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Economics In The Digital Age Is Different.

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Steve Denning is one of our most important and insightful writers at the intersection of economics, business, and management. He has been in the lead in alerting the business world to the imperative of new thinking about organization, embracing agility and the end of hierarchy, agile processes, and digital transformation. His message: management must change to keep up with technology.

Recently, he turned his attention to economics. His conclusion: economics must change to keep up with technology. Mainstream economics that is; we Austrians may claim a special position, as I’ll argue below.

A school or tradition of economics (such as “mainstream economics”) tends to be defined by stacking dead economists and their theories one on top of another and calling the resulting intellectual edifice a definitive body of work for the filling of textbooks. Later arrivals to the school limit themselves to publishing marginal elucidations. Keynesian economics continues as a set of theories derived from the conditions between the first and second world wars in socialist Britain. Keynesian economists in 2021 continue to insist that these theories still hold, and, in fact, they are the backbone of US Government economic policy today, and the reason it is so disastrous.

In his article Why Mainstream Economists Miss Digital Innovation, Denning drives home just exactly why this backward-looking process of economic theorizing takes us so far off base. Mainstream economists (he quotes Nobel prizewinner Robert Solow) had a very difficult time even recognizing the contribution of digital services to economic value. The “real economy”, Solow opined, was about physical products. Now the largest firms in the world are those delivering primarily digital services. So much for the validity of Nobel rise recognition.

Denning also calls out Robert J Gordon, who asserts that the great innovations occurred before 1970  – innovations such as electricity, household appliances that reduce work, air conditioning that increases comfort and productivity, flushing toilets that improve sanitation and health. Gordon dismisses innovation after 1970 as narrowly focused on entertainment, communication, and information technology. He referred to the arrival of the iPhone as a minor event in entertainment and communications. He failed to realize how a handheld computer in the hands of billions of people radically increases productivity and economic growth, which has been associated with the eradication of poverty, as well as changing how people are educated, given access to healthcare, and put on a pathway to higher aspirations and better lives.

Denning uses this example as an illustration for his conclusion that mainstream economics misses “that digital innovation has changed almost every aspect of human life”. Of what relevance is a field of study that is so oblivious to real life?

Fortunately, there’s a school of economics that understands the dominant role of digital innovation: Austrian economics. There are several points of difference with mainstream economics. One is the understanding that Austrians have of the market as a process and the economy as a constantly changing capital structure. Mainstream economists’ main tool is the study of equilibrium: under what conditions would the economy be perfectly balanced with no more change? Austrians understand that there is no equilibrium, and equilibrium is not a state we desire. The market is a flow of continuous, often dramatic and always accelerating change. Technologies build on technologies and change becomes exponential in terms of impact on growth and improvement. More and more customer value is generated, without limit.

Austrian capital theory recognizes capital in the economy as a flowing river of technology enabling more and more customer value, and constantly changing and improving in response to customers’ never-ending demand for betterment – faster, cheaper, more efficient, more convenient, more comfortable, more productive. Customers demand this continuous change, and technology helps to deliver it.

Another tool in the Austrian economists’ toolbox is the understanding of the role of the entrepreneur, entrepreneurship, and the entrepreneurial method. The entrepreneur has no role in mainstream economics. No one has figured out a mathematical equation to represent this most human of innovative influence. Entrepreneurs are those who look at the world and ask themselves how they can make it better than it is. That’s why Steve Denning can quote an entrepreneur like Marc Andreessen who wrote  “Why Software Is Eating The World” but can’t find any economists to quote.

He could have referred to W. Brian Arthur’s paper, Competing Technologies, Increasing Returns, and Lock-In By Historical Events, where he anticipated exponential growth and the rise of the tech titans. Brian Arthur calls his brand of economics “complexity economics”, which is a strand of Austrian economics. Denning might also have quoted Todd H. Chiles on Organizational Emergence, his theory about how firms and markets advance rapidly through stages of dramatic change and increasing value generation as a result of both technology and changing consumer preferences.

Steve Denning is right to say that it’s imperative that mainstream economics catches up with technology. He should go further and call for the widespread recognition of Austrian economics as the economics of radical economic change. It’s already the go-to theory to explain bitcoin, free software, and the economics of video games. Mainstream will never catch up.

129. Samuele Murtinu on How and Why Governments Fail in Venture Capital

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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, 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): Download PDF

These Are The Keywords Of Austrian Economics.

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An SEO keyword search for Austrian Economics can yield a lot of results like “Austrian Airlines” and “Vacations in Austria” and not much about economics.

A Google search might take the searcher back to 1871 and Carl Menger, the founder of Austrian economics.

The confusion of the country designation and the predominance of history is unfortunate in the sense that anyone in business today, and indeed anyone in life today, can learn a lot from the principles of Austrian economics.

It’s true that the founders of the stream of economic thought that’s called the Austrian school did their breakthrough thinking in Vienna. But it’s not very helpful for the understanding of the benefits their thought brings to mankind. The term Austrian economics describes a feature and not a benefit, and all of us who work in marketing know that to do so is a serious communications error.

If we were to think about Austrian economics in terms of the benefits it brings – its brand promise, if you will – what kinds of keywords might we generate?

Realistic.

Mainstream economics is purposely unrealistic. It’s about writing equations and constructing mathematical models to attempt to predict the unpredictable. Austrian economics, on the other hand, is about understanding individual people’s preferences and choices, and how they interact with the choices of others in economic systems of various sizes, from the family to the nation. 

As a result, Austrian economics is helpful to businesses and anyone trying to understand human economic behavior.

Keywords: Real economics, economic realism, business economics, Economics for business.

Human values

Because it focuses on human economic behavior, Austrian economics concerns itself with human values – the values that motivate choice and interaction, and the search for betterment for all.

Keywords: Human economics, humanist economics, humanomics 

Value generation

The purpose of economic behavior is the generation of value, firstly for others, and them for oneself. Value is an experience – recipients of value are pleased, satisfied, happy, sometimes delighted. Value generation is doing nice things for people, or giving them nice things, and enjoying their response. 

Austrian economics is totally focused on value – how to spot the potential for it, how to make it possible, and how to understand how and why some people find some things more valuable than others do. With this information, Austrian economics studies ways to generate even more value.

Keywords: Value economics, value logic, experiential economics

Entrepreneurship

There’s a special individual or grouping of individuals in the world of Austrian economics: entrepreneurs. These are the individuals or teams who are alert to customers’ desire for improvement in their product or service experiences, and responsive enough to create and offer something new and better to solve the satisfaction problem. 

Entrepreneurs are the ones to thank for all the innovation and improvement that ever hits the market, and all the value generation that results. They are economic heroes, the drivers of higher living standards and happier experiences. They make the world a better place.

Entrepreneurship is central to Austrian economic thought. Mainstream economics doesn’t even deal in the topic, because it doesn’t fit neatly into an equation. Yet it’s the engine of economy

Keywords: Entrepreneurial economics, entrepreneurship, economic heroes, economics of betterment

Opportunity

Austrian economics concerns itself with the generation of value in the future. What decisions do entrepreneurs make today, and what resources do they need to deploy over time, in order to deliver value to others in the future, and realize a future gain for themselves? All this is wrapped up in the concept of opportunity – customers have the opportunity of better future experiences, entrepreneurs have the opportunity to make a gain by delivering those future improvements. It’s uncertain, and someone must take action to make it come to fruition, so it’s a positive incentive and a happy outcome if it occurs. It’s optimistic. Everybody wins when opportunity is identified and then realized. There’s proactive creativity in bringing this about.

Keywords: Opportunity economics, optimism, excitement

Individual economic freedom

For entrepreneurship to be effective in serving customers as people, and for every customer to experience value as they subjectively and individually determine it, there is a requirement for the recognition of individualism on both the supply side and the demand side. Individual customers must be free to seek what they prefer (we often call this personalization or personal service) and individual entrepreneurs and entrepreneurial businesses must be free to craft and offer uniquely tailored products and services. Such an environment is made possible only by individual economic freedom. Austrian economics is the economics of individualism and individual freedom.

Keywords: Individualism, economic freedom, economics of liberty

Emergence

Austrian economics subsumes contemporary theories of complexity and adaptive systems. One of the characteristics of complex systems thinking is emergence – that system properties result in greater output capacity than is explained by the combination of inputs. “The whole is greater than the sum of the parts” is the popular expression that captures this feature of complexity science. In economics, this form of analysis can explain economic growth, rising productivity, and the improved performance of some firms that utilize the same technologies and resources as others. It’s not subject to mathematical equations, which can’t cope with the non-linearity of emergence, although it can be computer-simulated in some respects. The understanding of emergence is still emerging, but Austrian economists have described it for decades. For example, F.A. Hayek identified what he called spontaneous order – today’s complexity theorists would say “self-organizing systems” – in the 1940’s.

Emergence brings the excitement of unpredictability to economics, and changes it from a dismal to a thrilling science.

Keywords: Emergence, anti-routine, breakthrough, innovation, creativity, abundance, high performance, radical, thrilling

Let’s substitute these keywords of those of travel to Austria and historic references.

128. Matt McCaffrey: Austrian Business Strategy (Part 2): Principles

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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.

In episode #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 & 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): Download PDF

Austrian Perspectives on Entrepreneurship, Strategy, and Organization by Nicolai J. Foss, Peter G. Klein, and Matthew McCaffrey: But It On Amazon

127. Matt McCaffrey: Austrian Business Strategy (Part 1): Emergent, Not Planned

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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): Download PDF

Austrian Perspectives on Entrepreneurship, Strategy, and Organization by Nicolai J. Foss, Peter G. Klein, and Matthew McCaffrey: But It On Amazon

“Entrepreneurship and Firm Strategy: Integrating Resources, Capabilities, and Judgment through an Austrian Framework” by Matthew McCaffrey and Ulrich Möller (PDF): Download PDF

“‘When Harry Met Fritz’: Rules as Organizational Frameworks for Emergent Strategy Process” by Nicolai J. Foss, Matthew C. McCaffrey, and Carmen Elena Dorobăț (PDF): Download PDF

Entrepreneurial Economics Explained.

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There is a body of economic science that has identified entrepreneurship as the driving force of economic growth. 

The purpose of economic science is to discover and verify methods to achieve increased well-being for individuals, families and any groups they form or choose to belong to, such as communities and firms or collaborative networks and associations. Scientific process and results must be realistic, i.e. relate to the real world rather than to mathematical equations and models.

Economic science uses the language of means and ends: the science aims to identify the best and most appropriate means for achieving chosen ends. In the economics of individual well-being, the ends are not represented by so-called aggregate measures such as Gross Domestic Product (GDP – a measure of the total monetary value of finished goods and services produced within a country’s borders) or total employment. 

The end of this body of economic science is individual satisfaction, often identified via the concept of subjective value – subjective in the sense that the individual decides what is valuable and what they value. In this way, customers run the economy. Whatever they feel satisfies their needs and wants, i.e. what they decide is valuable, is what is ultimately produced. In this sense, customers create value – it isn’t valuable if they don’t say so. Economic growth means more of what customers feel is valuable.

Customers get help in value creation from the entrepreneur. It is the entrepreneur who studies customers, ascertains what they think is valuable, and undertakes a production process to deliver that value. Logically, they are producing for a future value experience, because production takes time. 

This is why the role of the entrepreneur is so pivotal in the creation of new economic value. Entrepreneurs take all the responsibility and all the risk in value generation. They bet on being able to identify customer preferences pretty accurately (they can never be exactly right) and then they bet on being able to assemble resources in the form of a firm to produce for that preference, and they bet that the preferences won’t have changed before they get to market, and they bet that they can get not only the product or service right but also the price, and they bet they can beat competitors who are rivalrously eyeing up the same set of possibilities. 

Economic science observes and recognizes this role of the entrepreneur. It’s not a matter of personality – anyone can be an entrepreneur. There is definitely a method to entrepreneurship, in spite of (in fact, because of) the uncertainty of betting on customers’ future preferences. The economics of entrepreneurship is not fueled by sources of finance like debt or equity, but by imagination. Entrepreneurial projects are built on the choice of which customers to serve and how to serve them, imagining a future world in which customers’ formerly unmet needs are now satisfied. Imagination is turned into the design of a business model, which is the mechanics of actually delivering imagined value to customers. Revenue is the feedback loop that tells entrepreneurs that they have offered something valuable, and profit is the feedback loop that tells them that they chose the right costs.

To embark upon and stay on the path of successful production for profit, entrepreneurs must embrace and overcome uncertainty. How do they do this? They act. They make a commitment. They get started on the project or business initiative. Having once moved into action, they begin to learn. They can never be 100% right, so some parts of what they do will go wrong, and be unsuccessful. 

The entrepreneurial firm learns what doesn’t work and what does, discards the former and does more of the latter. Business strategy is experimentation and learning, not multi-slide presentations and extensive spreadsheets. Agility – fast learning, fast adjustment – beats business school training.

Because of entrepreneurial exploration and experimentation to identify what works, the world advances – people enjoy more satisfaction and a higher standard of living, services and technology improve, and civilization advances. The world we live in is shaped by entrepreneurial economics.

One clear implication of this body of economic science is that there is no place for – and no need for – government economic policy. It can only get in the way of entrepreneurial exploration and experimentation. Governments extract value from the economy through their taxes and regulation, and then sometimes claim to redistribute it via subsidies and rebates. They claim to design policies such as what level of wages to pay, or the cost of imports, or the amount of market share any firm can have before an anti-trust suit. It’s all futile and, worse, damaging. In entrepreneurial economics, the role of government is to stand back, get out of the way, and marvel at the living standard enhancements entrepreneurship brings.

Academics call this body of science Austrian economics, because its early thought leaders came from Austria when Vienna was the commercial and cultural capital of the globe. Thinking in the Austrian way is helpful to entrepreneurial success, but, for economic growth, we don’t need to adopt the name, just the method.