Chance and Intent

Managing the Risks of Innovation and Entrepreneurship

David L. Bodde, Caron H. St. John

• Publisher: Routledge
• Year: 2012
• eBook ISBN: 9781136457678
• Topic: Business
• Subtopic: Business General
• Index: Business

A compact and readable book will help executives, entrepreneurs, and venture investors learn to search out and plan for those enterprise hazards that reside outside the bell curve, the conventional domain of risk:

• Uncertainty, where outcomes can be characterized in advance, reliable estimates cannot be made for the likelihood that they will occur;
• Ambiguity, where the events and outcomes cannot be well characterized, in some cases because we cannot imagine them and in others because characterization depends upon the institutional interests or cultural values of the observer; and,
• Ignorance, where neither likelihood estimates nor well-characterized events enjoy much credibility.

This edited volume emphasizes practical strategies for understanding and managing the hazards of the new venture in light of recent research. It will help corporate innovators, entrepreneurs, and investors employ a wider spectrum of risk management strategies than is now possible.

PART I

Decision-Making Under Stress and Uncertainty

. . . don’t let the sound of your own wheels make you crazy.

Jackson Brown

POOR DECISIONS BY SMART, capable people mark the history of all human endeavor, and this is no less true for entrepreneurs and innovators. This opening section of Chance and Intent seeks ways to understand and to manage the idiosyncrasies of that most difficult of human activities, wise decision-making.

Two kinds of pressures strongly influence human judgment, and we must understand both if we are to attempt to manage them. The first arises from the idiosyncrasies of individual behavior: our decisions are biased by the many small irrationalities that separate human judgments from those that would be made by a rational actor … or a robot. The story of the doomed polar expedition of the British explorer Sir Ernest Shackleton, which follows, illustrates the foibles of individual decision-making for good and for ill.

The second pressure is organizational. Decisions are rarely made outside the context of some institution, whether it be a small startup, major corporation, or government agency. The culture of the organization within which decisions must be made strongly influences the choices of the decision-makers. The fatal decision to launch the space shuttle Challenger, also following, illustrates the influence of organizational context.

ERROR AND RESILIENCE: SHACKLETON’S LAST POLAR EXPEDITION

Judgments of risk and return must eventually be made by individuals, and so their decision-making propensities bear examination. Consider the case of Sir Ernest Shackleton, an Antarctic explorer who never fully achieved the promises made to investors in any of his explorations. His final expedition, which set out in 1914 to trek from one side of Antarctica to the other via the South Pole, never set foot on the continent. Instead, an error in judgment left his ship, Endurance, trapped offshore in the ice floe and eventually crushed by it. Yet the story of how Shackleton led his entire team to safety remains today an exemplar of resilient decision-making and leadership.

The exploration industry was a thriving, keenly competitive enterprise as the nineteenth century rolled into the twentieth. Entrepreneurial explorers raised funds from wealthy individuals (who got their names on mountains, promontories, and other recognizable topography), scientific societies (rewarded through their association with important discoveries), and governments (who got to plant the flag). Among the best of these was Sir Ernest Shackleton, and his chosen territory, the Antarctic, had become the focus of an international race to reach the South Pole. In 1895, the Sixth International Geographical Congress had convened in London to declare the Antarctic the most urgent scientific quest of the era.

Shackleton could offer impressive credentials to prospective financial supporters. He had gained experience as a member of Scott’s 1901–2 expedition, which succeeded in getting closer to the Pole than any previous explorers. Around 1905, Shackleton began fund raising for another expedition, seeking a sum that would translate into the $3–5 million range in today’s dollars. In good entrepreneurial fashion, he contacted a list of about 70 prominent London business persons, gained scientific credibility through the Royal Geographic Society, and used family connections to reach persons of influence and wealth. Seeking market space in the progressive Victorian mind, he even promised to use an automobile and motorized sledge on the ice—though common sense prevailed and these were later dropped.

The resulting 1907–8 expedition came within 100 miles of the South Pole, but turned back debilitated by hunger and frostbite. No doubt this disappointed Shackleton keenly. But this man of courage and intense competitive drive also possessed the good judgment to recognize an unacceptable risk—that continuing toward the Pole would cost the expedition their lives—and the humility to act responsibly on that knowledge. Though falling short of its goal, the Shackleton expedition did set a world record, which gained him a knighthood in 1909.

The race to the South Pole was won in 1911 by Norwegian explorer Roald Amundsen. This left Shackleton, who had been raising funds for another expedition, bereft of a compelling goal. Ever the entrepreneur, he soon conceived the next big thing—a transcontinental journey from sea to sea while crossing the Pole. Fund raising, however, proved difficult because both the Amundsen victory and the increasing prospect of war in Europe eclipsed Antarctic exploration in the public mind. Nevertheless, Shackleton’s persistence paid off. By the end of 1913, enough had been raised to procure supplies and a ship, named Endurance after the Shackleton family motto. Endurance departed a London dock just as England declared war on Germany in August of 1914.

The expedition arrived at South Georgia Island, the southernmost of Britain’s whaling stations where Shackleton was advised by local captains that the ice floes that year had reached the most northerly point in memory. They strongly advised him that to sail risked becoming trapped in the ice. Shackleton waited a month on South Georgia. But when conditions failed to improve, the expedition departed for Antarctica in December of 1914 (midsummer in the Southern Hemisphere) betting on the triumph of audacity and good fortune over ill circumstance.

Making its way slowly through the thickening ice, Endurance had drawn within sight of the Antarctic shore when the floes closed all possibility of passage. Hopelessly trapped in the ice, the expedition would have to drift with the ice pack until it crushed the ship. And drift they did, generally northwest from January of 1915 when Endurance became trapped, until April of 1916 when they left the floe in lifeboats for Elephant Island, a barren, windswept rockpile just off the Antarctic continent. From there, Shackleton and a carefully selected crew sailed one of the boats 800 miles northeast to the whaling station at South Georgia, arriving there in May of 1916—one of the most remarkable feats of navigation and seamanship of all time. A rescue ship later recovered the remainder of the expedition from Elephant Island. All members of the expedition survived.

This meager telling does little justice to the saga, and far richer accounts are available (Lansing 1999). Instead, our purpose is to illustrate issues of individual decision-making in the face of high risk. These issues are the subject of Chapter 1 of Part I, “Managing an Entrepreneur’s Risk-Taking Propensity.” Drs. Philip Bromiley, Devaki Rau, and Caron H. St. John draw upon the work of psychologists and experimental economists to understand the idiosyncrasies of human behavior toward risk. Their synthesis sheds additional light on the Shackleton story.

For example, why would the normally prudent Shackleton make the enormous mistake of setting out from South Georgia despite the advice of experienced sailors familiar with the region? Though we cannot know his mind, the answer might be financial. Shackleton’s personal credit was effectively ruined by over-extended loans he had taken out to finance the expedition. He must have known that any extended delay would require additional supplies, and he had every reason to believe that the financing to procure them would not be available. So rather than suffer the sure loss of the polar expedition, he took a gamble on the possibility of an even greater loss involving human suffering and possible death—a behavior entirely consistent with the observations of Bromiley, Rau, and St. John.

But why then did Shackleton’s judgments become flawless once Endurance had been trapped by the closing ice? Each of his subsequent decisions—from abandoning the doomed Endurance, to the trek across the ice floes in search of open water, to the sail to Elephant Island, to the final sea crossing to South Georgia—proved to be well-conceived responses to desperate circumstances. Again, we must speculate. But once all hope of the promised trans-polar trek had been lost, it appears that Shackleton’s reference point had become survival and not mission accomplishment. And so from that point forward, every choice made was the least risky of a set of high-risk options, a conclusion entirely consistent with the behaviors set out by Bromiley, Rau, and St. John.

THE CHALLENGER LAUNCH DECISION: CULTURE AND THE NORMALIZATION OF DEVIANCE

We all know (or think we know) the public story—how mid-level managers at NASA and its contractor Thiokol over-rode the objections of knowledgeable engineers and decided to launch STS 51L that cold January morning in 1986. Lift-off occurred at 11:38 a.m. at a launch pad temperature of 36 degrees. Seventy-three seconds later the Challenger disappeared in a catastrophic explosion, and all seven of the crew perished.

The proximate cause was plain. The field joint that linked sections of the right solid rocket booster (SRB) had failed to contain the high pressure combustion gas. The zinc-chromate putty designed to seal the O-rings from the combustion gas failed to do so, and the resiliency of the O-rings themselves was impaired by the ambient cold. About 59 seconds after launch, a small flame became visible from the side of the SRB, and this impinged on the external tank containing the liquid hydrogen and oxygen fuels. At 73 seconds, the catastrophic explosion occurred.

Three major investigations followed quickly: one by a Presidential Commission led by former Attorney General William Rogers, one by the House Committee on Science and Technology, and one by NASA itself. From these investigations emerged the commonly understood narrative of the tragedy: that wrongdoing by mid-level managers seeking to maintain the launch schedule and hence the “productivity” of the shuttle system led to an otherwise preventable tragedy. Yet like so many historically accepted accounts, this narrative is incomplete and hence misleading. We must take time to understand the real lessons of the Challenger if we are to apply them to the risk of launching new ventures.

Such an understanding appears in a remarkable book, The Challenger Launch Decision, by Dr. Diane Vaughan (Vaughan 1996), and we will apply her conclusions about the NASA decision process to the risks of decision-making by new venture management teams. Vaughan’s central point concerns the “normalization of deviance,” by which she means the tendency of a culture—in this case that of NASA space flight operations—to ignore evidence that disconfirms the central theses of that culture. In the NASA of the 1980s, the central organizational thesis was that shuttle operations had become routine—even the name “Space Shuttle” implied the equivalent of a bus ride to the airport and carried the same expectations for reliability and economy. That sense of the routine built an operational culture within the shuttle working group that enabled and reinforced itself, and that had difficulty recognizing signals of anomalous events.

Yet anomalous events abounded. Though the O-rings had been troublesome from the earliest days of the shuttle’s development, striking evidence came with the second flight, STS-2, in November of 1981. When the SRBs were disassembled for examination after the flight, the NASA engineers discovered that the combustion gas had indeed penetrated the putty and impinged on the O-ring. This was entirely contrary to the design expectations, which held that the gas would never reach the O-ring. Subsequent flights confirmed this deviance, and incremental attempts were made to address the problem. These fixes did not fully succeed, but the shuttle missions did. And so the working group culture came to accept a bit of char on an O-ring as normal. The original design expectations forgotten, compelling evidence could not be found to delay the launch of STS 51L. This is what Vaughan means by “the normalization of deviance.” And so, the institutional framework exerts a powerful influence on what risks are acceptable and what risks are not (Vaughan 1996).

For our purpose in understanding the risk of new ventures, an important lesson emerges: that the culture and institutional norms of the innovator strongly influence the kinds of risk that are undertaken and their acceptability. This is true whether the innovating institution is large and complex like NASA or General Motors, or a garage startup with two partners and a dog. In Chapter 2, “Risk-Takers and Taking Risks,” Drs. William B. Gartner and Jianwen Liao summarize their recent research into the risk-taking propensities of entrepreneurs. They conclude that those considered to be entrepreneurs are not inherently greater risk-takers than non-entrepreneurs. And successful entrepreneurs show no different risk propensities than the unsuccessful. To the contrary, Gartner and Liao show that the organizational and social context to be a principal influence on the risk of new ventures, and they suggest ways to manage it.

TOWARD IMPROVED DECISION-MAKING

Unlike physics, which is governed by laws that compel obedience, human behaviors are subject to central tendencies, and even these are inconsistently observed. Thus, neither of the chapters in Part I can offer a full prescription for the foibles of human nature. What they do, however, is provide a richer understanding of the cognitive biases that influence risk-taking, and in doing so, help to improve the likelihood of wise choice. Perhaps the best summary of advice for managing the risks of decision-making is to select decision-makers of known character and integrity, to seek a diversity of opinion in risky circumstances, and to carefully manage the risk and reward context within which the decisions are taken.

REFERENCES

Lansing, Alfred (1999) Endurance: Shackleton’s Incredible Voyage. London: Weidenfeld & Nicolson.

Vaughan, Diane (1996) The Challenger Launch Decision. Chicago: University of Chicago Press.

Chapter 1

Managing an Entrepreneur’s Risk-Taking Propensity

PHILIP BROMILEY, DEVAKI RAU AND CARON H. ST. JOHN

We make investments in entrepreneurs—not businesses. Our fund would rather invest in a great entrepreneur and a mediocre business—than a mediocre entrepreneur with a great business concept.

We want entrepreneurs with experience—someone who has taken a business full circle from start-up to exit. Even if they have failed before, they will have learned from their mistakes. And, by trying again, they are demonstrating their toughness and resilience in the face of adversity.

We want entrepreneurs to have “skin in the game.” We want them to have money and their livelihood at risk to show their commitment to the success of the business. We don’t want them to be able to walk away if things get rough.

INVESTORS IN EARLY-STAGE entrepreneurial ventures often align with these beliefs—that the success of the business is more tied to the talent and insight of the entrepreneurial team than the business concept proposed in the prospectus; that experience accumulates and improves the likelihood of success with a second or third venture; and that by increasing the entrepreneur’s up-front commitment to the venture—increasing their personal stake at risk—the business will benefit. How do these ideas mesh with what we know about risk and decision-making?

The word “entrepreneur” is derived from the French word “entreprendre” which means “to undertake.” It is, by definition, action oriented. But, before taking action, the entrepreneur decides to take action, decides which actions to take, decides when to act and with what level of resource commitment. Once the new venture is launched, the entrepreneur and advisers decide the direction, timing, and investment for growth. If the venture is doing poorly, they decide what to do, including invest more or quit. These patterns of decisions made by entrepreneurs and their advisers largely determine the success or failure of the new venture over time. Ultimately everything that occurs in and around the formation and continuation of a new venture is a product of a decision made by a human mind, in an environment of uncertainty.

Economists and psychologists have studied decision-making and uncertainty for decades, with considerable attention in recent decades on the role of human cognition. Human cognition refers to the way we acquire, interpret, and use information, including the way we recognize opportunities, make decisions, and plan actions. These cognitive processes are influenced by a variety of personal and environmental factors, which is why two people who see the same factual information may draw very different conclusions about its meaning, why one person may see an opportunity that the other does not, why one person sees an action as risky that the other does not. Most importantly, psychologists and economists have learned that risk-taking propensity is not a permanent characteristic of an individual. A decision-maker’s risk-taking propensity can change over time, differ by context, and be influenced by the p...

Table of contents

• Cover
• Title
• Copyright
• Contents
• Acknowledgements
• Introduction: Some Thoughts at the Beginning Concerning Risk and its Management
• PART I. Decision-Making Under Stress and Uncertainty
• PART II. Managing Unruly Reality: Risks from the Business Environment
• PART III. Open Innovation: New Horizons, New Risks
• Author Biographies
• Index