A podcast based on the winning principle that entrepreneurs need only know the laws of economics plus the minds of customers. After that, apply your imagination.

151. Mark Packard On Entrepreneurial Imagination: You Can’t Do Business Without It

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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

150. Six Powerful Business Insights From Austrian Economics

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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: Listen to the Episode
Resource: “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: Listen to the Episode
Resource: “The Value Generation Business Model” (Video: Watch Video

Matt McCaffrey outlines the Austrian approach to business strategy: emergent not planned.
Episode #127: Listen to the Episode
Resource: “Emergent Strategy Process Map” (PDF): Download PDF

Mark McGrath orients entrepreneurs to purposeful adaptation to emergence via the OODA loop.
Episode #138: Listen to the Episode
Resource: John Boyd’s “OODA Loop Graphic” (PPT): Download the PPT

Ulrich Moeller provides the organization design model for the adaptive entrepreneurial firm: it’s boss-less.
Episode #133: Listen to the Episode
Resource: “The Future Of Organization Design” (PDF) Download PDF

Saras Sarasvathy pulls it all together in the form of The Entrepreneurial Method.
Episode #131: Listen to the Episode
Resource: “Better Lives and a Better Society” (PDF) Download PDF

149: Victor Chor: The Journey From Flipping to Global High-Tech Brand Building

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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): Download PDF

Visit Infinacore.com

Follow Infinacore on Instagram: @Infinacore

148. Diana Jones: The New Management Model — Guarding Group Relationships

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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): Download PDF

Leadership Levers: Releasing The Power Of Relationships For Exceptional Participation, Alignment, and Team Results by Diana Jones: Buy It On Amazon

Visit Diana’s personal website at Diana-Jones.com

147. Mohammad Keyhani: Strategic Entrepreneurship — The Smart Practice of Combining Business Theories for Marketplace Success

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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) 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 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): Download PDF

“The Logic Of Strategic Entrepreneurship” by Mohammad Keyhani: Download Paper

“Was Hayek an ACE?” by  Nicolaas J. Vriend: Download Paper

The ultimate list of tools for entrepreneurs—”Entrepreneur Tools” by Mohammad Keyhani: https://entrepreneur-tools.zeef.com/keyhanimo

146. Luca Dellanna on the Power of Adaptation: Adapt or Die

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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): Download PDF

Read Luca Dellanna’s book, The Power Of Adaptation: Download PDF

Another application of adaptation, Teams Are Adaptive Systems: 12 Principles For Effective Management by Luca Dellanna: Download PDF

Visit Luca Dellanna’s website to find more resources: Luca-Dellanna.com

E-mail Luca at luca@luca-dellanna.com