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

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Why do entrepreneurs start businesses in the first place? They have a vision for the future and seek to work with other people to bring it about. Those other people may be colleagues and employees, directors and investors, suppliers, and customers. Organizing this multivalent work is hard. Thinking of your organization as a complex adaptive system yields new understanding and a new approach to organizing that results in improved goal achievement.

Laura and Derek Cabrera of Cabrera Research Lab are dedicated to sharing research findings that enhance the capability of any organization to reach business goals. They join the Economics For Business podcast to do some sharing with the E4B community.

Key Takeaways and Actionable Insights

Systems Thinking resolves the mismatch between the way the real world works and the way firms think it works.

World hunger is a wicked problem, yet there is enough food to feed the world. We don’t have the right mental model to account for all the social, economic, political, motivational, and cultural issues that shape the problem.

In the same vein, systems thinking in business is about building mental models that better align with the real world. Laura and Derek Cabrera provide an introduction in Systems Thinking Made Simple, and they mentioned some of the important changes in thinking that businesses must embrace to enter the new world of possibilities that systems thinking opens up. The first step is to recognize that LAMO thinking is inappropriate for a VUCA world.

The real world is agnostic about human endeavors

VUCA WorldLAMO Thinking
The real world is non-linearbut we think in linear ways.
yet we tend to look sat things through a human-centered (anthropocentric) lens.yet we tend to look sat things through a human-centered (anthropocentric) lens.
The real world is adaptive and organicyet we tend to think mechanistically and the metaphors we use reference machines (e.g., a universe like clockwork; mind is a computer).
The real world is networked and complex with a sprinkling of randomnessyet we think of things in ordered categories and hierarchies.

All businesses are complex adaptive systems. We have no choice in the matter. An organization is a living, breathing thing, organic — lots of individuals dynamically making decisions that roll up into the complex system. It’s not a machine.

An implication is that business executives and managers can’t operate on outcomes directly (e.g., via business “planning” or business “strategy”). Outcomes are emergent from the system and can be worked on only indirectly.

The traditional mental model for business organization is flawed.

Laura and Derek capture the traditional mental model for organizational management in the acronym PCCU: Plan, Command, Control, Utilize.

Plan: Businesses create plans for the future, often in great detail, with rigorous discipline, and lots of numbers and projections. But the real world is changing too fast, and outlining detailed steps to reach a goal amidst rapid change introduces biases that can occlude opportunities for rapid and profitable adaptation to change.

Command: Hierarchical organization designs assume a military metaphor of command. Organizations are much more organic in the real world, tempered by social influence, compliance, resistance, and rebellion. Better to think of then organization as a network and a culture.

Control: Management likes to feel like it is in control, but the control paradigm is both unrealistic and unresponsive to organic change.

Utilize: The most detrimental organizational construct is the Human Resources department. Treating people like resources to be utilized is unsustainable. People are independent agents in the system who wish to co-evolve to a place where their individual goals and those of the organization are well-aligned.

The mental model for how complex adaptive systems work is Simple Rules.

The great insight from complex adaptive systems thinking is that organizational behavior isn’t directed by leaders, but driven by followers. What are they following? Simple rules.

We can think of an organization as a superorganism. It self-organizes by following simple rules that guide the actions of individual agents in variable contexts. Autonomous agents follow simple rules based on what’s happening locally (that is, around them), the collective dynamics of which lead to the emergence of the complex, system-level behavior we observe: adaptiveness and robustness.

The simple rules for successful adaptive organizations are summed up as V-M-C-L.

Vision: A seeing thing. Something we all see in the future, where we are headed. Not a tagline, not a statement on a website, not a corporate word salad. A vision is a shared mental model that everyone in the organization can see and articulate and align with. It’s in their hearts and minds. It gets employees excited and connected.

Mission: A doing thing. A mission is something that you do repeatedly over and over again to bring about the vision. It directs the work in the organization, with clarity about who does what. It’s clear, concise, easily understood and measurable.

Capacity: The organization must have the capacity to do the mission: the energy, the resources, the skills. Capacity is a system of systems all connected and working together, focused on, and directed towards doing the mission.

Learning: Learning is critical to expand capacity, reinforce mission and refine vision. It is the adaptive function. Organizations must love learning – seeking unvarnished feedback from the outside world as input into making the changes that are needed for improvement. This means loving reality and being brutally honest about the current state. Learning means improving mental models, and embracing the possibility that your current model is wrong.

In their book Flock Not Clock (see Mises.org/E4B_152_Book), where there is a detailed exposition and explanation of V-M-C-L, Laura and Derek cite the example of the app My Fitness Pal.

Vision: Healthy living is the new normal

Mission: Facilitate and motivate healthy behavior choices

Capacity: Build mission-critical systems: design, engineering, R&D, sales, and marketing, etc.

Learning: Feedback on whether living healthy is getting easier, whether more people are making healthy choices, whether more people are feeling joyful and powerful as a result.

Think of the elements of V-M-C-L as a pyramid you can construct from first principles: Thinking drives Learning, which drives Capacity, which drives Mission, which brings about Vision.

The emergent result of V-M-C-L is culture.

Laura and Derek talk about training people to think in order to be able to learn. The first step is often unlearning the misleading mental models we’ve been taught to believe. When people start to think about mental models, they can recognize their own and those of others, and make comparisons, make changes, and find common ground.

If your mental model about your current situation is real — “brutally honest,” as Derek put it — then the chance of changing that situation for the better is good. You’ll be able to identify a path out.

Culture can be built around the simple rules of vision, mission, capacity, and learning, by purposely constructing the four mental models of V-M-C-L. There is enormous organizational and economic power in the new understanding of complex adaptive systems and how they work in getting a group of disparate people to work together towards a goal as if they are a single unified organism.

Additional Resources

Sign up for Laura and Derek’s Vision-Mission Bootcamp:  Go.CabreraResearch.org/VMBootcamp

Visit Cabrera Research Lab online at CabreraResearch.org and on LinkedIn (Mises.org/E4B_152_LinkedIn).

“20-Point V-M-C-L Checklist” (PDF): Mises.org/E4B_152_PDF1

“Constructing the VMCL System” (PDF): Mises.org/E4B_152_PDF2

Flock Not Clock: Align People, Processes and Systems to Achieve Your Vision by Derek and Laura Cabrera: Mises.org/E4B_152_Book

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

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Strategic management theories and entrepreneurship theories have diverged in academia. One perspective can’t recognize the other. Yet the most promising and successful new business approaches demonstrate an agile combination of both sets of theories. Professor Mohammad Keyhani joins Economics For Business to explain this phenomenon and help us point the way to the future of strategic entrepreneurship.

Key Takeaways and Actionable Insights.

In business school thinking, there is a dichotomy between strategic management and entrepreneurship.

In management scholarship, strategic management and entrepreneurship are distinct fields of study. Professor Keyhani calls them “two logics” of business.

Both logics have gained legitimacy from their origins in economics. As business theories, they base their arguments on models from the field of economics, which, of course, is older and more mature. By importing thinking from economics, these business disciplines are able to construct generalizable theories (as opposed to, for example, a case study approach). The most famous generalizable theory in strategic management is Michael Porter’s five forces framework, which borrowed from industrial organization economics. Most strategic management theories have been based on general equilibrium models of neo-classical economics. Strategic management became a theory of structures and constraints, and of imperfections in equilibrium (such as the concept of competitive advantage).

The entrepreneurship discipline has been more varied and diverse and less dominated by economic models. Entrepreneurship scholars look to Austrian economics, which is based on verbal logic rather than mathematical models. But Professor Keyhani, in his Ph.D. dissertation, found an integration route between strategic management and entrepreneurship using the framework of game theory, adding elements of time and dynamics (both critical in Austrian theory) and adding the innovation of computer simulation (to which more and more Austrian economists are open as a way of adding computable algorithmic rigor to verbal logic).

He established a way for strategic management and entrepreneurship to communicate with each other.

Strategic management is a theory of competitive structures.

Strategic management models are based on models of competition among players with similar value propositions, maybe with slightly different cost structures and other small differences, but all considered as competitors to each other. The models look at the nature of the competition, the structure of the competition, and seek insights into why some companies may have advantages over others.

Strategy becomes an approach of identifying and building on strengths, about sustaining and managing an existing system, about operations rather than innovation, and about control and prediction.

The consequence is a series of blind spots, mostly to do with the dynamics of action over time, the uncertainty that accompanies action, and the learning that results.

Entrepreneurship is a theory of dynamic value creation.

The question in entrepreneurship is how to create value and how to build a value creation system in the first place. The entrepreneur faces the questions, “Am I creating any value at all? Is anyone going to pay for this innovation and be happy with it? And will I be able to get more customers?” These questions precede the models that strategy and strategic management theory have been based on. Those models start off with the entrepreneur’s questions having been answered, so they are not useful at the value creation stage.

Based on Austrian economics, the entrepreneurship literature has provided mental tools and mental models for entrepreneurial thinking and an entrepreneurial approach to business. These include the emphasis on subjective value and customer sovereignty, and on uncertainty and unpredictability in business. There is value in action in the face of uncertainty, because it creates new information, which can support better decision-making. That mechanism is totally lacking in the equilibrium models of strategy.

Theories of entrepreneurial action to generate learning are useful not only for startups but also for larger companies, to help them think and act more entrepreneurially, and to counter the defensive and anti-innovative thinking of building on strengths and defending position. Managing an existing value generation system can result in losing the long-term perspective of innovation, adding new product lines, taking advantage of opportunities, and potentially building new strengths.

“Do both!” The best approach combines strategy and entrepreneurship.

Professor Keyhani argues that, ideally, firms think strategically and act entrepreneurially, and he recognizes that, in the real world of practitioners, this is what businesses do.

He uses blockchain as an example. No company can say that they have an existing strength in blockchain because it’s a new technology and the business concepts that utilize it are only just emerging. It’s a level playing field.

Are there any advantages a company could have? Maybe a company has a lot of computer scientists and mathematicians. That might be a slight strength. But getting into blockchain businesses is an entrepreneurial action, largely different than building on strengths.

The approach to innovation we support here at Economics For Business is “Explore And Expand”, and Professor Keyhani sees a good match between the explore-expand dichotomy and the entrepreneurship-strategy dichotomy. Exploration is a blind spot in strategic management theory and modeling — there is pretty much no exploration in the five forces framework or the RBV (resource-based view) framework. Exploration — acting for the learning value to open up options for more things that can be done in the future — is the entrepreneurial way of thinking.

Effectuation (covered in Episode #131) is another form of entrepreneurial logic. It recognizes that the entrepreneur faces so much uncertainty that it may not be possible to set specific objectives. But the entrepreneur knows that they want to do something, that they have knowledge and resources and relationships, and that they may be able to create some value from them. Effectuation is the “fuzzy front end” of value creation.

Another way to combine entrepreneurship and strategy is speed of learning. The general capability to be more adaptive than competition, to go through the learning cycle faster, is a dynamic capability that can be strategic.

Competitive moats in the software world.

Is the structure-and-constraints approach of strategic management useless in the digital era we live in? Sustainable competitive advantage seems to be inapplicable when anyone can write software (or download it from Github), and access hosting and storage at scale from AWS.

But in fact, software entrepreneurs do think in terms of competitive advantage. The modern term for it is “moats”. Venture capitalists look favorably on businesses that can surround themselves with a moat to keep out competition.

The most discussed moat is network effects. This concept did not come from the neo-classical economics equilibrium models, but from the dynamic analysis of more users coming in to join existing users. The five forces framework suggests that advantages lie either in cost or differentiation, but a network effects advantage can be both.

Two-sided platforms with two-sided network effects add even more complexity. It’s strategic to achieve that status, but the theory did not emanate from traditional strategic management thinking.

Professor Keyhani introduces the next entrepreneurial strategy breakthrough: generativity.

We talked in Episode #104 about the new phenomenon of digital businesses identified by Professor Keyhani: generativity. Achieving generativity confers significant competitive advantage for any entrepreneurial firms who can develop it through technology. It’s an advantage that is not identified by existing strategy theories.

Generativity can be thought of as the automation of open innovation. Products and services can be designed to offer features that enable outsiders to innovate with them, and these outside innovations benefit the company. For example, the Google Pixel smartphone and the Apple iPhone are generative products or generative systems. With the tools these firms provide in the phones, outside developers can create new apps, that they offer on the Pixel or iPhone platform for other outsiders to use. The app developers make money, and so do Google and Apple, both from sales of outsider-developed apps in their app stores, and from in-app purchases. Google and Apple are not utilizing their own knowledge — they don’t know the problem the app is solving, or even who developed it or where they are. They don’t have to make the solution, don’t have to take the risk, and don’t have to pay salaries or development costs. Yet they profit from the innovation. It’s a huge competitive advantage for these two entrepreneurial companies.

Additional Resources

“The Strategic Management Model versus the Entrepreneurial Model” (PDF): Download PDF

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

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

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

143: Per Bylund: How Austrian Entrepreneurs Succeed

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Successful entrepreneurs are Austrians, they just don’t know it yet. This is a famous assertion from Dr. Per Bylund, and we dissect its meaning in the latest Economics For Business podcast.

Key Takeaways and Actionable Insights

Success starts from a deep understanding of subjective value (see Mises.org/E4B_143_PPT).

What’s the value of a successfully completed Google search? What’s the value of the feeling of satisfaction that results from having cooked an excellent meal enjoyed by your family? What’s the value of the PowerPoint template you utilized to make a well-received boardroom presentation that may boost your corporate career?

Austrian entrepreneurs know not to ask the question in that form. First, value is not measurable; it’s a feeling or experience in the mental domain. It may have great intensity, it may have long duration, but it can’t be measured in dollars or with any other number.

Yet the generation of customer value is the entrepreneur’s goal. How can the goal be achieved when the understanding of value is so challenging and its measurement is impossible? This is the brilliant advantage of the Austrian entrepreneur.

The customer learns what a value experience feels like.

A customer can’t describe the value they are seeking or what goods and services will deliver it. The value process is not one of demand and supply. As Ludwig von Mises understood, customers feel a sense of unease — “things could be better” — and begin to explore possible avenues to relieving their unease. Of course, this exploration takes place within a complex system of needs: individual and personal goals, family comfort and security, job success and economic status. Customers sort through possibilities with incomplete information and in the context of uncertainty. The gap between feeling unease and finding the best good or service to address it is large. They might try multiple potential solutions with varied cost/benefit profiles before they arrive at one that seems best, or better than alternatives. In other words, they learn: value is a learning process.

The entrepreneur helps their customers to learn.

The customer’s value thinking is constrained: in the present, they can’t imagine a solution that they haven’t yet tried or that has not been available to them. The entrepreneur innovates around the constraint, by providing and communicating new means that the customer could utilize in the future.

Entrepreneurs can’t directly shape the customer’s choice. It’s a fallacy to believe that advertising or promotions or presentation of features and benefits can accomplish that. The customer’s context is too complex for such a simple mechanism to work. The entrepreneur creates a tomorrow in which the customer will feel better off, and provides the means to facilitate the experience, a means for the customer to learn what a better tomorrow feels like. They meet customers in a market that doesn’t yet exist.

Austrian entrepreneurs have a unique value generation tool.

The complexity of the customer’s value system — all the components of value interacting and changing in time — can be simplified with the use of a key that Austrians call the hierarchy of values. Every individual has a set of goals or values they pursue in life. Some of these are more important than others — we call them the highest values. For example, people who engage in sport and athletic activities may have several values for doing so: for fitness and health, for social reasons, for self-improvement, and so on. One value may be the most important in their own individual hierarchy — for many people it is the sense of achievement. By improving their speed or time of running or bicycling, by winning a tournament or a league or playing on a winning team, the individual can experience a sense of personal achievement that is rare, valuable, and fulfilling.

It is a commercially strong behavior to appeal to this highest value among customers. Nike does this for example with its “Just do it” appeal. To simply undertake the athletic activity is achievement: you’ve done something. And, of course, Nike wearables help the process of experiencing the highest value.

All entrepreneurs can appeal to customers’ highest values, and the Austrian entrepreneur has deeper insight into this action.

Austrian humility is a success factor.

So much of business success is projected as heroic implementation of superior strategy. Austrian entrepreneurs do not suffer from such hubris. They take a humble approach to business, understanding that the customer is often engaged in searching and learning without a clear outcome in mind, and that, therefore, the entrepreneurial business cannot be certain of any future results. Entrepreneurs humbly follow, letting the searching customer take the lead, and accepting the customer’s terms of service.

This is how entrepreneurs learn how to facilitate value — often from the harms they suffer from getting their value proposition out of alignment with the customer’s preferences. If the value proposition is wrong, or the price is too high, or the convenience not to the customer’s liking, then no transaction is made, and the entrepreneur must — humbly — adjust. The most successful entrepreneurs are able to maintain their attitude of humility at all points in the value cycle.

Austrian entrepreneurs take the role of fitting in to the customer’s value system. It’s a flow, not a plan.

Conventional business planning is anathema to Austrian entrepreneurs. The linear process of producing and selling to generate transactions with the goal of meeting a targeted volume or revenue in a fixed period of time is not appropriate for the humble, learning, exploring business of entrepreneurship.

Entrepreneurial success stems not from good planning but from adaptively fitting in to the evolving value system we call the market — a system that is different for every individual customer, and into which many overlapping and competing entrepreneurial value propositions are also trying to fit.

Planning is not a good tool for this purpose. Creativity, imagination, and adaptiveness are called for. The dynamic of learning from the customer and adjusting to changing signals calls for responsiveness not plans. The entrepreneurial journey with the customer is a flow, sometimes through white water. In this context, the Silicon Valley concept of pivoting is appropriate, although not quite as the West Coast gurus see it. Their pivot is a one-time major shift in direction, perhaps to a new business model when the original one proves inadequate. The Austrian pivot is continuous and flowing, adjusting the boat to the subtle and frequent signals sent by customers.

Explore, Realize, Then Keep Exploring.

We’ve talked in the past about an “explore and expand” model for entrepreneurial value generation. The entrepreneur co-explores various paths to value with the customer, and when one emerges as productive of significant value, the entrepreneur can expand the allocation of resources to that path and drive revenue growth, through selling more to the same customers, or recruiting new customers or both.

Professor Bylund added some nuance to this: the entrepreneur never stops exploring. When an exploration results in substantial value realized, there remains a lot of further exploration to understand the value experience of the customer in greater depth and detail, and continuous monitoring of changes and adjustments in the customer’s system and value network. The entrepreneur is continuously tested.

The entrepreneurial ethic is an ethic of service; profit is a shared outcome of consumer and producer choices.

Entrepreneurial firms are in business to serve customers. This principle may be appropriately expressed via mission statements and expressions of purpose; it remains the core of all entrepreneurship. Profit is an outcome of two collaborative choices: the exchange price the consumer is willing to pay for the value they anticipate receiving, and the choice of costs the entrepreneur considers proportionate to the value he or she expects to generate for the customer. There are many entrepreneurs in the market for resources bidding on costs at the same time, and so the individual entrepreneur’s choices are conditioned by those made by others. Profits emerge from this system.

Cash flow is a better indicator of the capacity of the entrepreneur’s business model to convert resources into exchange value for customers (although not the artificial cash flows of engineered P&L’s — rather, the true cash flow of the customer’s eagerness to exchange for the newly produced offerings from the entrepreneur).

There’s a distinctly Austrian approach to entrepreneurial business.

In a famous paper called “Inversions of Service-Dominant Logic,” professors Stephen Vargo and Robert Lusch called for inverting “old enterprise economics or neoclassical economics” in favor of a new perspective. One of their proposals was an inversion of “entrepreneurship and the view that value creation is an unfolding, emergent process” to a position “superordinate to management”. Business schools, they stated, teach a management discipline rooted in the industrial revolution. There’s an emphasis on centralized control and planning. Vargo and Lusch sought to replace this approach with value creation as “an emergent process within an ever-changing context, including ever-changing resources; it is, by necessity, an entrepreneurial process”.

The distinctive Austrian entrepreneurship approach captures and expresses the emergent process, and provides entrepreneurs (and managers) with the tools and methods to help them shape thriving businesses as they discover new solutions to relieve customer unease.

Additional Resources

“Explore and Realize (and Keep Exploring): How Austrian Entrepreneurs Generate Value on the Path to Business Success” (PowerPoint): Download Slides

“Inversions of Service-Dominant Logic” by Stephen L. Vargo and Robert F. Lusch (PDF): Download_PDF

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

120. Mark Schaefer on Cumulative Advantage

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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

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