The example above demonstrates how strategic practices and learning can help young firms survive a crisis of initial misperception. The firm was able to learn because it applied strategic insights that, according to the information processing literature, can enhance performance (e.g., Thomas et al., 1993). Our emphasis, in terms of developing propositions and setting forth a model, is on the application of strategic factors to enhance the double loop learning that emerges from information processing systems.
However, we take a holistic approach to model development. Therefore, before we can investigate the information processing systems of interest, we first discuss the gestation of these initial misperceptions. This is important because we believe that how founders approach learning in the earliest stages of innovative opportunity recognition will affect the learning components of the information processing systems that are ultimately implemented.
In this section, therefore, we address two aspects of entrepreneurial learning and strategy that correspond to the earliest stages of new venture development. The first is the entrepreneurial cognitions that an individual entrepreneur or team of founders experience during the early stages of opportunity discovery and formation. The second is the learning capabilities that are developed in the organizing stage after the venture has been launched. Before we explore these two conditions, however, we establish the baseline proposition of our model: misperceptions have a negative effect on performance, ceteris paribus.
A Baseline Proposition
We want to highlight several reasons why inaccurate perceptions are so common among innovative business start-ups and the direct consequences of such perceptions, if not moderated by other factors. We set out these arguments here in a ‘‘baseline’’ proposition. First, the venture start-up context, especially as it relates to innovation, is inherently uncertain. Often, little is known and much may be unknowable in terms of market potential, performance expectations, operational issues, and so forth. This condition of uncertainty may lead entrepreneurs to use cognitive biases (mental shortcuts that can lead to fundamental errors in judgment) in differing degrees. Many entrepreneurs are especially susceptible to these biases MARK SIMON ET AL.
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(Busenitz & Barney, 1997). In fact, several authors (e.g., Katz, 1992; Simon, Houghton, & Aquino, 2000) suggest that the very creation of their firms may depend upon the use of these biases. As a result, entrepreneurs may overestimate key venture success factors, such as the size of a potential market, access to capital, the firm’s overall skill level, and so forth (Barnes, 1984; Schwenk, 1984; Simon & Houghton, 2003). These overestimations put the venture on precarious grounds, right from the start.
We suggest, therefore, that absent moderating factors, entrepreneurs who pursue an innovative opportunity based upon inaccurate perceptions may fail to achieve their intended outcomes, much less a competitive advantage.
Specifically, the strategic management literature suggests that the willingness to act on misperceptions may not be valuable because accurate information helps in making effective strategic decisions (Bourgeois, 1985). Sutcliffe (1994) argues that the majority of work on performance in strategic management implicitly requires managers to have accurate perceptions to succeed. Along a similar line, studies have found that the further the perceptions of the environment are from the actual environment, the worse the organization will perform (e.g., Bourgeois, 1985; Sutcliffe, 1994). Thus, we suggest the following proposition regarding entrepreneurs who base their initial opportunity upon misperceptions.
P1. The greater the inaccuracy of the founder’s initial perceptions, the lower the new venture’s performance.
Entrepreneurial Cognitions
Recent research has suggested that entrepreneurs may employ a unique kind of decision-making process that allows them to go forward with a business launch even in the face of uncertainty (Busenitz & Barney, 1997). This approach has been labeled ‘‘entrepreneurial cognition’’ and is defined as
‘‘the extensive use of individual heuristics and beliefs that impact decision making’’ (Alvarez & Busenitz, 2001, p. 758). Use of heuristics is especially prevalent when new ventures engage in more innovative activities (Houghton, Simon, Aquino, & Goldberg, 2000), which is the type of venture this paper focuses on. Heuristics, in this context, are nonrational decision rules or cognitive mechanisms that simplify an entrepreneur’s decision-making process. These simplifying strategies enable entrepreneurs to seize opportunities by providing decision-making shortcuts in complex decision settings (Tversky & Kahneman, 1974). Thus, compared to
managers of large firms, entrepreneurs are more likely to make decisions based on limited information. This, in turn, increases the likelihood of
‘‘misperceptions.’’
The use of a heuristics-based logic explains, in part, why it may not be necessary for the initial perception of an opportunity to be especially accurate. First, entrepreneurs are willing to make significant leaps in their perception of opportunities in ways that other decision makers may be unable to. Furthermore, more accurate assessments of opportunities might lead many entrepreneurs to refrain from starting ventures even though, over time, they may have been able to correct their erroneous perceptions.
Finally, opportunities that can easily be identified and analyzed are unlikely to confer any distinct advantage because they may be less rare, valuable, and more imitable. Unique insights or unanalyzable situations, by contrast, may push entrepreneurs to be more inventive and risk taking, yet simultaneously shield their creative opportunity from detection by competitors (Daft &
Weick, 1984; Mosakowski, 1998). For example, SHN might never have been launched if its founders perceived that its subscription model would not work. The critical issue is how they thought about their venture – their cognitions – and how they were able to adjust their thinking and perceptions by processing information and learning.
Many theorists agree that entrepreneurial situations that involve innovations are typically unanalyzable (e.g., Minniti & Bygrave, 2001).
If this is so, entrepreneurs have little choice but to make decisions and move on. That is, entrepreneurial decision making propels an entrepreneur down a corridor where one decision or event leads to another. Along such a decision path, some outcomes will be positive, others negative. Therefore our use of the term ‘‘misperceptions’’ is not meant to suggest ‘‘one big mistake,’’ but rather decisions that are inaccurate because they are made under conditions of uncertainty in unanalyzable situations. Whether or not this cognitive style will lead an entrepreneur to eventual success may depend on his or her learning capabilities and the learning capabilities of the subsequent organizational system.
Learning Capabilities
Even though entrepreneurial cognitions may explain why entrepreneurs often act on the basis of inaccurate perceptions, it does not explain whether they will be successful. In this section, we suggest that depends on their style of cognitive learning and their use of new knowledge. Knowledge MARK SIMON ET AL.
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creation in a small new venture that engages in innovative activities requires the capacity to absorb knowledge and technology from outside and integrate it in unique ways inside the firm (Cohen & Levinthal, 1990).
The emphasis on survival in new ventures generates an inherent openness to new ideas in contrast to the ‘‘Not Invented Here’’ syndrome that can plague older firms. Thus, entrepreneurial ventures with an openness to incoming information may have a higher absorptive capacity than larger firms, even though their levels of R&D spending may be proportionately lower.
According to research by Nonaka (1988, 1994), the qualities for enhancing individuals’ ability to create information and knowledge – intention, autonomy, and fluctuation – are much more likely to exist in small and new firms than in large corporations. These qualities are best supported in an environment of ‘‘creative chaos, which triggers the process of organizational knowledge creation’’ (Nonaka, 1994, p. 28).
[T]he more chaos or fluctuation an organization has inside its built-in structure, the more likely it is to have a lively information-creation activity. Chaos is used here interchangeably with such concepts as freedom, fluctuation, randomness, redundancy, ambiguity, and uncertainty. A lively activity is created since the positive role of fluctuation or chaos widens the spectrum of options and forces the organization to seek imagination and new points of view. (Nonaka, 1988, pp. 60–61)
This approach is related to the resource-based view of strategy because it holds that the knowledge creation process itself creates unique competencies with which a firm can compete. As such, organizational learning leads to an increase in the ‘‘organization’s capacity to take effective action’’ (Kim, 1993, p. 43) as well as to the ‘‘mobilization of tacit knowledge held by individuals [that can] provide the forum for a ‘spiral of knowledge’ creation’’ (Nonaka, 1994, p. 34). Such learning, in turn, leads to greater firm effectiveness (Barney, 1991).
This suggests the need for an environment in which decisions are not
‘‘final,’’ but instead are analogous to experiments that may foster a heightened level of learning (Cope, 2003). The entrepreneur’s role in such a setting is to support the creation of new knowledge. Entrepreneurs who are themselves able to learn in these settings and encourage others to learn are more likely to be successful. Additionally, we believe, they are more likely to build double loop learning organizations. Implementing team approaches, for example, may enhance this type of learning if the team is constructed appropriately. This however requires a proactive approach to learning and information processing. It is that topic that we turn to next.