Sunday, January 17, 2016

The Constitutive Role of Risk in Entrepreneurship

In an earlier, somewhat inaccessible essay, we began to explore some of the rough outlines of what constitutes entrepreneurship. In particular we suggested that a novel, instrumental idea, along with the desire and action to see it realized, might be minimum or necessary conditions, though they may not be sufficient. Here we will explore the potential constitutive role of another factor that is often associated with entrepreneurship: risk.

In this piece, our examples will all involve commercial business situations, but that is for the sake of simplicity and clarity, not to limit the discussion or conclusions to entrepreneurship of a commercial nature. Further, for those concerned with rigor, I will point out that in any definitional enterprise there are two value-laden considerations. The first is due to the fact that we have purposes driving the need for a distinct term, and the second that if we are to trouble ourselves with a distinct term, then its meaning should be unique in some way so as to perform some cognitive work. While the latter point is generic, I should clarify for the sake of the former that my purpose is in studying the nature of entrepreneurship, as I believe it has been and will be a major contributor to human civilization.

The popular archetype of an entrepreneur includes “risk-taker” as an attribute, and risk is normally present in entrepreneurship. However, this could be a consequence of another factor, or even just a coincidence resulting from the way entrepreneurship is historically conducted. We would like to determine whether it is among the necessary or sufficient conditions constituting entrepreneurship. We would also like to understand more about the role it plays, given its apparent ubiquity.

To do that, we will need to look more closely at what the term “risk” means in this context. It has several definitions, such as “variability of economic returns” (finance) and “uncertainty of outcome in making a decision” (psychology). In relation to entrepreneurship, we might instead emphasize the possibility of loss of something one currently possesses. What sorts of things might an entrepreneur lose?

Most obvious is the potential for financial loss. Entrepreneurs are usually their own first investors, not only supporting direct outlays but also expending effort and time that could have been directed toward earning money. Bootstrap entrepreneurs sometimes use credit cards, second mortgages, and savings to get the business off the ground. And entrepreneurs - even those with outside financing - rarely draw a full market salary.

Also apparent is the possibility of harming one’s reputation. If the venture fails, one might be viewed as less competent or capable by colleagues, as an embarrassment to one’s family, as an object of pity to one’s friends. Recently, there has been some emphasis on the positive aspects of business failure (for example, learning and experience), and in Silicon Valley some entrepreneurs even tout such failures as a selling point. Nevertheless, loss of reputation remains a real risk.

Less widely understood is the potential for a toll on one’s health, both physical and mental. Entrepreneurship typically involves long working hours, grueling travel, and rushed or indulgent meals. It involves substantial emotional stress, difficult and awkward interactions with a wide variety of people, and extraordinary volatility in the prospects for success. Depression is common and the daily instability may exacerbate any propensity to bipolar disorders.

A few other potential losses, possibly not as consistently present, come to mind. Often an enterprise is founded with trusted and respected colleagues: those relationships could be damaged. The entrepreneur’s adventurous spirit or enthusiasm could be lost. Sometimes the very vision that guides the effort is a longtime dream and an integral part of the entrepreneur’s persona, and failure would do violence to it.

Thus when we speak of risk in entrepreneurship we are typically talking about important values such as these, values that the individual currently possesses and that the venture might directly or indirectly cause to be lost. Further, if the notion of risk is to help us demarcate entrepreneurship from other endeavors, it seems necessary that such risk exceeds that of commonplace activities - whether due to putting larger quantities of the aforementioned values at stake, or from a higher probability of loss.

With that framing of risk in place, let us now consider whether it is a necessary or sufficient condition for entrepreneurship.

We do not normally consider gamblers and thrill-seekers to be entrepreneurs despite their bearing considerable risk. The reason seems to have something to do with the absence of creation: even if the gambler wins, or the thrill-seeker survives and garners an adrenaline boost, nothing new has been produced. This becomes even more clear if we add a creative element to each activity. A “gambler” who develops a team method of counting cards, or a thrill-seeker who devises a new way to plunge toward the earth and decelerate before impact, these activities seem to come closer to our sense of what an entrepreneur does.

Based on these examples it seems that risk alone is not a sufficient condition to constitute entrepreneurship. More difficult to ascertain is whether it is necessary. Put another way, is it possible for an activity to be entrepreneurship if there is no incremental risk?

Let us assume for a moment that our previously suggested conditions are necessary but perhaps not sufficient. A putative entrepreneur has a novel, instrumental idea along with a desire to see it realized, and takes action on that account. Do we need to add risk to the broth?

Suppose we stipulate further that our subject is financially very sound, physically and emotionally healthy, and has had several large successes as well as some failures, putting her reputation beyond reproach and rendering her ego stable. The amount of time and money she intends to put at risk are proportionately small. The envisioned widget is clearly needed in the market and for whatever reason there are no competitors. Is this activity entrepreneurship?

If we were to claim that it is not, we would be in a somewhat uncomfortable position. An activity that, earlier in our subject’s career, might have been clearly entrepreneurship, is not so designated because the person has managed to be successful and healthy and the project is relatively small. By requiring risk per se, we make the question of whether an activity is entrepreneurship dependent on the financial, health, or reputational status of the subject pursuing the activity. This would be a startling result. We do not ask about a scientist’s prior success to determine whether his latest experiment is science, nor an artist’s mental condition to decide whether her attempts at sculpture constitute art.

Perhaps, though, the necessary conditions we assumed are too strong, and occlude an underlying need for risk in constituting entrepreneurship. Two elements that seem promising in this regard are the novelty of the idea and the need for action. We can consider each in turn.

Imagine an individual investing his entire net worth to purchase a local chain of dry cleaning outlets from the retiring owner. The chain is successful, and no significant changes are planned, so there is no novelty in this endeavor aside from the fact that our subject will be managing the business. Nevertheless, there is considerable risk due to the scale of the investment and the ever-present, uncontrollable macroeconomic factors that affect all businesses. Is this entrepreneurship?

It is a case where opinions might vary. Peter Drucker, in Innovation and Entrepreneurship, excludes situations such as this despite the risk, because there is no innovation involved. Others might hold that in this case the risk substitutes for novelty in constituting entrepreneurship. Still others might claim that the existence of the risk implies at least some hidden novelty - for example, every moment in time has different characteristics - though this sort of claim tends to blur any distinction between entrepreneurship and other activities.

We can more likely agree if we perturb the scenario, so that the subject does not actually operate the business but merely makes the investment. In that case we see the individual as an investor, or perhaps a gambler, but not an entrepreneur. It seems that at a minimum, for risk to act as a substitute for novelty, we also need to see ongoing involvement beyond an initial transaction.

We can take this further, and address the requirement for action, through the following, admittedly recherché, scenario. Here imagine an individual who is a non-operational major shareholder in a company, who has a novel idea and a desire to see it realized. She describes this idea to an operating executive but takes no further action. There is novelty, and there is also risk, but there is no direct action on the part of the shareholder.

Though agreement may not be universal here, most would not call this entrepreneurship. The reason is subtle: the risk does not appreciably arise from the idea or even the fact that it was shared. The risk antedates the sharing of the idea, and exists whether or not the idea is ultimately implemented. WIthout her stake in the company, our subject is merely someone who has an idea and shares it, which is quite outside the realm of entrepreneurship.

From these scenarios we conclude that in constituting entrepreneurship, risk cannot substitute for action, and to the extent that we think that risk can substitute for novelty, it needs to be combined with ongoing action. Consequently, risk is neither a sufficient nor necessary component of entrepreneurship, unless it is substituting for novelty.

We now return to a more realistic scenario to fill out the picture. Suppose an individual seeks a role within a large organization, having distinct novel ideas about how the role could contribute to the firm’s success, and subsequently joins the firm and executes on those ideas. This seems to be entrepreneurial without being entrepreneurship. That is to say, it is similar to entrepreneurship, or has some but not all of the qualities of entrepreneurship. A comprehensive elaboration of this distinction is outside the scope of the present discussion.

But what if we now substitute risk for novelty, as we did before? For example, the subject leaves a stable job and moves her family to a new city to join a company in a particular role, but has no particular novel ideas about that role. Here the similarity seems to fail. The subject is merely making a risky job move; not only is it not entrepreneurship per se, it does not even seem particularly entrepreneurial. This outcome suggests that, even if we do consider risk to be a potential substitute for novelty, its constitutive role is considerably weaker.

If risk is only a necessary condition for entrepreneurship in limited circumstances, and even there its constitutive role is weak, why does it seem to be present virtually all of the time? There are two straightforward reasons.

First, action in the face of novelty always carries incremental risk, above and beyond that of prosaic activities, even if such risk seems immaterial to a particular subject. Not only is there some probability of failure; that probability can be quite difficult to estimate, because there are no genuine comparables to rely on.

Second, the relatively strong requirement of action means that there is an opportunity cost risk for the entrepreneur. Typically, an entrepreneur makes a deep commitment to a single venture rather than engaging in a portfolio as an investor would; thus there is significant unique risk (as the term is used in portfolio theory) relating to the time, money, and effort expended. Even in cases where the entrepreneur is involved in multiple activities simultaneously, each one limits the time available for the others. This commitment implies a concomitant risk, again even if it is not material for the individual.

Given these straightforward causal relationships, it is no wonder that we often conflate risk with entrepreneurship. More accurately, we might consider certain forms of risk to be entrepreneurial, even if the activity as a whole is not genuinely entrepreneurship. As a similarity relation, the term entrepreneurial admits of degrees. For example, in a scenario where an individual takes a job with a startup at half-pay in exchange for a significant equity stake: that is surely entrepreneurial in some degree, simply because bearing risk of this particular kind is common among entrepreneurs.

Finally, risk is often present in entrepreneurship because investors and other parties see it as a motivational tool. The upside is a carrot; the risk is a stick. An entrepreneur who takes little risk is seen as lacking commitment. When difficult situations arise, so this view goes, the entrepreneur with “skin in the game” will be more likely to persevere in the effort and do whatever is needed to succeed. Whatever the merits of this view, risk incurred for this reason is clearly not constitutive of the activity of entrepreneurship, but simply represents a common business practice.

As the practice of entrepreneurship continues to become more professionalized and systematized, it is important to recognize that the presence of risk is a common but not inevitable artifact of other, essential characteristics, or of particular business methods.

8 comments:

  1. I find this fascinating. The only comment I have is with regards to this passage:

    "Suppose an individual seeks a role within a large organization, having distinct novel ideas about how the role could contribute to the firm’s success, and subsequently joins the firm and executes on those ideas. This seems to be entrepreneurial without being entrepreneurship."

    I believe the term for this is 'intrapreneurship'. (see https://en.wikipedia.org/wiki/Intrapreneurship)

    From personal experience, I find intrapreneurship far more fulfilling than entrepreneurship. I haven't looked deeply at the philosophy involved though, so I'd be interested to see what you have to say about it if you cover it in a future post.

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    1. Exactly - there are many different ways to exhibit entrepreneurial action without its adding up to entrepreneurship in full. Some of them (like this example) are frequent or important enough to have a coined term. I would argue that the name is valuable because it does represent a useful distinction.

      Entrepreneurship and intrapreneurship are different in many ways, including control, personal financial risk, and scale potential. Both are important, and each is fulfilling to different personal preferences.

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  2. You're obviously on top of this subject. Let me see if I can push you outside your comfort zone. Do you believe in the possibility of interpreneurship?

    This is a speculative term (i.e. I don't believe it's a proper term). It is possible that the term is superfluous, and that entrepreneurship already captures all that interpreneurship might refer to. But in the odd chance that the term might refer to a meaningful subclass (or distinguishing form) of entrepreneurship, allow me to speculate a bit about what this term might refer to if it refers to anything.

    On first examination, we can easily infer that "inter-"preneurs would be persons who seek to realize their ideas with regard to the interactions between a set of disjoint firms. In this sense, it would not be unreasonable to infer that their ideas are perhaps machiavellian (though not necessarily amoral), in that they are realizing social artifices (or networks in a social graph).

    Another way to describe interpreneurship is as reference to persons who are not vested in the firms they expressly promote. Yet they are still applying their own distinct novel ideas directly in service of the success of said firms. What is abnormal is that they are not incentivized (financially or otherwise) by the success of the firms that their ideas help, but rather they are incentivized by the successful realization of a particular social graph.

    The obvious problem is to understand how (or why) this would be fulfilling. The nearest analogy I can think of is that of a village match-maker who gets their identity and status from curating the social structure of the village. Presumably, this personality type would be drawn to realizing their ideas with regards to social-graph engineering in an industry or market.

    Examples of interpreneurs might include politicians and lobbyists whose personal career is invested in realizing a vision for regulation reform (or policies relating to persons, whether corporate or human). Other examples might include founders of local associations (e.g. chambers of commerce) with distinct or novel charters.

    Ultimately, this class is not interested in building a better mouse trap, or empowering a firm to build a better mouse trap. Instead they are interested in building a network that can build better mouse traps.

    Thoughts?

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  3. The notion that you describe is a real thing: in addition to your examples, think about people who bring companies together to agree on technology standards, or to form industry associations. And sure, as long as it is a novel idea in the world and the person acts to see it realized, I think it qualifies as entrepreneurship. I don't see financial incentive as a criterion for entrepreneurship. Further, firm structure *definitely* is not a criterion.

    Whether we need a distinct word for this mainly depends on whether it is different enough from other things but common enough that it needs to be referred to frequently. I've never needed that word, but there is perhaps a segment that would find it useful.

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  4. Quite true.

    You mentioned scientists though, which has me wondering. Does your criteria apply to academic researchers? I think so. An ideal researcher commits to personally realizing a novel idea over a period of time. This clearly has significant 'unique risk' (since they could be doing other things with their time, like teaching, or consulting for industry), as well as political risk (since flawed work can lead to ostracization or career handicaps). So we can clearly say that an ideal researcher is entrepreneurial.

    But then what happens when an ideal researcher receives tenure? Is 'unique risk' sufficient for them to remain entrepreneurial? Assuming I've applied your criteria correctly, that strikes me as an unexpected place to find entrepreneurship. Unexpected, but very interesting.

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  5. First, note that the main point of this essay is that "risk" is not a primary determinant of whether an activity should be considered entrepreneurship. Second, I said it in the essay but not in my comments that the novel idea needs to be *instrumental* and that the ostensible entrepreneur *act to see it realized* in the world. Consequently, many academic research activities would not be classified as entrepreneurship using this criterion. You might want to read the predecessor article that is linked, though as mentioned it is difficult to get through (when I wrote it, I had just finished Heidegger's "What is called Thinking?", which is not an influence that promotes clarity or ease of reading).

    For an academic, the thing that makes the distinction most clear is to consider the scenario, nowadays more common, that the academic takes time off from teaching and research to build a company around one of her or his ideas or research topics. That would be entrepreneurship. Alternatively, one can at least imagine an academic who plans to do that all along, but knows that the idea needs to be incubated in a pure research context first. That could be considered entrepreneurship in view of the long term plan.

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  6. I'm surprised this was the comment you pushed back on! I do believe I understood your posts. So let me try to clarify.

    (1) Assume that by 'academic research' we only refer to what is publishable in a high quality journal. This then satisfies being a novel idea.

    (2) Such research clearly carries various types of risk (unique/political/etc).

    (3) Now, was the idea realized into the world? Did someone bring about a better mouse trap for others to use? Well let's see. If the idea was a conjecture, then running the experiment, or creating a proof, or laying out the mathematics, is the labour required to render the idea indisputable and bring on it the weight of existential force. If such research is of high-quality, then upon its completion it has brought about new instrumental knowledge into the world.

    For instance, you can imagine Einstein saying "It must be so, and I will make it so." before setting out to derive his theory of Special Relativity. Such knowledge, while not bought or sold, is still quite instrumental to 'customers' in the public and private sectors. The same applies with theoretical frameworks, mathematical links between phenomena, and new methodologies. But as you wrote, these must not be mere designs, prototypes or milestones along the way. Here we must refer only to complete instrumental works, expressed as ready-to-use 'knowledge products'.

    "The first glimpse of such a putative truth occurs whenever someone has a creative idea, whether or not accompanied by desire. The entrepreneur, who brings forth desire, commits to unfurling that truth and completing its disclosure through action."

    The above passage applies precisely to the mathematician who "feels" the outline of a proof, but then spends the rest of the year fleshing it out. Or the physicist who sees hints of new phenomena, but must spend years engineering new instruments before finally seeing something that no human eyes have ever seen before.

    The academic 'paper' at the end of all this is merely a formality, a sharing of knowledge. But the "bringing about" took years of labour and borderline-obsessive perseverance. Even then, only a few successful 'knowledge products' will live on for years, decades or centuries, often requiring further attention and maintenance by the creators as product's users find flaws or impracticalities in their various applications. Of course, most research is not successful in that sense, and instead remains unused in obscurity. Or as you wrote, "building it does not ensure that they will come; if they do not come, what was disclosed was not the truth envisioned". Everyone wants their research to be used and cited by others, as that is the vision of the academic. But it is not to be so for most. If it wasn't for the love of what they do, academics would surely not continue on like this all their lives. But as you wrote, "How we live our lives discloses our purpose and defines who we are."

    Even the psychology you attributed to the entrepreneur aligns with the academic, for many academics (especially the young or especially old) rebel against the prevailing paradigms of their field, rallying grads to "right the wrongs, to correct the errors, to establish that the will has its transcendent power after all, despite the facticity of what exists today." But even while academics "free to act in and on the future", they are all necessarily "helpless against the past". Science only moves forward, and proven results are not easily overturned.


    So, do you see what I mean? The criteria applies to something most people wouldn't consider entrepreneurship. And yet when seen in that light, it isn't all that absurd. It's like Bertrand Russell said, "The point of philosophy is to start with something so simple as not to seem worth stating, and to end with something so paradoxical that no one will believe it." In this sense, you succeeded!

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  7. Proposing a way to circumscribe the extension of a concept is always a tricky business. Surely you could argue for using the term in this way. But on that basis I have a hard time seeing how you could then leave out other creators, so then the word just overlaps with "creator." I address it directly here:

    "Up to this point, our discussion is not strongly particular to the entrepreneur – it is largely applicable to any creator, including for example artists and authors. What is essentially different about the entrepreneur is that his idea describes an instrumental outcome. True, the works of artists and authors sometimes have an instrumental component in persuading the audience or moving it emotionally. But these goals remain somewhat mental, and any residual instrumental outcome is achieved through a pathway of conditioning rather than directly. So the creation of the entrepreneur emphasizes direct instrumentality: “I will build a better mousetrap, and people will use it to catch mice.” We see further that the entrepreneur must intend to fully realize the idea in its instrumental form. A design, a patent, even a prototype, is not the objective of the entrepreneur, though these artifacts may be milestones along the way."

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