Dispatches from the Frontier

The Willingness to Be Wrong

Take another look at this video from Ken Robinson:

If you are not willing to be wrong, you will never come up with anything original.

In business, we want to be innovative, but too often we're not willing to risk being wrong. I hate being wrong, but I find that I fear being irrelevant more.

The Purpose of Business

My friend and former colleague Gael Andry recently shared an article titled How Will You Measure Your Life? by Clayton Christensen of disruptive innovation fame.  The article is well worth reading in its entirety, but the following passage caught my attention, in particular:

If you study the root causes of business disasters, over and over you'll find this predisposition toward endeavors that offer immediate gratification. If you look at personal lives through that lens, you'll see the same stunning and sobering pattern: people allocating fewer and fewer resources to the things they would have once said mattered most.

Jensen and Meckling's analysis of agency costs has frequently been used as the justification for the assertion that the purpose of business is to maximize shareholder value.  Single factor maximization is appealing because it is mathematically tractable and seemingly actionable.  But, I believe it to be fundamentally inappropriate.

Generating sufficient returns for shareholders is a constraint, not an objective.  To continue in business, providers of capital must be offered adequate returns.  Likewise, customers have to be served competitively, suppliers must make a reasonable profit, and employees must be compensated fairly.

The purpose of business is to allow us to live meaningfully.  It's up to each of us to define, and be responsible for, the purpose of the business in which we engage.

Fast Thinking, Innovation, and Decision Making

Please read Thinking, Fast and Slow by Daniel Kahneman, a psychologist  and winner of the Nobel Prize in Economics.  Kahneman has played a principal role in the development of Prospect Theory, which has changed our understanding of how real people make decisions, including decisions about investing in prospective innovation.  One of the key components of Prospect Theory is that decision makers weight outcomes in a manner that is at odds with what we might consider strictly rational behavior.

For example, consider the following, staightforward relationship between underlying probability (on the x axis) and decision weights (on the y axis):

The preceding simply suggests that decisions are weighted according to the underlying probabilities of possible outcomes.  In this Homo Economicus scenario, the expected value of a $1,000 payoff that has a 50% chance of occuring is $500.  Furthermore, given the same potential payoff of $1,000, an increase in the probability from 50% to 60% increases the expected value of the bet by $100.

In the context of new product development, for instance, Homo Economicus perceives value in proportion to a reduction in uncertainty.  Presumably, he would be willing to pay for marginal increases in the probability of a desired outcome such as revenue growth.

Prospect Theory, however, suggests that people aren't strictly rational.  Our typical behavior reflects these general patterns:

1. We tend to over-weight very low probabilities, which helps explain why people play the lottery.  For example, the odds of winning the Montana Lottery Wild Card 2 jackpot is 1:1,359,288 per play.  Two plays costs $1, and the jackpot as of the date of this post was $125,000.  The expected payoff from a $1 bet, therefore is $125,000 x 2 x 1:1,359,288 - $1 = -$0.82.  Homo Economicus wouldn't make that bet, but we humans do it all the time.
2. We tend to under-weight near-certain probabilities.  Let's say that there is a 95% chance that you will receive a $1,000 payoff tomorrow.  Alternatively, you can receive a certain payment today.  Homo Economicus wouldn't expect any less than $950.  Humans, however, will, on average, accept less today for certain than the expected (but uncertain) value of $950 tomorrow.
3. We  tend not to discriminate among intermediate levels of probability.  We humans can be overly sensitive to best case and worst case scenarios.  However, we can be amazingly insensitive to in-between cases.  If the underlying probability of a successful outcome were increased from 50% to 60%, a human, in contrast to Homo Economicus above, isn't likely to make the attribution of a 10% increase in value to the opportunity.

The preceding observations are reflected in the following S-shaped curve:

The preceding elements of Prospect Theory have a number of implications regarding innovation:

• Inventors who have little to lose but much to gain from the adoption of a candidate technology tend to over-estimate the likelihood of success and, consequently, will over-value their invention.
• Profitable companies who perceive the risk of loss (e.g. of brand reputation) tend to be risk averse.  Consequently, they will often under-value promising, but still uncertain, concepts.
• Entrepreneurs who help resolve uncertainty (i.e. increase probability) tread dangerous ground: even a significant increase in probability to anything less than certainty may not result in a proportionate increase in perceived value.  On the other hand, resolving uncertainty through the development of prototypes, market trials, etc. can be quite expensive.  The risk of over-investment (from the narrow perspective of the entrepreneur), therefore, is significant.

As a Principal of Evergreen Innovation Partners, I've seen the above play out time and time again.  The fast, intuitive thinking in which we humans engage doesn't always serve us well in the context of innovation.   We exaggerate long odds, under-value near-certainty, and fail to assess intermediate probabilities and marginal increases in value with sufficient finesse.  Over time, we engage in such behaviors to our collective disadvantage.

Open Innovation for Small and Medium-sized Businesses

Embedded below is a video of Jeffrey Baumgartner regarding the applicability of Open Innovation to small and medium-sized businesses:

Recently, I stumbled upon Jeffrey's astute observations on prospect theory, risk, and innovation.

The Limits of Intuition

Faced with a complex system characterized by delay and feedback, our intuition often serves to occlude understanding.   According to the authors of these two books, that fact does little to diminish our confidence in what our senses and intuition tell us and the stories we create to make sense of the world:

The Invisible Gorilla and Other Ways our Intuitions Deceive Us

Everything is Obvious (Once You Know the Answer): How Common Sense Fails Us

The scientific method remains our best path to understanding, sometimes in spite of our intuition and common sense.

Art of the New: Bill Clem of the Gallatin Valley Robotics Center

 

You can learn more about the GVRC via its Facebook page.

Art of the New: Will Ritter of Spark R&D

From time to time, I intend to post short video introductions under the "Art of the New" banner.  (It's a term I stole from George Gendron, the former editor of Inc. magazine.)  My intent is to help make interesting people and organizations engaged in learning and creating become a little more visible.

To kick things off, check out Will Ritter of Spark R&D in Bozeman, Montana:

 

Will is a very talented design engineer and is rapidly becoming a skilled businessman.  In the growing world of splitboard backcountry riding, Spark R&D is developing a heady reputation for the design and manufacture of innovative products.

Questioning Our Intuition About Viral Marketing

Duncan Watts knows more about small world networks than most of us.  That's why we should take note when he challenges some of the key assumptions underpinning the prescriptions of viral marketing:

We imagine information or influence propagating through a network in the manner of an infectious disease. We talk about viral videos and viral media, and we really think things spread this way. What we recently stumbled on is that almost nothing spreads. Instead, the vast majority of all adoptions happen within just one degree of the seed...Research suggests that when we do see big events—things that we call viral—something other than word-of-mouth, peer-to-peer diffusion is happening..Once you get your so-called viral video on the front page of Yahoo!, 100 million people see that. So this is not about viral anymore. This is mass media.

 

Read the McKinsey Quarterly article here.

 

Flipping the Classroom

Watch Salman Khan talk at TED about how technology can be used to humanize the classroom.  This is powerful stuff:

Can a Startup Have Too Much Capital?

Clayton Christensen thinks so:

Ironically, one thing that many promising startup companies suffer from is having too much capital. Once a company gets burdened with too much investor capital, it starts to think that it needs to grow very quickly. Almost always, a startup’s first strategy is wrong. Once they get out into the marketplace and try to sell things, they find that many of the things that they had assumed are untrue, and that their strategy needs recalibrating. But when a company is overcapitalized, the founders can assume that they’re right for quite a while before they start to need to depend on peoples’ willingness to pay. The more capital, the longer a company can go without testing its fundamental assumptions. Tough economic circumstances tend to keep capitalizations lower, so in general, in the long term, I think that lean economic times can foster a proliferation of disruptive companies.