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169. Jeff Arnold: A Passionate Entrepreneur Profitably Redesigns The Insurance Experience

Is there any industry a passionate entrepreneur can’t improve and enhance by elevating the customer experience? The answer is clearly no. Economics For Business talks to Jeff Arnold, who finds insurance fun, exciting, and a source of inspiration, and who is advancing profitably towards the new future he’s imagining, where buying insurance is so enjoyable that customers will stop shopping on price and clamor for the new experience he is designing.

Key Takeaways and Actionable Insights

Passionate, creative entrepreneurs can deliver profitable innovation to any industry, no matter how static and rigid it may seem.

Jeff Arnold loves insurance. He told us he finds it fun, awesome, and exciting. Studying the intricacies of contractually trading and transferring risk for payment generated a lifetime interest and passion in him. He’s turned that passion into revenue and profit by delivering new value to customers in aspect of their life or their business that is extremely important to them.

As a good Austrian, Jeff Arnold views his industry first from the customer’s perspective.

Customer-first. That’s the Austrian way of business. When Jeff thinks about insurance, he thinks from the consumers’ perspective. They pay hundreds of thousands of dollars over a lifetime for insurance of many kinds: house, automobile, business, medical care, and more. Do they know exactly what they are buying — or, perhaps more importantly, not buying because of exclusions buried deep in the small type of the appendices to an insurance policy agreement? How do they feel about the customer interface, including call center phone trees and hard-to-decipher policy documents?

From this perspective, he is able to develop design principles for an insurance business with a better customer experience:

  • Help customers to think about a systematic lifetime plan for all their insurances;
  • Help them develop the knowledge required to properly understand insurance offers and alternative policies;
  • Give them the opportunity to customize insurance products for their needs as opposed to buying a commoditized vanilla product;
  • Help them to get the exchange value from the purchase that is right for them.
  • Give them an interpersonal experience that’s much better than the industry norm.

Jeff focuses his customers on value, not price.

Most often, buyers approach an insurance purchase with a transactional frame of mind: how can I pay the lowest price. They’ll shop around to find it. Jeff wants to put an end to “price shopping”, to be replaced with a value calculation: what coverage do I need, how did I get it, and who is the best provider?

The value calculation often entails discovering and eliminating exclusions — coverages that are excluded in the fine print of the contract. These exclusions occur in home insurance (which is especially hard to read and understand) auto insurance (there are 12-14 exclusions to look for according to Jeff) and commercial or business insurance (where many coverages are automatically excluded and must be built back in item by item, with careful attention to detail).

The value solution lies in the integration of technology and personal service.

Jeff’s latest business, RightSure, aims to get individuals the right insurance by using A.I. in combination with “famously friendly humans”, i.e., staff carefully selected and trained to deliver knowledge and service in an amenable way. The A.I. can provide a preliminary phone interface, a chatbot interface on the website, and can do an excellent job of matching customer needs to the right policies. Famously friendly people can patiently explain all the policy options, point out what’s covered and what’s excluded, answer customer questions, and help them to make informed decisions. They’re good at listening, exhibit high empathy, and can help customers navigate from suspicion to trust.

The combination of A.I. and famously friendly humans delivers a superior customer experience while also achieving high levels of efficiency. The return on investment in human capital is as high as the return on technology capital. The combination generates brand uniqueness.

Jeff represents entrepreneurship in action in the insurance industry.

Jeff Arnold is a quintessential entrepreneur. He’s driven by a passion for his industry, where he spent a career in multiple roles before launching his current business. He gathered knowledge he learned from others and from his own experience in those various roles. He innovates by having a more highly developed customer focus than others, and commits to a better experience for his customers than they can expect elsewhere. And he knows how to combine and recombine assets and resources in new ways to deliver that better experience. He continuously monitors the customer experience and customer sentiment to keep improving.

His primary skill are empathy and imagination — understanding the experience customers prefer and designing it in his mind before bringing it to life. He doesn’t need technology expertise to bring his vision to life; he can buy that on the market. It is the human factors of empathy and imagination that lie behind his superior product.

Imagining the future drives product and service innovation.

After a lifetime in the insurance industry and informed by hundreds and thousands of conversations with consumers, Jeff can accurately identify current dissatisfactions and easily imagine future products and services to address some of those satisfactions. Some of the ones he mentioned in our conversation were:

The macro policy: Why do customers have to buy home and auto and business and medical insurance I separate policies and separate transactions. What if there could be one macro policy for a family, adjustable to new needs as life goes on yet still a “one policy” solution for managing all the risks a family faces?

Expanding liability coverage: It seems like lawmakers and courts are continuously finding new things the rest of us are guilty of, like saying bad things on social media. Liabilities are expanding — Jeff called it social inflation. What if our policies could keep up without us having to adjust them in new transactions?

New payment systems: What if we bought automobile insurance by the mile instead of in a lump? Or what if we got refunds based on good driving habits (which is beginning to happen with telematics)? Generally, the payment system of lump sums for coverage over a time period can be replaced by behavioral measures of consumption.

These are the kinds of innovation Jeff is imagining, and working hard on bringing to market. Entrepreneurs make the world a better place.

Additional Resources

Jeff Arnold’s author page on Amazon.com: Mises.org/E4B_169_Author

Jeff’s website, Ambassador For The Insurance Industry: JeffArnold.com

The Art Of The Insurance Deal by Jeff Arnold: Mises.org/E4B_169_Book

RightSure.com

168. Anthony J. Evans: Markets for Managers and Entrepreneurs

Markets are marvelous. They’re the poetry of economics. They are one of the most remarkable technologies humans have ever built. Beautiful businesses develop new markets both outside and inside the firm. We discuss markets with Anthony J. Evans, a business school professor who teaches that all businesspeople must become economists.

Key Takeaways and Actionable Insights

A business economist is an Austrian who looks at the fields of economics and business to see how one is best applied to the other.

Aim to be a good economist and a good business practitioner. Managerial economics is the application of the economic way of thinking and the insights of economics to the managerial task of creating value. It was Shlomo Maital who wrote, “Managers can’t just employ economists, they must become economists”. Anthony Evans follows that direction and teaches his students at ESCP Business School that they’ll be more productive and more capable as businesspeople as a result of learning and applying economics.

Market system economics provides businesses with the best toolkit for success.

Businesses are participants in the market system. Managerial economists study markets in order to find ways for businesses to use market insights, harness market mechanisms and understand the signals and information that markets provide. It’s easy for firms to overestimate their ability to affect the markets in which they are participating, and don’t sometimes they don’t fully understand or properly analyze what market prices are telling them.

Prices are the most important market signals, and they can transmit information about potential futures. They can guide firms on understanding how much value they are creating relative to competitors. They can provide signals about how to increase revenue by moving process higher or lower. They can help businesses understand opportunity costs and transaction costs.

Markets are decentralized experimentation, and if some new experiments by disruptive competitors are commanding purchases from actual buyers today, that may signal more buyers and more transactions in the future especially after prices adjust to higher transaction volumes. Monitoring prices and reading the signals must be a core managerial skill.

Market tests should be applied whenever feasible. Technology can help.

Businesses should run a market test for every question that a market can answer: is this offering or initiative valued, is it preferred, can we put a price on it, will varying the price change the level of demand or acceptance, is the benefit greater than the cost, do some customers prefer a competitive offer? Run a market test — A/B test, pilot program, prototype evaluation, survey with customers, whatever is feasible.

Today’s technology provides tremendous help with low-cost digital testing methods, fast feedback loops, and efficient data processing. In fact, more and more, technology can relieve managers of the task of formulating their own understanding by automating the test procedures and the analytics and recommendations.

Markets can be brought inside the firm to improve business performance.

Markets stimulate innovation, lower costs, and efficiency because customers always want better, cheaper, and faster and competing entrepreneurial firms always want to provide those benefits in the search for profits. The same effects of the market order can be sought inside the firm. What is the market value and the right price for marketing services from the marketing department, or HR services or IT services? What’s the marginal cost versus marginal benefit analysis for one more HR staff member, or the opportunity cost of one more IT system installation versus one more sales campaign? What’s the value of the knowledge flowing through the firm?

These are the kinds of questions that the market order can answer, and managers should always be asking them. Prices can be the metric for all learning.

Market economics can also guide organizational design and processes.

Markets are dynamic and ever changing. Businesses must reflect and emulate this dynamism. Organizational design and structures must be flexible enough to enable dynamism and not erect barriers to change and adaptation. What are the forces that make markets grow and decline, and what are the forces that have this effect on firms? Organization should harness the forces of market growth.

Professor Evans’ suggestion is a constitutional view of the firm. Let simple rules of conduct emerge from a shared sense of vision and mission, codify them, and then let decentralized teams run the experiments that feel constitutionally right to them given their reading of market signals.

Subjective value is immeasurable, but can be gauged in market tests.

The purpose of a firm is to generate subjective value, which is created by customers through their own experiences and co-created by the firms and brands and services that facilitate those experiences. Subjective value is intangible and immeasurable. But exchange value — what customers actually pay in an exchange transaction — can be a proxy in some cases.

Subjective value is a hard concept to grasp for those who have been educated or trained to think of value in objective terms, as something inherent in a product. Professor Evans finds his students, when asked to describe the value of an offering or an idea, instinctively gravitate to the product-based view, citing attributes, features and performance benefits.

Taking the customer perspective is very hard, and perhaps unnatural. The economic point of view is always to put the producer in the shoes of the customer, to take the customer’s view and identify the customer’s mental model for processing information and observation. It’s hard to do, and requires significant cognitive effort. But done well, it’s key to marketing, innovation, product improvement and competitive positioning. Empathically diagnosing subjective value is one of the greatest insights economics can give to business.

Entrepreneurs thrive in markets.

Markets are the place where entrepreneurs ply their skills, and the entrepreneurial role will never diminish. Their imagination of the future and anticipation of future demand – even under conditions of uncertainty – their creativity and their judgment will always be important in the context of dynamic interactions of multiple players, offerings, and institutions within markets. The human factor is the most important.

Entrepreneurship is not an academic matter to be debated for the distinction of different nuances, but a practical matter of working and succeeding in markets. It concerns the identification of a profit opportunity via some kind of new product, service, method, or recombination of capital, and the ability to introduce this novelty into the marketplace, actively making decisions about resource allocation, cost, investment, communications and all the other elements of a business, overcoming obstacles and resolving difficult challenges. It is, as Professor Evans stated it, both ideational and implementational. Ambidextrous.

And the common backdrop for all entrepreneurs and businesses of all kinds is continuous change. In his book Economics: A Complete Guide For Business, Prof Evans states that, “Economic change will disintegrate existing combinations (of capital goods) and force entrepreneurs to find new ones”. This action, which Prof Evans refers to as “recalculation”, is core to the dynamics and agility of entrepreneurs in markets. Recalculation is the creative pulse that provides the energy for generating new capital structures out of old ones.

Austrian economists have always been acutely aware of change as an economic factor. Perhaps the business world is catching up, but Austrians have always been ahead. It’s the perspective that entrepreneurs and businesses can co-ordinate with each other fruitfully in markets where change is so pervasive and so fast that no-one has complete knowledge and yet must be able to act. Austrian economics demonstrates that good outcomes are possible, even in these conditions of bounded knowledge, for everyone participating in the market, so long as entrepreneurs are free to do their work without intervention. It’s a very powerful message.

People in business can be proud of acting as value generators and not feel any imposed need to “give back” or sacrifice themselves to artificially constructed restraints.

Additional Resources

Economics: A Complete Guide For Business by Anthony J. Evans: Buy It On Amazon

AnthonyJEvans.com

166. Murray Sabrin: What Entrepreneurs Do When The Yield Curve Inverts

To what extent should entrepreneurial businesspeople concern themselves with macro-economic variables? At E4B, our point of view is: not much. We don’t believe you can fully trust the data, we don’t believe you should put much credence in the interpretations of it, and we encourage businesses to concentrate on serving customers and generating value.

We made an exception this week to discuss the phenomenon of the inverted yield curve, because it might, conceivably, have some immediate effect on businesses and their customers. We talked with Dr. Murray Sabrin, author of Navigating the Boom/Bust Cycle:  An Entrepreneur’s Survival Guide.

Key Takeaways and Actionable Insights

The yield curve inverted. What does that mean?

Technically, the yield curve inversion refers to short term interest rates on the 2-year treasury note doing above the interest rate on the 10-year treasury note.

Chart 1

The reason this is of interest is that, historically, it’s a signal that the countdown to a recession has begun. At the human level, it means that market participants expect tighter short-term borrowing conditions, potentially making financing business activity more expensive and more difficult.

In reality, there’s no way to be certain of future conditions, and there are so many variables, from inflation to unpredictable Federal Reserve activities, that prediction is inevitably inaccurate.

Moreover, on their own terms, the Federal Reserve interest rate data are not consistent. The 3-month treasury rate remains 2% below the 10-year rate — no inversion there.

Chart 2

Therefore, predictions of a recession should be taken with the proverbial grain of salt. It may be different this time.

What matters is what entrepreneurs do in the face of this uncertainty.

Dr. Sabrin has a number of ideas and pieces of advice for businesses.

  • Examine conditions in your own sector rather than in macro-economic variables.

Economic conditions and trends and outcomes vary significantly by sector. What’s happening in automobiles, housing, energy, and retailing is sector specific.

Look especially for those sectors where free markets are allowed to operate; there may be different trends there. For example, deflation (a continuous trend towards lower prices) might be anticipated from the technology sector as result of innovation and competitive striving, rather than the price inflation we are being promised from other sectors.

  • Similarly, pay greatest attention to your most relevant geography: neighborhood, city, and state.

Economic conditions in Florida are a lot different than in California. Manhattan is different than San Diego. Your neighborhood might be different. Maybe your business operates internationally. Think about your relevant geography and not about the macro-economic headlines.

  • Focus first on your supply chain.

Dr. Sabrin’s extensive research into the longitudinal success of entrepreneurial businesses emphasizes the important of reliable inputs. In risky economic periods, the supply chain may need bolstering — extra inventory coverage, additional suppliers in case of disruptions. This may be expensive and more expensive to finance amidst rising rates, but guarding against supply chain disruption is a primary concern. Don’t risk disappointing your customers because your supply chain breaks.

  • Maintain your most important lending relationships.

If financing is a concern, look to bolster and strengthen lending relationships. Secure a line of credit. Nurture the relationship with your bank. And explore the newly emerging landscape of fintech lending — another example of free markets expanding the range of options and possibilities for entrepreneurs.

Here’s a financial landscape map from an earlier E4B podcast — use it to become familiar with the latest financing options: Mises.org/E4B_166_PDF

Your individual cost curve is not the same as that of the market.

The current pervasive concern is with higher interest rates and higher costs. These are macro-economic variables. But the cost curve for your business does not have to be the same. Many suppliers will be lowering prices and offering promotions or special terms to maintain their business flow. You can take advantage by shopping around, rebidding contracts, and seeking out the most eager suppliers. Your micro-economics can be different than the headline macro trends.

Most importantly, seek opportunities within changing economic circumstances.

An inverted yield curve is just another instance of continuous change, and change is the condition under which entrepreneurs thrive. They find opportunities in change. There are always growth sectors, there are always customers with needs, and there are always new openings, even when some doors are closing. The agile entrepreneur is alert to new possibilities.

Additional Resources

Navigating the Boom/Bust Cycle: An Entrepreneur’s Survival Guide by Murray Sabrin: Mises.org/E4B_166_Book

“Financial Capital Options For Businesses at All Stages” (PDF): Mises.org/E4B_166_PDF

164. Per Bylund: Think Better, Think Austrian — A How-To Guide

Think better, think Austrian is the mantra we have adopted for our Economics For Business project. Economics is a way of thinking. It’s conceptual, and its concepts can help businesses to make better decisions. The most important business decisions are those that pertain to the generation of value for customers, since that is the purpose of the firm. We talk with economist Dr. Per Bylund about exactly how the Austrian way of thinking helps businesspeople in every role to think better, and the business benefits that ensue.

Key takeaways and Actionable Insights.

“Think Better, Think Austrian” means starting from first principles.

Businesses are concerned with behavior — with action. The most important behavior is that of customers . Do they buy, or do they not buy?

The Austrian economics framework places people, and the effort to understand what they are trying to do, in the center of its analysis. First principles in Austrian economics teach us that people act to improve their circumstances—to somehow make things better for themselves. We recognize that people have a purpose in mind, and they make choices that lead them to attaining what they want or need.

It is from this first principle that business owners and entrepreneurs can work backwards to understand the motivations behind the actions of our prospective customers. We can ask why. And we should.

Thinking backwards reveals new understanding.

If customers act in a way we don’t understand, or differently from the way we expect them to act, or hope they will act, we can work backwards from what we’ve learned without judgment and instead exercise empathy. They might do something “crazy” — like using a product in a very unexpected way, or buying a competitive product that we know to be “inferior” in some sense. We know that their action made sense to them, and that they believed they would be better off compared to alternative choices or actions. Working backwards from this understanding enables us to deduce their motivation, and what value they were seeking. We can learn from their “crazy” action and rethink our offering. We can choose to take their feedback, even if it doesn’t make sense to us, and offer them an alternative.

Thinking better requires a relationship with the customer.

Successful business owners and entrepreneurs must develop a deep enough relationship with their customers to understand how they think, how they feel, and how they perceive things. Additionally, we must learn the context in which they are making their choices—there’s no such thing as a non-contextual choice. Per Bylund makes this clear when he explains that ice cream in summer is a different product choice than ice cream in winter, and clothes for business wear at the office are a different choice than clothes for working from home. Consider this: Whom does the consumer believe is observing and judging them and what standards are being applied? Those are important contextual factors to be taken into account.

The Austrian thinker considers all these influences on the customer and uses them to build and nurture relationships

We know that the ultimate purpose for customer action is the relief of some unease.

How do consumers and customers decide what they want to spend their money on? Rather than asking ourselves what people want to buy, we can ask ourselves what decisions people make in pursuit of better circumstances. They start from a position of dissatisfaction. They feel unhappy, or disappointed, or feel let down or lacking in some way. Contented people don’t act. People whose every comfort has been seen to, and who lack nothing—people who aren’t experiencing any unease—don’t buy. Discontented people do. This never-fully-satisfied feeling of discontent on the part of the customer is the universal resource for the entrepreneur. It is never exhausted because people are never fully content or fully satisfied in all of their many needs.

Customers use this heuristic to calculate potential value, even though they likely have no idea they are doing it. They think, to what degree do I expect my choice to relieve my discontent? Satisfaction is achieved not so much via the benefit that products and services promise, but via the burdens that are taken away: less work, less difficulty, less effort, less cost to get to a feeling of less discontent or less fear or less concern or less stress.

Often, of course, customers’ concerns are social. How do others see me, how do I appear to them, how do I compare to others in appearance or competence or achievement? The relief of unease is always subjective and often the subjectivity comes in the form of the customer comparing themselves to others, or to their own assessment of others’ judgment of them.

The entrepreneur listens carefully to what customers say, and observes their actual behavior, then uses empathy to understand what process the customer is using to define their unease and ways to relieve it.

Additional Resources

“Think Better, Think Austrian” How-To Guide (PDF): Download PDF

“Per Bylund on Opportunity Costs”: Listen To Episode 7

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

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

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