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

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

120. Mark Schaefer on Cumulative Advantage

Economists recognize the phenomenon of increasing returns. Knowledge markets such as those for software, operating systems and platforms, tend to tilt in favor of a product or service or brand that gets ahead, even to the point of lock-in. There is a growing body of theory — often under the heading of complexity theory, and supported by computational simulation — underpinning the concept of increasing returns.

Mark Schaefer is an expert at bringing economic theories of this kind into vibrant contemporary life. He coined the term Cumulative Advantage and wants all entrepreneurs to know how to harness it.

First of all, it’s not new. It’s in the Bible: For whoever has will be given more. Sociologist Robert K. Merton therefore called it The Matthew Effect.

How can entrepreneurs and their firms take advantage of increasing returns to achieve cumulative advantage? Consistent with the processual approach to value of Austrian economics, Mark has a five-step process.

Key Takeaways & Actionable Insights

Identify an initial advantage.

How do entrepreneurs identify a small initial advantage that sets momentum in motion? There are unlimited sources within complex economic systems. Mark tells us to look for collisions of events, ideas, people and circumstances from which entrepreneurs can derive their unique advantage. He calls them “click moments”. They are happy, random, emergent phenomena. He gives the example of Bill Bowerman’s experiment with latex in a waffle iron to create a new type of running shoe — the click moment for Nike.

Importantly, these random outcomes are spurred by action — acting on curiosity, and pursuing an energetic quest to establish how ideas and imagination can be exploited to solve customers’ problems.

Discover a seam of timely opportunity.

Mark rejects the concepts of strategy and planning. Business success can’t result from 50-page documents and elaborate spreadsheets. Momentum is a consequence of action. Entrepreneurs replace strategy with their own subjectively defined opportunity to exploit speed, time and space. A seam is a fracture in the status quo through which the entrepreneur sprints. Relentless searching for an open seam is the core activity of entrepreneurship. Seams are always opening as a result of the continuing, ongoing change of business and the economy, best understood through the dynamic lens provided by Austrian economics. Often the timing of the opening is the key factor in the success of an entrepreneurial initiative. Timing cannot be predicted, and so continuous experimentation is the best approach, to create the maximum possibility for “click moments”.

Create significant awareness through a “sonic boom” of social proof.

Once a business has entered a seam, it’s the occasion to search for amplification. Mark Schaefer proposes the leverage available through influence and influencers, those who can provide social proof to a broader audience that a new entrepreneurial offering is sufficiently worthy to command widespread demand. The customer is the marketer in this construct of social proof — which is a development, of course, of the Austrian theory of consumer sovereignty. People believe each other more than they believe advertising, promotion or PR.

Gain access to a higher orbit by reaching out and up to powerful partners and allies.

Once awareness and social proof of the entrepreneurial offering begin to build, the next process step is to seek partners and allies who can provide access to higher-level resources: powerful connections, better channels, financial capital, value-multiplying alliances. Network theory applies: denser and more active connections through bigger and more strategic network nodes can result in accelerated business expansion.

Maybe it’s distribution in Walmart or Target, or endorsement by a celebrity athlete, or presence on a FinTech trading platform, or access to new resources. Reaching up is an exercise in finding partners to expand an entrepreneur’s market potential.

Build momentum through constancy of purpose.

Ultimately, says Mark, the killer app is constancy of purpose. Discipline, resilience, purpose and persistence accompany entrepreneurs on the path to achievement. There’s flexibility and adaptiveness and agility of course, and these can bring changes in direction, but the goal and the purpose always retain their primary role in the narrative of success.

Additional Resources

Cumulative Advantage — The Theory of Increasing Returns (PDF): Download PDF

Cumulative Advantage: How to Build Momentum for your Ideas, Business and Life Against All Odds by Mark Schaefer: Buy the Book

Mark Schaefer’s Website: BusinessGrow.com

BSquared Media: BSquared.media

The Austrian Business Model (video): https://e4epod.com/model

Start Your Own Entrepreneurial Journey

Ready to put Austrian Economics knowledge from the podcast to work for your business? Start your own entrepreneurial journey.

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110: Yousif Almoayyed: Apply Economic Thinking To Better Manage Your Technology Projects

Does economic knowledge help you manage complex IT projects? Yousif Almoayyed thinks it does. He combines management knowledge with careful project management and principled economic thinking.

Economic thinking utilizes foundational principles to integrate knowledge management and business task management for all kinds of projects. IT projects provide a representative example.

Download The Episode Resource Economic Thinking About IT Projects – Download

Key Takeaways & Actionable Insights

The economic principles for IT project management include:

  • Ends-Means analysis.
  • Marginal benefit — marginal cost analysis
  • The law of returns — savings, investment and future benefit flows
  • Combinatorial productivity
  • Knowledge-based processes
  • Incentives alignment
  • Trust and reliability as institutional enablers

Ends-Means Thinking

Your ends are business ends: to generate new economic value by serving customers with continuously improving and continuously innovative services. Technology can be a means to achieve those ends, if properly harnessed. It can help with value delivery, it can help lower costs, eliminate waste and increase efficiency.

The key to economic thinking is to keep business ends and customer experience primary, and manage technology to serve those ends. Don’t let technology be the business’s master.

Marginal Benefits and Marginal Costs, and The Law Of Returns

The so-called Law of Diminishing Returns theorizes that, after a firm or a production process has attained some optimal level of performance, each further addition of an input will tend to achieve a smaller and smaller output increase. This can be true of technology projects and repays careful benefit-cost analysis. You probably already have considerable technology resources in your business, including access to services via the internet. Examine each additional tech input, at the margin, and identify just how much additional business benefit you can anticipate as a result of the new input. A rigorous approach to this analysis can be helpful in ordering priorities and understanding trade-offs.

Combinatorial Productivity

Economic thinking recognizes capital as a flexible, continuously changing combination of elements. Some combinations are capable of generating higher productivity than its individual components can achieve separately. This combinatorial productivity may not be intuitively predictable in advance, and so experimental combinations are appropriate, e.g. of old and new systems.

Don’t be afraid of mistakes in your experiments. If you don’t encounter some surprises, you are probably not experimenting enough. Don’t permit technology vendors to constrain your experimentation. Proprietary systems can force you to work within their boundaries; there are plenty of routes to new productivity outside these boundaries. Yousif mentioned his experiments with Raspberry Pi — the single-board computer used by many for experimental applications such as robotics — as an example.

Knowledge and People As Critical Assets.

Economic processes are knowledge processes: bringing the right knowledge to bear at the appropriate step. Much of the knowledge is tacit – in individuals’ heads, based on their own individual experience. Consequently, assembling and preserving the right team with the right knowledge — both inside and outside the firm — is the primary task in IT project management.

How much tech knowledge do you need? It’s certainly not the most important knowledge for your project. That position is reserved for business knowledge: your project team, in order to attain the business ends you have established for the initiative, must have complete understanding of your firm’s business mission and purpose, and of the customer service context of the current project.

If you are clear in communicating business ends both internally and externally, you will be prized customer for IT suppliers, since this clarity is often lacking and can lead to confusion and conflict.

You will always be able to assemble the appropriate tech knowledge when your business aims are clearly stated.

Choose the outside vendors who best demonstrate their ability to understand and absorb your business ends, in combination with mastery of the specific technology means you require.

Incentives Alignment and Scope Specificity

Economic thinking pays special attention to the roles of multiple players in a system and the incentives under which each player is operating. For example, a systems integrator salesperson or project manager may be incentivized by his or her company to sell more units, or more customization that requires more installation hours now and more upgrade complexity in the future.

Your internal project management includes the alignment of roles and incentives to guard against this kind of conflict. Best to have your own internal project manager.

A big part of the internal project manager’s role is to think through the project scope in great detail, to give the business ends clear dominance over all other ends, to be as specific as possible on the technology means, and to guard against mission creep and the opportunistic exercise of power by IT managers internally or IT vendors externally who might use their technical knowledge to force choices that are inappropriate to business ends.

Big data analytics projects and A.I. projects can be examples of inappropriate technology choices. Big data projects that include extensive data gathering (e.g. through sensors or via cameras for visual data) can promise new insights through analysis of the newly acquired datasets, but a careful analysis of the potential value facilitation of the output might tell a manager that the marginal benefit is inadequate. Always ask whether the project facilitates new economic value for customers or in the firm’s capacity to serve customers. Make sure the incentives to install new technology are truly business-aligned and not simply to be modern or up-to-date, and staying close to the technological edge.

Trust, Reliability and Institutional Guardrails

All economic systems are collaborative networks of individuals, strategies and artifacts. Economists examine systems not only for efficiency but also for integrity, which often comes via institutional factors such as trust between people, and reliability of input performance from people and groups. Without these institutional factors, collaboration can become impeded and frictions can arise, slowing down projects or even rendering them unsuccessful. Great project managers check for these intangibles as well as for the robustness of the technology.

Technology Combined with Economic Thinking Can Open Up New Business Horizons

Some of these economic factors sound restrictive but they’re not. They help guide you to efficient and effective choices by thinking through resource allocations, trade-offs, system optimality and the long term consequences of invisibles such as incentive alignment.

Technology is capable of changing the economics of the firm. For example, it can change the constraints of size and resource availability via new connections to a vast array of external resources that were not previously accessible and that can boost your firm’s effective scale. Yousif pointed to applications such as Upwork to add global specialized talent at variable cost, and also made reference to his collection of previously unavailable commodity supply data that was once shielded but now is made available by technology and can provide early warning signals about market price movements, making his firm better informed that it was before, and therefore better placed to serve customers.

Use technology economically to expand your capabilities so that your marginal benefits exceed your marginal costs in reaching expanded and elevated business ends.

Additional Resources

“Economic Thinking About IT Projects” (PDF): Download Here

A Guide To The Project Management Body Of Knowledge (May 2021):- Download Here

The Austrian Business Model (video): https://e4epod.com/model

Start Your Own Entrepreneurial Journey

Ready to put Austrian Economics knowledge from the podcast to work for your business? Start your own entrepreneurial journey.

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109: Desmond Ng: Entrepreneurial Empowerment and the Austrian Approach to Value-Generating Organizational Design

Austrian economics offers a wide range of knowledge and applications for better business performance. One of them is the design of high-value organizations

Download The Episode ResourceEntrepreneurial Empowerment – Download

Key Takeaways & Actionable Insights

Austrians understand the function of entrepreneurial businesses in the economy is to pursue and generate new economic value. That value is subjective, experienced by individuals as an improvement in their feelings of well-being. We also understand that subjective value applies not only to consumers but also to producers, including employees in firms whose purpose is value facilitation.

To fully realize the skills and talents of their employees in the pursuit of the organization’s visions and goals, entrepreneurial businesses look for the best ways to empower employees to utilize their Hayekian individual knowledge for the innovation and adaptation that leads to marketplace success.

Dr. Desmond Ng uses the term Entrepreneurial Empowerment to describe this approach to designing an organization that best unleashes the creativity of its entrepreneurial employees.

Austrian economics is particularly suited to addressing the organizational challenges faced by today’s entrepreneurial firms.

Businesses understand that they need to be more responsive to customers and the market. Firms are moving from a top down decision-making structure and searching for ways to move to a more decentralized firm structure. They are aiming to take advantage of all the different knowledge experiences that may be inside the firm, to be more adaptive to changing market environments and to acknowledge the importance of empowering employees.

Austrian economists like Friedrich Hayek fully recognized the benefits of decentralization in adapting to changing market processes. Today, Austrians can apply that same understanding at the firm level, in the pursuit of unleashing the subjective experiences and individual knowledge of each employee to greatest economic effect.

The organizational design tool to achieve maximum decentralized value generation is Entrepreneurial Empowerment (EE)

A firm that organizes using Entrepreneurial Empowerment focuses at the leadership level on clearly defining the ends of the company (which can be packaged in the form of vision or mission or goals or objectives) and on ensuring that internal communications are strong enough and effective enough to ensure complete and fully distributed understanding and buy-in among the employee base.

The means for each individual to contribute to the achievement of these ends are left open to employees; they are not dictated or bound with managerial or administrative constraints. Leadership in an entrepreneurially empowered firm is non-interventionist, free of the strictures of central planning.

EE has two components: the first is structural empowerment (SE).

The structural empowerment element of EE refers to the communication structure that delivers employee empowerment. Se informs them about their opportunities for taking action and making decisions, and provides support for them to utilize their own knowledge in doing so.

Professor Ng used the example of design firm IDEO, which provides a fully-available repository of all the firms designs and ideas from all its engineers and teams, along with information about how past teams tackled the solutions to design problems, with what outcomes. Designers on today’s teams can utilize this shared knowledge, learn from the pooled experiences, and enjoy the freedom of embarking on new design paths by combining their own knowledge and skills with the corporate knowledge repository.

Structural empowerment also requires a policy to regard failure as an acceptable part of the innovation process, in order to foster greater risk-taking behavior among employees, and a greater willingness to experiment with new and unproven ideas. SE is a process that leaders and managers must actively and persistently support. The danger is that leaders may succumb to the temptations of power and control, and to seek to centralize their authority. This can be fatal to entrepreneurial empowerment and negate all its benefits.

The second core component is psychological empowerment (PE).

Employees perform best, innovate best and contribute the most creativity when they enjoy psychic rewards from their work. One important aspect of psychic reward is the search for and successful achievement of meaning and purpose. Research is clear that these high values are found in work when it is conducted in an environment that encourages their development. Professor Ng used Chick-Fil-A as an example where, because the company subscribes to a set of values, employees in what might appear to observers as the simplest and most repetitive service and production jobs can find meaning in their work. The result is unrivaled customer service ratings. Psychological empowerment comes from leadership conveying a set of principles.

Monetary incentives, rewards, and the awarding of titles can not match psychological empowerment in terms of effectiveness for motivating employees. The Austrian perspective delivers some quite revolutionary policies and approaches for organizational design.

Rethinking the concept of leadership.

In recent years, business schools have commanded a lot of attention by marketing and selling leadership studies, with products ranging from executive education to books and online courses. However, Austrian economics suggests skepticism about the underlying concept of leadership in business. Firstly, structural empowerment and psychological empowerment are the antitheses of business school style leadership — they suggest non-leadership, letting go of control, and abandoning hierarchy.

Secondly, as Professor Ng pointed out, the centralized authority suggested by business school style leadership tends to lead to the corruption of seizing power and control, clouding the ethical considerations that are at the heart of entrepreneurship, and undermining the trust of employees lower down the hierarchy. The results can be both a loss of legitimacy for the bosses and a loss of business performance for the firm.

The Austrian perspective on organizational design and management can lead us to a higher-performing firm, a more innovative firm, a firm that facilitates purpose and meaning for those individuals who work there, and trust and legitimacy for founders and executives.

Additional Resources

“Entrepreneurial Empowerment” (PDF): Download Here

Professor Ng’s Research Paper Entrepreneurial Empowerment: “You Are Only as Good as Your Employees” (PDF):- Download Here

The Austrian Business Model (video): https://e4epod.com/model

Start Your Own Entrepreneurial Journey

Ready to put Austrian Economics knowledge from the podcast to work for your business? Start your own entrepreneurial journey.

Enjoying The Podcast? Review, Subscribe & Listen On Your Favorite Platform:

Apple PodcastsGoogle PlayStitcherSpotify

92. Clay Miller: 5 Austrian Principles Applicable to Your Business Today

Principles of Austrian economics have immediate applications in business. Clay Miller, a deeply experienced and highly successful global tech entrepreneur, makes the case via five principles drawn from five easily-accessible sources of Austrian economic theory, with many accompanying examples.

Key Takeaways & Actionable Insights

Principle 1: The distribution of knowledge requires disaggregated thinking.

Source: “The Use Of Knowledge In Society,” F.A. Hayek – Get It Here

Hayek wrote this paper as part of a research program into the problem that economics tries to solve. He defined it as a knowledge problem. Knowledge “never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess”.

The implication he drew was for central planning by governments and their departments and committees that would attempt to plan production or set prices. Such central planning is impossible because dispersed knowledge can not be aggregated and so the planners never have enough knowledge on which to base a plan.

Quote

“The statistics which such a central authority would have to use would have to be arrived at precisely by abstracting from minor differences between the things, by lumping together, as resources of one kind, items which differ as regards location, quality, and other particulars, in a way which may be very significant for the specific decision. It follows from this that central planning based on statistical information by its nature cannot take direct account of these circumstances of time and place…..”

Application

In our Economics For Business project, we have the opportunity to help entrepreneurs apply the same principle to business knowledge, or data. Too much aggregation can obscure information that is really important and most useful for improving business performance.

Here’s an example. A frequently used KPI (Key Performance Indicator) is average revenue per customer. It’s calculated by aggregating all customer revenue into one number and dividing by the number of customers. For this to be actionable intelligence, it is necessary to assume that spending by each customer is very uniform. But consider the case where average revenue per customer is $190 for a customer base of 10 users, composed of 9 who spend $100 each and one who spends $1,000. The KPI does not suggest that each new customer you acquire will spend $190. In fact, it’s more likely they’ll spend $100. And, in fact, what you would really like to know is the profile of the $1000 customer and whether that profile, applied in recruiting new customers, would enable you to recruit more $1,000 spenders. You really want to choose metrics that can provide insight into individual customer behavior — like the nature and motivation of the one $1,000 spender.

Similar Austrian thinking would apply, for example, to Google analytics, which can profile the type of customer interacting with your website or app, and observable behavior such as conversion rate by page visited, or abandonment rate for specific pages. These are disaggregated statistics that can help you serve customers better.

Austrian thinking is rigorous in seeking to identify cause and effect, and to ensure that correlation is not mistaken for causation. A simple example is restaurant data that exhibits a 30% increase in customer traffic on Tuesdays. There’s a correlation between day-of-week and traffic increases — but it’s not causation. Tuesday does not cause the traffic increase. What does? It requires digging to find out, perhaps, that a local firm offers a perk to office workers to pay for them eating out on Tuesdays. As Hayek would say, this is specific knowledge of time and place, more likely to be qualitative than statistical, embracing the subjectivity that’s central to Austrian economics.

Principle 2: Consumer Sovereignty requires that entrepreneurs are directed by their customers.

SourceBureaucracy, Ludwig von Mises: Get It Here

This book focuses on the inefficiencies and ineffectiveness of bureaucratic organizational structures and processes. In a chapter titled Profit Management, Mises defines the Austrian concept of consumer sovereignty. Understanding and applying this concept is central to entrepreneurs’ capability to create effective value propositions for their offering, brand or business.

Quote

“Thus the capitalist system of production is an economic democracy, in which every penny gives the right to vote. The consumers are the sovereign people. The capitalists, the entrepreneurs, and the farmers are the people’s mandatories. If they do not obey, if they fail to produce, at the lowest possible cost, what the consumers are asking for, they lose their office. Their task is service to the consumer. Profit and loss are the instruments by means of which the consumers keep a tight rein on all business activities.”

Application

Consumers are the ones driving production. It’s up to business managers to make sure that every decision is towards bettering the value proposition offered to customers.

For example, the décor in a restaurant should be chosen not because the owner favors it or because an interior designer decrees it, but for the purpose of enhancing the value experience of those consumers the owner wants to attract and to serve. This requires empathy. Consumer sovereignty and entrepreneurial empathy go together.

Because consumers are the ones valuing what is produced, they are the ones ascribing value to the product or service the entrepreneur produces. The entrepreneur needs to anticipate what they value, and to do so requires ever-greater closeness to the customer. Clay described the value provided by simple but tasty barbecue restaurants in his home state of north Carolina, in a décor of plastic and paper and small booths. But that wouldn’t attract the customers who prefer fine dining in a five star restaurant. The customer decides what experience they value.

Startups can usefully anticipate consumer preferences by creating an imaginary perfect customer, and thinking through the value they want and the value the business can facilitate for them. Once in production, get as much feedback as possible on the actual value experience and the customer’s feeling about it. Every decision made inside the business needs to be for the purpose of and directed towards improving the customer value proposition and value experience.

Principle 3: Human value scales are complex and ever-changing and entrepreneurial empathy is required in order to reach an understanding of customers’ value dynamics.

SourceHuman Action, Ludwig von Mises: Get It Here

Human Action is the magnum opus of Austrian economic theory. Every chapter will yield great insights for business. Clay selected value scales as a topic.

Quote

“It is customary to say that acting man has a scale of wants or values in his mind when he arranges his actions. On the basis of such a scale he satisfies what is of higher value, i.e., his more urgent wants, and leaves unsatisfied what is of lower value, i.e., what is a less urgent want. There is no objection to such a presentation of the state of affairs. However, one must not forget that the scale of values or wants manifests itself only in the reality of action. These scales have no independent existence apart from the actual behavior of individuals. The only source from which our knowledge concerning these scales is derived is the observation of a man’s actions.”

Application

When a person makes a decision to purchase your product or service, they conduct a quite complex evaluation to integrate your offering into their scale of values. And the values and the scale is constantly changing. Consumers are not static robots. Their circumstances change, their preferences for saving or spending change, their time of life or even time of day demand rearranging of value scales.

A consumer may have a high preference for Krispy-Kreme donuts. But then they go on a diet. Their value scale changes. Losing weight and increasing fitness are now higher values than enjoying a donut. If you are the Krispy-Kreme donut franchisee, it’s important to be aware of the value scale change, and to empathize with the customer. Maybe you could develop a promotion called “Cheat Day” that rewards them with a donut treat after a week of exercise and donut restraint. As Wayne Gretzky used to say, skate to where the puck is going to be, not where it is now.

How can you understand value scales? One interview with a customer — what a researcher would call deep, rich qualitative information — can be worth much, much more than survey data. Mises said that we can only know an individual’s value scales by observing an individual’s actions. Having them answer a survey question such as “How highly do you value this item?” or “What price would you pay for this item?” does not indicate how they would fit the item into their value scale. They may say they would pay $250,000 for a Ferrari, but, when they weighted the experience of owning the Ferrari versus the opportunity cost of foregoing other experiences, would they actually make the purchase? The survey answers won’t tell you.

Entrepreneurs are rewarded for estimating correctly what the customer values and creating the appropriate value proposition.

Principle 4: The market is a discovery process, with uncertainty on both sides of market exchanges. All entrepreneurial actions are tests, with no certain outcomes.

SourceCompetition And Entrepreneurship, Israel Kirzner: Get It Here

This is a seminal work on entrepreneurship. One of the major themes is that markets are a process of discovery. That insight directs entrepreneurs to think in dynamic, process terms. The entrepreneur experiences uncertainty in what he or she is producing, because they are not sure of what customers will value in the future. The customer is uncertain, too, because they’re unsure of how they’ll value what the entrepreneur produces. Whenever we, as consumers, feel trepidation about “pulling the trigger” on a purchase, we are experiencing this uncertainty. Meanwhile, the producer is anxiously discovering the receptiveness to his or her value proposition.

Quote

“The market process, then, is set in motion by the results of the initial market ignorance of the participants. The process itself consists of the systematic plan changes generated by the flow of market information released by market participation — that is, by the testing of the plans in the market.”

Application

Kirzner points out that every plan an entrepreneur has, every value proposition, every offering made to prospective customers can only be a test, a trial. Nothing in the market can be certain. Entrepreneurs are trying to anticipate what customers are going to value, and they can never be sure in advance.

That’s why entrepreneurs use empathy, to imagine, if they were the customer, what type of experience the customer would be looking for. Entrepreneurs must imagine what customers might enjoy in the future. They must seek the customer’s agreement that, “Yes, your product or service delivered what you promised and made me feel better.”

One implication of Kirzner’s principle of “market ignorance” is for branding. If a brand has accrued a certain level of market reputation, consumers will feel less ignorant. They will feel they “know” a brand that’s been producing for 100 years, that is symbolized by the 3-point star that can be seen everywhere, and that is trusted and approved by many other consumers. A brand represents the stored experience and the stored reputation of many customers.

Principle 5: All entrepreneurship is for social good, and more social good is achieved by subjecting business to the marketplace test of profit and loss.

SourceAustrian Perspectives on Entrepreneurship, Strategy and Organization, Peter G Klein, Nicolai Foss, and Matthew McCaffrey, “Austrian Perspectives On Entrepreneurship, Strategy and Organization”: Get It Here

In Chapter 4 of this book, the authors discuss the concept of social entrepreneurship. This is an idea that seems to be gaining traction, especially among millennial business owners and millennial entrepreneurs. The idea is that business should be focused on something more than profit and loss. It should provide some “social value”, making the world better. Klein, Foss, and McCaffrey provide some robust Austrian thinking with regard to social entrepreneurship.

Quote

“However, these metaphors (“social value”, etc) often imply a false conflict with traditional entrepreneurship. For example, the contrast between conventional market entrepreneurship and social entrepreneurship implies that the former is somehow not social, or even anti-social. This is misleading, however; for example, Austrians would respond that Mises’s calculation argument demonstrates that the entrepreneurial market economy is profoundly social. Entrepreneurs, by bearing uncertainty in an effort to satisfy consumers, work ceaselessly to improve the welfare of all members of society, and their work in turn strengthens bonds of cooperation between individuals and communities, while at the same time disincentivizing conflict and exploitation. This is social behavior in its most fundamental form.”

Application

Steve Jobs improved society greatly by inventing the iPhone. The impact on society was considerable — better communication and information sharing, and higher productivity for billions of people.

Every venture — including social ventures — must grapple with basic economic problems. Taking on a social mission does not relieve the firm of the pressures of the marketplace. Social enterprises are business organizations, and if they earn revenues through the sale of goods and services, they must apply judgement to allocate scarce resources in the face of uncertainty. Genuine participation in the marketplace requires them to be subject to the profit and loss test.

Klein, Foss and McCaffrey make the point that “social value” is incalculable. What’s good for one individual is not the same as for another. Individuals value things subjectively. When a business pleases one group, it may be adversely affecting another.

Profit is not evil. It’s impossible to make a profit without serving your fellow man. You are doing good for society by being an entrepreneur, by producing things that people want and value. You forego your own consumption by investing in your business, and so you are making a sacrifice to serve others. And if social entrepreneurs are not subjecting themselves to the profit and loss test — if they are supported by charity or grants — then they are not receiving the signals form consumers that they are allocating scarce resources in the way that consumers — i.e., society — prefers.

The ethic of entrepreneurship is to serve, and to make others’ lives better, and to receive the approval and reward of customers via the profit and loss mechanism of the market.

Free Downloads & Extras From The Episode

“The Use Of Knowledge In Society,” F.A. Hayek (American Economic Review, Vol. XXXV, No. 4, September 1945; pp. 519–30): Get It Here

Bureaucracy, Ludwig von Mises (Yale University Press, 1944): Get It Here

Human Action, Ludwig von Mises (Mises Institute, 1999): Get It Here

Competition and Entrepreneurship, Israel Kirzner (Liberty Fund, 1978): Get It Here

Austrian Perspectives on Entrepreneurship, Strategy and Organization, Peter G Klein, Nicolai Foss, and Matthew McCaffrey (Cambridge University Press, 2019): Get It Here

“The Austrian Business Model” (video): https://e4epod.com/model

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88. David K. Hurst: Managing People-As-Ends and not People-As-Means.

Key Takeaways and Actionable Insights

In many situations, the complexities in managing a diverse and layered team of people is to view individuals as ends and not means.

Management and organizational frameworks often treat people as means. The business ends are external: so-called shareholder value, or stakeholder value, which is fashionable today, or simply revenue and unit sales goals or metrics and KPI’s.

Managers are taught to look at people through an economic lens as resources – human resources – in the same way as material resources and financial resources, to be utilized as efficiently as possible.

But people are not means. They are subjects, and they have subjective ends of their own. They’re searching for identity, meaning, and trying to meet their own potential. If managers recognize this, their approach to people as team members and employees will be much different.

Individuals need to be able to tell their own story in their own space.

We work for money but we live for story. The most important story is the one we tell about ourselves and our values. People need opportunities to tell their story. Everyone at every level in an organization and in every type of role or job needs this opportunity.

To do so, they need their own space in which to create and embellish their story, a space that is unique to them and gives them a fine-grained perspective of which they are masters, and for which others will prize them.

David Hurst gave the example of Costco, where the in-store personnel have space to use their own discretion to serve customers. If a customer (a guest, in Costco parlance) requires assistance in locating an item, a Costco associate will stop whatever they are doing and escort the guest all the way to the shelf location. They have their own space and their own discretion to design and deliver a unique level of service, and a story they can tell about their customer commitment. This becomes a culture that pervades the entire company.

FedEx has similar spaces, and similar stories about individual employees going to extraordinary lengths to make sure packages are delivered on time.

One way to create these spaces is to give everyone intelligence gathering roles.

David Hurst tells the story of delivery truck drivers in the steel fabrication business. He treated them with deference for their ability to gather real-time intelligence: which competitors had trucks in the customer’s yard; what concerns were customer employees talking about; which customers were friendly and which ones adversarial? These front line employees are able to gather and feed back market intelligence that was faster, deeper more local and more detailed than traditional reports. It’s small data, often much more valuable than big data. And the employees can tell their stories about their intelligence gathering and their important role in company processes, from their unique space.

The word in management usage now is fine-grained. The front line has a fine-grained perspective and fine-grained intelligence. This fine grain is highly valuable, especially when shared in collaborative teams and structures where everyone knows their role, which is not tied to hierarchy.

Hierarchy and structure create a cascade of negative effects for the people in them.

As companies grow and become larger, they require internal specializations and experts in narrow, technical fields. Specialization brings hierarchy, where general managers can supervise those in specialized roles. Hierarchy leads to careerism and status, when employees are not collaborating with each other but competing. The result is what David calls a power trap. The firm becomes trapped on the right had side of his Management In A Field Of Tensions model.

Recently, it has become fashionable to coin terms such as human capital, or brand capital, or relationship capital, or even spiritual capital or street capital. All of these terms are sloppy definitions of capital from an Austrian point of view.

Management In A Field of Tensions Diagram

Click on the graphic to download it.

The tension for management lies in a continuous pull of the “hard, scientific” side of the model, away from the humanistic side.

Austrians lean towards the left hand side of David’s model: humanistic, treating people as ends, respecting narrative more than data. For example, the exercise of judgement under uncertainty, so central to the Austrian paradigm of the entrepreneurially-driven economic system, lies on the left hand side of the model. It’s practical, grounded wisdom, when entrepreneurs make decisions when they don’t have all the data. (And the Hayekian insight is that no-one ever has all the data.) They glean what they can from the individual observations of people involved in the situation at hand (small data), and then decide, knowing that the consequences are uncertain, and that they will need to be adaptive to change in the future.

The right hand side of the model represents the pull of so-called science: hard data, mathematical calculation, plans and administrative bureaucracy.

Smaller, private, more entrepreneurial companies can often avoid the right hand side of the model.

Smaller and privately held companies have many advantages. They tend to be more frugal in good times and bad, and act carefully with cash, thus retaining flexibility in difficult markets. They have a high bar for capital expenditures and make fewer malinvestment decisions. They often try to avoid carrying too much debt, so that bankers don’t have power over them. And, importantly, they are often better at retaining talent and keeping experience inside the firm. They can avoid the careerism of competing for status in the hierarchy, and just let people become better and better at their jobs. On the left hand side of the model, as David describes, it’s all about people.

Free Downloads & Extras From The Episode

Read about David’s management philosophy of Leading Like A Gardener here.

Get David’s book The New Ecology Of Leadership here.

“The Austrian Business Model” (video): https://e4epod.com/model

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