Despite the deep pockets and resources of established, large companies, time and again, cash-strapped startups invent and disrupt markets. Many explanations have been given for this — entrepreneurial firms are more agile, more risk-taking, don’t have legacy considerations, it’s more cost effective to let entrepreneurial firms innovate and then the established firms can just acquire them. But I’d suggest a different reason: they have different decision processes.
Established firms analyze before they act. They study supply and demand, calculate ROI, list and analyze all alternatives, and estimate expected utility curves. They focus on predicting as much as possible. This is a rational approach if you have an established product or service and sufficient information about it to estimate the risk.
New product and service offerings, particularly those that are highly novel, however, have decision contexts that are uncertain. The processes used by firms need to match the uncertain decision-making conditions. In conditions of uncertainty, calculation and prediction aren’t helpful. The best decision-making practices and methods under conditions of risk are not the best under conditions of uncertainty, and vice versa.
Conditions of uncertainty
In conditions of uncertainty, more information, time and computation aren’t always better.
Take Uber, for example. While many analysts focus on the competition between Uber and taxi drivers — what is perhaps even more amazing is that Uber convinced a large population that it’s OK to get into a stranger’s car. The sharing economy has emerged in large part because of Uber, and it fundamentally conflicts what many knew to be true before Uber: “Don’t get into cars with strangers.”
In conditions of uncertainty, there are things we know we don’t know and things we don’t know we don’t know, but the most problematic for entrepreneurship and innovation are the things we think we know that we really don’t know. This is often true of demand. For example, Starbucks launched and had phenomenal growth at a time when demand for coffee in the U.S. and the price and quality of coffee were declining. Starbucks created new market demand that didn’t exist prior to its efforts.
Think differently
When making decisions in uncertain contexts, using your “gut intuition” — more formally called biases and heuristics like overconfidence, generalizing from an experience of one or escalation of commitment — may be more effective than all the analysis in the world.
When established firms invest in innovative projects or programs, it’s important to think differently about the business or project delivery and tell a compelling story about those differences that will ultimately become a vision. Be willing to update the story as the innovative process creates new information — it is OK to ride with strangers!
Mistakes will be made as the process unfolds, but try to make those mistakes learning experiences, so there is no such thing as failure. Make the experiments small so that cost doesn’t drive the decision to go forward. It’s one thing to lose several thousand dollars and quite another to lose several million.
Finally, leverage diverse individuals and their experiences, because you never know what information will be important, what will be unimportant and what new information you will create.
Sharon Alvarez is the Tom W. Olofson Chair in Entrepreneurship at University of Pittsburgh Joseph M. Katz Graduate School of Business and College of Business Administration. Her current research includes entrepreneurship theory of opportunities, firm and market emergence.
