken into account. Only one unit is valued at the margin. All the others are given higher value, namely, that marginal value that would prevail without the units already given a lower value. Each unit must be given a different marginal value from which we can calculate the sum. But this means nothing else than that the total value is an integral.
The next “Division,” entitled “Capitalization and Time-Value,” starts with a theory of money. Little by little, as the result of a long discussion, a robust theory of money smoothly breaks fresh ground. Fetter’s theory points in the right direction, as this sentence shows: “money in all its money uses is an indirect agent to be judged just as other indirect agents are.”Added by translator: (Fetter 2003, p. 63). This is indeed a very useful starting point. It just goes a bit too far to use the notion of money as a tool not merely as an analogy, but to take it completely seriously and speak in the same way about income earned from the ownership of money as income earned from the ownership of a tool.
We now turn to the notion of capital and the theory of capitalization. The former is characterized by its clarity. Fetter rejects Clark’s separation of capital and capital goods. What is said about capitalization is entirely up to date. The derivation of the value of capital from the value of the return is nicely illustrated with the example of the purchase of rent-charges.Added by translator: (Fetter 2003, ch. 15). This may be the most attractive presentation of the topic, and to have clarified it, one of the largest advances in modern theory is.Added by translator: Schumpeter’s original syntax truly resembles the style of Master Yoda here. It is as unusual in the original German as it would be in English today, although it might have been a stylistic device in Austria at the time. The original reads: “Es ist das vielleicht die anziehendste Darstellung dieses Themas, das klargestellt zu haben, einer der größten Fortschritte der modernen Theorie ist” (Schumpeter 1908, p. 417). Then again, it may simply be a mistake. In that case, the translation does justice to it. If not, it was worth a reference to Yoda. Only one thing is not quite in order. Prof. Fetter seems to regard the discounting of future revenues as a matter of course, and only tries to determine the magnitude of the discount factor. This is not proper. Moreover, the way in which the “Time-Discount” is determined is not quite satisfactory. Following this, more practical explanations follow which are suited to facilitate the beginner’s understanding of the processes involved in financial reality.
Next, the author addresses the subject of interest on money loans and treats it in the Böhm-Bawerkian spirit, in order to provide an elaborated and sound “Theory of Time-Value.” The following chapter is also very useful: “Relatively Fixed and Relatively Increasable Forms of Capital.” Less satisfactory is the treatment of the relationship between the interest rate and savings activity. Apart from the fact that only detailed statistical investigations could definitely solve this problem, it is already shown by everyday experience—and besides also the new theory—that savings cannot be considered a simple function of the interest rate and that deviations are merely due to secondary causes, as Fetter seems to suggest.
The second part is entitled “The Value of Human Services” and contains first of all a theory of wages and then a theory of enterprises and entrepreneurial profit. Most of what is presented here has little to do with the principle of value. Strictly speaking, this classification only fits to the few words on the pure theory of wages. The latter assumes that labor is an economic good, a starting point which is ever more generally considered to be useful, but does not lead very far.
The author covers the topic of “The Supply of Labour,” by which is meant the theory of population. He truly attempts to overcome the hidden complexity, which makes this area one of the darkest of political economy. But this attempt only shows how little can be said about the problem from our point of view, and to what extent the answers must lie with other sciences.
Fetter begins with biological facts, but of course, what he offers is neither complete nor does it guarantee scientific reliability. Besides that, already the first lines [of this discussion] contain a number of unproven assertions, some of which surely must surprise us, such as that humans have overcome the stage in which natural forces blindly determined their reproduction, and that in “earlier stages” one had merely sought to keep the population at a certain level, that war used to be the normal condition of the peoples, and many more, points about which the appointed expert in the field would surely shake his head in disbelief. We use this occasion to express our conviction that the omission of such territory would be one of the most urgently needed reforms in the system of economics.
The following chapters, like the one called “The Law of Wages” or the one on “The Relation of Labour to Value,” are of economic nature. The latter is very close to Böhm-Bawerk’s thought and goes to show that this theory is increasingly gaining recognition.
A correct and calm outline of the rather accepted modern views on the iron law of wages and the wages fund doctrine closes the theoretical part of this “Division,” the rest of which deals with aspects that are usually explained in reference to the theory of wages, albeit there actually is no deeper connection, for example, wage systems, the progress of the working classes, trade-unionism etc.
The second “Division” of this part is entitled “Enterprise and Profit,” where the latter term refers to entrepreneurial profit in the narrower sense. Again, we wish to direct the reader’s attention to the original systematization of the book, which it would possibly be worthwhile to imitate. The theory of distribution would accordingly not form a separate topic, the claim to which it has lost as soon as one realizes that incomes are merely instances of price and value phenomena, at least in so far as their sheer economic nature is under consideration. We see such as approach here: interest and rent fall under “The Value of Material Things,” so that in this section there only remains to be explained the value of human efforts, which for several reasons the author wishes not to conflate with material goods. For this classification to be complete, all the incomes, except the two mentioned, must thus be explained as the results of human labor. Therein lies not only an economic but also a very important social theory, which we cannot further explain here. The most important purely economic implication of this view is that entrepreneurial profit is based on labor, that is, more precisely the entrepreneurial profit in the narrower sense, which, as is well-known, has to be separated from the entrepreneur’s salary.Added by translator: Schumpeter uses the term ”Unternehmerlohn“ (Schumpeter 1908, p. 419), which seems to be translated best as “entrepreneur’s salary” or “employer’s salary.” Fetter mentions a number of qualifications that are necessary to perform this particular kind of labor and seems to explain the extent of entrepreneurial profit exclusively from their scarcity.
This implies that entrepreneurial profit must be as much a regular phenomenon as wages, interest and rent, and that its tendency to disappear, ascribed to it by pure theory, does not exist.
It seems to us that this theory, which has already often been advocated, is not tenable for the following reason: if one is to explain an income from the value and the price of an effort, it is necessary that supply and demand enter into a price battle on the market with mutual over- and underbidding to set a price to which the theoretical exchange scheme fits. The latter becomes useless, however, as soon as the process is different, which is the case here. One must not confuse a general ethical judgment of the entrepreneurial function in the social production process with those individual valuations that determine price formation. The entrepreneur does not appear on the market in order to sell at a fixed rate his entrepreneurial effort to the workers, capitalists, landowners or the consumers, or to society as such.
The lack of the latter is precisely the characteristic element. The imagined buyer of entrepreneurial effort, whoever it may be, is not even capable of forming an opinion about the price that he pays, and so he is incapable of comparing it with the utility he expects from the entrepreneurial effort. The entrepreneur appears on the market not to sell his effort, but to sell goods. Moreover, he buys production goods and pays their owners, so that he stands on the opposite side of the workers, capitalists, and landowners. The principle of value thus breaks down when it comes to the income of the entrepreneur. In addition, the latter is not nearly as steady a phenomenon as the other sources of income. One tends to express this fact quite often in contrasting entrepreneurial profit as a “dynamic” source of income with the three “static” ones.
In fact, the distinction between static and dynamic is meanwhile generally accepted and represents in my eyes one of the major advances in new economic theories. We have sorely missed this distinction in Professor Fetter’s system.
Thereafter, the author discusses the phenomenon of monopoly. In doing so, the whole exact monopoly theory, one of the best in pure economics and surely not without some practical relevance for that matter, is omitted. After some brief remarks of very general nature, Professor Fetter proceeds directly to the discussion of organization and especially the problem of trusts. What he says about this is certainly very useful. The data provided are also very instructive for the beginner. Short remarks on speculation and crises close this part.
The third part is very rich in content and very well suited as an introduction to economic policy, especially for the American student.
Another aspect has to be mentioned, namely, the appendix of questions and critical notes, which seems to be a very practical didactic device. Indeed, the American method of education is very different, and one can hardly compare American or English classes with our seminars. Nonetheless, such a collection of questions seems to be very appropriate for our study programs too.
[Full issue of the Quarterly Journal of Austrian Economics 20, no. 4 (2017)
Public Policy, Productive and Unproductive Entrepreneurship: The Impact of Public Policy on Entrepreneurial OutcomesEdited by Gregory M. Randolph, Michael T. Tasto, and Robert F. Salvino Jr.Cheltenham, U.K.: Edward Elgar, 2017, 176 pp.
Entrepreneurship is a double-edged sword. On the one hand, it has become almost universally recognized over the past few decades that entrepreneurship is the engine of economic change, the generator of economic growth, and the main cause of job creation. Consequently, policy is often used in different ways to support entrepreneurs to thereby create benefits from the positive effects of entrepreneurship.
On the other hand, as William Baumol (1990) famously identified, the outcome of entrepreneurship is not necessarily productive and a boon to the economy. Rather, entrepreneurship can be both productive and unproductive—and even destructive—depending on the institutional framework in which it takes place. Where the institutional “rules of the game” (North, 1990) can themselves be exploited for profit, entrepreneurs find themselves in a zero-sum game competing for the privileged position without producing value for consumers. Similarly, the framework for entrepreneurial action can be a source of uncertainty that harms the functioning of the market process (Bylund and McCaffrey, 2017).
Using policy to support entrepreneurship, therefore, is a balancing act between helping facilitate productive entrepreneurship while avoiding incentives that lead to unproductive behavior.
The recently published collection of essays Public Policy, Productive and Unproductive Entrepreneurship: The Impact of Public Policy on Entrepreneurial Outcomes aims to shed light on how public policy impacts entrepreneurial outcomes. The underlying yet implied question, with obvious policy implications, is this: under what circumstances does entrepreneurship contribute to raising our standard of living? To use Russell S. Sobel’s words from the foreword, the book’s eight essays “highlight both the potential and actual negative consequences of policies that encourage unproductive entrepreneurship” (pp. xii–xiii).
In the first essay (chapter 2) following the editors’ introduction, Joshua C. Hall, Robert A. Lawson, and Saurav Roychoudhury argue that economic freedom is critical to create an “entrepreneurial environment,” that is, an economic culture within which entrepreneurship thrives. Relying on insights from the Economic Freedom of the World reports, the authors demonstrate that economic freedom is empirically correlated with many measures of entrepreneurship. And, consequently, they conclude asking “would it not be prudent to at least consider eliminating the various government policies that stifle [entrepreneurship]?” (p. 7)
The second essay, by Pavel A. Yakovlev and Saurav Roychoudhury, analyzes the effect of specific types of regulatory burdens on business of varying sizes. They also argue that there is a link between migration and entrepreneurship, as both involve risk taking, and thus that countries that offer an institutional environment that facilitates entrepreneurship can benefit from both domestic and immigrant entrepreneurs.
The book’s third essay looks at the relationship between regulation and entrepreneurship from the point of view of the regulator. The authors, James Fetzner and Gregory M. Randolph, provide an overview of challenges that regulators face due to the nature of the political process with respect to the design, implementation, updating and reforming of regulations.
Chapter 5 studies committee-based efforts in the United States Congress intended to increase entrepreneurship by supporting small business growth. The real effect, however, as revealed by the studied data, is that states represented on these committees experience lower levels of entrepreneurship. The author Matt E. Ryan concludes the chapter by noting that this suggests that “more politics leads to less entrepreneurship” (p. 76)—even though the intended effect is the exact opposite.
In chapter 6, Michael T. Tasto looks at how state spending on firm recruitment and economic development programs affect employment and find a positive relationship. States that do not spend on similar programs consequently lose and may thus be compelled to create such programs while other states increase their spending to stay ahead in a “race to the bottom.” Also, the author argues, such state-level spending can be taken advantage of by entrepreneurs engaging in unproductive or destructive behavior to capitalize on the offered subsidies.
The next essay is a transcript of Peter G. Klein’s testimony before the US House Committee on Financial Services in May 2012. Klein analyzes the Federal Reserve from the point of view of organizational economic theory offering a “reasonable, pragmatic, realistic view” (p. 108) of the central bank. The essay thus focuses on a specific institution and its implications for entrepreneurs, finding it both inefficient and ineffective.
The second to last essay introduces morality and human nature in the analysis of regulations. Authors Robert F. Salvino Jr. and Michael Latta argue that “Morality and economic actions may converge, but for this to be so over the long-run, the actions and their desired outcomes cannot violate human nature” (p. 111). They find that individuals need to be free to engage in economic actions to thereby “express and defend his or her moral purpose.” This applies to policy as well, as policy designed without regard for economic and moral costs disrupts rather than supports entrepreneurship.
In the final chapter, Gregory M. Randolph and Marek Rivero discuss informal institutions and entrepreneurship. The development and evolution of informal institutions remains understudied in the literature and these processes are thus poorly understood, which is problematic for policy making. The chapter discusses the definition, measurement, and analysis of informal institutions, and what this means for policy.
Overall, the book offers little that would surprise Austrians or economists used to public choice analysis. The chapters elaborate on and analyze the measurable burden of regulation on entrepreneurship using various types of data, but do not venture far from the near-obvious (to praxeologists) unintended consequences of policy or inefficiency of policy-induced reallocation of resources. The chapters also do not make any theoretical contributions regarding how entrepreneurship and policy are (inter)related.
But this is not the purpose of the book and should therefore not be considered a major weakness.
This collection of essays is best described as a primer on the topic indicated in the book’s subtitle: the impact of public policy on entrepreneurial outcomes. Each of the eight essays targets a specific aspect of policy effects on entrepreneurship, and they each contribute in their own way to the common conclusion that entrepreneurship is a double-edged sword that can be both productive and unproductive—depending on the institutional rules of the game. And they paint a broad yet consistent picture that should be of great help to those familiarizing themselves with the study of entrepreneurship and policy.
(Excerpt from chapter 17 of Mises: The Last Knight of Liberalism, pp. 770–73.)
It was through the writings of Carl Menger and Eugen von Böhm-Bawerk that Mises had come to understand the market economy as a rational social order in which all factors of production are geared toward the satisfaction of consumer wants. Not only the allocation of the production factors, but also the incomes of the owners of these factors ultimately depended exclusively on their relative contribution to the satisfaction of human wants. All values, all prices, as Frank Fetter had put it, depend on a daily referendum in the market democracy.“The market is a democracy where every penny gives a right of vote.” Frank A. Fetter, The Principles of Economics (New York: The Century Co., 1905), p. 395. A few pages later he states: “So each is measuring the services of all others, and all are valuing each. It is the democracy of valuation” (p. 410).
But in none of his predecessors did Mises find a satisfactory account of the process through which the structure of production was brought in line with consumer preferences. His fellow Böhm-Bawerk seminar member, Joseph Schumpeter, had brilliantly shown how entrepreneurs drive the market. According to Schumpeter’s Theory of Economic Development,Joseph A. Schumpeter, Theorie der wirtschaftlichen Entwicklung (Munich: Duncker & Humblot, 1911). entrepreneurs are innovators who constantly interrupt the smooth operation of an inert economy.
Schumpeter had a point. Innovation does play a central role in the market economy. But how does this fit with the Mengerian picture of the market economy as a rational social order? Was there a contradiction between the Schumpeterian notion that entrepreneurs reap profits for innovation and the Mengerian insight that all incomes depend on consumer wishes? In Nationalökonomie, Mises reconciles Schumpeter with Menger. From Schumpeter, he adopted the idea that entrepreneurs are the motor of the market process. But they cannot earn a profit for innovation per se — only for innovations that improve the satisfaction of consumer wants.
Entrepreneurs constantly adjust the structure of production to what they expect will be the future preferences of consumers. The different entrepreneurs act in effect as advocates for different consumer needs. Based on their estimates of what they expect to obtain for an imagined product in the future, they go to the factor markets where they compete with other entrepreneurs, bidding up prices for the available factors of production—workers and material supplies. This pricing process determines the incomes of all factors of production, and it ensures that only the most important investment projects (“important” in terms of future consumer spending) will be realized.
The driving force of entrepreneurship is the profit motive. Profit is the specific remuneration a person receives for bearing uncertainty. In the market economy, entrepreneurs act with due caution and responsibility because they are personally liable for any wrong decisions. Loss is the punishment for unsuccessful entrepreneurship. Profit and loss are together the measure of entrepreneurship.
Are all businessmen entrepreneurs? Are all entrepreneurs businessmen? If not, how could entrepreneurs be distinguished from “regular” businessmen and other market participants? Mises answered these difficult questions by defining entrepreneurship as a social function, namely, as the function of assuming responsibility for the uncertainty of the future. The entrepreneur in Mises’s theory is not a person but a role played by people — and it is not at all limited to businessmen. Ultimately anyone can be an entrepreneur to the extent that he assumes the repercussions of uncertainty. Profits and losses do not only determine the income of businessmen, but also of wage-earners and capitalists. They always come mixed with specific factor incomes such as wages and interest.
One of the great problems Mises had to solve in this theory was to give a precise definition of profit and loss. In particular, he had to distinguish profit and loss from interest. His solution was that profit and loss were the results of human error. In other words, profits and losses can only exist in situations of disequilibrium. In contrast, money interest ultimately springs from time preference and has nothing to do with whether the market participants make good or bad decisions. Money interest exists both in general equilibrium and in disequilibrium, whereas profit and loss exist only in the latter case.
But then this line of argument makes it necessary to clarify the precise meaning of general equilibrium, as well as its role in economic analysis. Mises argued that general equilibrium — which he called the stationary economy (stationäre Wirtschaft)In Human Action, he called it the “evenly rotating economy,” pp. 246–47. — is a purely methodological device. It is an imaginary construct (Gedankenbild) that has no counterpart in the real world. Its only purpose is for the definition of profit and loss.
The Murray N. Rothbard Memorial Lecture, sponsored by Helio Beltrão. Presented at the Austrian Economics Research Conference at the Mises Institute in Auburn, Alabama, on 11 March 2017. Includes introductory remarks by Joseph T. Salerno.