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160. Laura and Derek Cabrera: Systems Thinking For Business

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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. Everything is a system because it contains parts. Every e-mail contains words that contain letters 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

158. Mark Romera’s Globally Orchestrated Entrepreneurial Design Journey

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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): Download Now

See the completion of the journey: Spimbey.com

152. Laura and Derek Cabrera: Building An Entrepreneurial Business Culture With Systems Thinking

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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 WorldLAMO Thinking
The real world is non-linearbut 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 organicyet 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 randomnessyet 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

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

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