The Entrepreneurial Firm
Two cluster of events in 2024, so far, have changed my mind about the nature of the entrepreneurial firm:
- In January, a tour of the Open Source Software Community and adjacent meetups and efforts in and around San Francisco.
- In August, the The Academy of Management Chicago conference.
The post I shared in March, 2024 titled Honesty, Error, Deception, Fraud was a direct response a part of what I experienced in January. It represented the most coherent summary of what I thought I saw and heard. The post in May, Non-fictional intent in fictional contexts was a follow-on about belief, make-believe, deception, and self-deception. July’s post on The nature of secrets – a secret having a component of deception and often a non-fictional intent was in part a response to re-reading prior material with new eyes. The nature of belief, self-belief, self-object-belief, deception, self-deception, make-belief, belief-speaking, delusion, performance, performance art, effectuation, realization, presentation of self in everyday life, experience, and results form a tangle of fibres that just might be coherent enough to be a thread.
ISMS 2024 happened in Sydney, Australia this year. I would have loved to go. I enjoy Australian, Hong Kong, Taiwanese, and South Korean researchers, and sometimes, there’s a stronger mainland Chinese contingent that’s quite interesting to listen to. There are considerably fewer privacy controls on mainland data so it always makes for fascinating presentations. But I had a prior obligation and couldn’t make it.
Instead, Gil Peleg invited me to the Academy of Management conference in Chicago. I haven’t ever attended, so I did a much more thorough literature scan in preparation for it before assembling a plan to move through the event, and to learn which interesting researchers were doing interesting work on the things that I’m troubled by.
This post doesn’t contain a full synthesis of what I learned at that conference. Learning takes months after an event to soak in and it can take time for a change in some heuristic to make a major change in another set. And it takes time to reflect, follow up on reading, review notes, write, and re-write in order to sort things out. I’m not done pushing through the backlog of reading that spun out, and I haven’t figured out an expressible position even for this space.
In part, that’s what makes this blog a difficult read.
Where I’m going to start is with the Theory of the Entrepreneurial Firm – a wonderful paper I encountered a third of the way through the literature review in preparation for AOM in August. Then I’ll try to incorporate the theory within that framework into the experience, and leave you with a heuristic – some token – for reading along.
The Entrepreneurial Firm
Chihmao Hsieh, Jack A. Nickerson, and Todd R. Zenger, in 2007, published a paper in the Journal of Management Studies titled: “Opportunity Discovery, Problem Solving and a Theory of the Entrepreneurial Firm.” I’ve included the full reference below. You should read it for yourself. It’s good.
The abstract opens with a delightful question:
“When should an entrepreneur employ a market to help discover and exploit opportunities, and when should the entrepreneur create a firm to do so?”
And the paper answers the question with a theory.
An opportunity exists, in part, because there’s a problem that some market needs solving. A problem has several features. One of them is problem complexity. The authors cluster problem complexity into three bins: low, medium, or high. Problem complexity is in part related to search. Search is an entire branch of research that is unto itself interesting and I won’t try to summarize it here. Problem complexity also has to do with how much gum, hair, and dirt are embedded around a knot. Some problems are just easier to solve than others.
Problem complexity and estimation come together to inform one of three kinds of firms that entrepreneurs form to engage in search and to convert problems into infinitely renewing revenue streams from now into infinity.
The first kind is just the matchmaker, the connector, the man-about-town, the finger-clicker. They do simple matching. At its most basic form: a small business complains about their website, so the man-about-town gives them a link to Shopify or Squarespace or the latest wrapper on a library, along with his referral code, so he gets financial renumeration. Easy. And if the small business doesn’t have time to set it up and complains to him about it, well he has a friend who runs a small agency that does Shopify customizations for rapidly growing businesses, so he refers them on, and he pockets a referral bonus from them too. And this guy really doesn’t really need a corporation or a firm to do any of this. There’s no complexity here. They’re matching. They’re arbitraging. They capture a portion of the rent that could have gone to an advertising platform.
The second kind of firm is a container for the subject matter expert, the nerd, the gigabrain to direct relatively moderate complexity in a moderate complex environment. They’re an expert in some area, like maybe eCommerce sticker production, and they’re irritated by something – maybe the speed at which an adhesive is cured – and they shout that there has to be a better way. And so, as an expert in adhesive chemistry, they start a firm, hire one or two interns, and they do most of the research. They might hire a patent lawyer, and then, assuming they can get a patent, they sell the company to the largest sticker manufacturer or the hairiest patent troll in America. And they’re done. They found a firm because they need a vessel to arrange research and development costs and to have an entity to bundle the expert knowledge.
The third kind of firm is a container that aligns the incentives of multiple experts. The entrepreneur understands that the problem is extremely complex, and that she’ll need a coalition of extremely bright people to solve it. However, in exchange for solving it, the firm, through the innovation of fractional ownership, can be used to align the interests of the experts long enough to realize a solution, find customers, generate revenue, and achieve an exit. So long as the participants in the firm continue to to possess priors wherein the the likelihood of a positive payout exceeds the opportunity cost of defecting, the firm will continue to align the interests. Firms of the third kind must use consensus-based networks if they’re to manage multiple types of the risk successfully, including the risk to social cohesion, market match risk, macroeconomic risk, solution risk, and ecosystem risk.
So what? Endowments!
If all you know is how to loosely match common problems with commodified solutions, then you don’t need a firm to do that. The endowments of the founder are pretty basic: they have to know enough keywords to match so that when they hear somebody kind of saying something that sounds like the stuff they kind of know about, they can kind of make the connection. A lot of people have such endowments: your uber driver, your banana guy, your Ford dealer. It’s undifferentiated. It isn’t too interesting.
If all you know is how to solve a mild problem with mild solutions, then you probably need a firm to do that. You’re looking at capping out, depending on how well you communicate, at 7 headcount before the micromanaging starts to break you. A lot of firms cap out at 7 in part for this reason, capped by the capability of the leader and not so much by the capability of the collective team. The story of the heroic micromanager orchestrating everything can be read in fairy pop business literature books by those with heroic self-narratives, by markets for heroic narratives. There’s a reason why these narratives are commercial and find commercial audiences.
If all you know is how to orchestrate the solving of a complex problem with mild or complex solutions, you not only need a firm to do that, but you need quite a few additional capabilities to pull it off. There’s a lot of skill there in which – there isn’t much incentive in the market to talk about because it’s difficult to explain and rarely culminates in four syllable heuristics like best practices and founder mode.
There’s certainly an evolutionary incentive to systematically overestimate ones owns endowments until the end. One either outruns the bear or they’re eaten, one either cruises a hundred mates or they go home empty handed, one either correctly deduces spoor or they go hungry. Who dares, wins. There’s certainly an evolutionary incentive to engage in deception about ones’ own endowments. Evolution, however, is a pretty inefficient, brutal, teacher. I bet we can do better. We have virtual organs that enable us to do better.
There’s certainly a monetary incentive for an individual to accurately predict ones own endowments, and then make the best decision on what kind of a firm to pursue. If all you can do reliably is to match, then match. If you can invent something new, then invent. If you can lead a coalition, lead. To know for sure what your endowments now and what they are likely to be later, to possess as close to ground truth of those ideas, to effectuate, appears to be an advantage to the extent that it enables intelligent action.
There may be a short-term or medium-term monetary incentive on the part of a venture capitalist to look for individuals who will cap out at some lower level of complexity, so as to separate the founder from their firm, and then recombine it with other holdings in their portfolio. If a VC understands that a founder is useful in some dimension, and vulnerable in another, then it may make more sense to collect and stack entrepreneurial firms together into a stack that matches their investment thesis. In the medium-term, some founders would be able to correctly deduce the predation and learn to avoid specific venture capitalists. In the short-term, there’d simply be no way of knowing.
Take from these perspectives, the incentive structure for cooperation appear to be severely constrained. There’s a pervasive incentive to obfuscate the ground truth, accurate self-knowledge, with diabetes-inducing levels of sugary behaviour. Every emotion stated needs to be dialled up to eleven and everybody needs to appear as pro-social as possible, regardless if they truly believe it. The system doesn’t appear to be designed for accuracy.
There’s a mystery here. Sometimes the obvious choices aren’t the best ones, and sometimes…they are.
Sources
Goffman, E. (1959). The presentation of self in everyday life. Garden City, NY, 259.
Hsieh, C., Nickerson, J. A., & Zenger, T. R. (2007). Opportunity discovery, problem solving and a theory of the entrepreneurial firm. Journal of Management Studies, 44(7), 1255-1277.