The psychology of entrepreneurial strategic decisions

Objectives

• Examine entrepreneurial strategic decision-making factors of risk and motivation

• Understand cognitive biases and heuristics common in entrepreneurship

What makes a decision “strategic”?

• Involves the planning of actions in an uncertain and unpredictable future

• Requires significant allocations of resources

• Results in substantial gains or losses as a result of the decision and its subsequent outcomes

Traits and factors influencing decision-making• Personal attributes and

characteristics• Attitudinal • Risk taking• Motivational• Emotional• Cognitive

Entrepreneurial strategic decision-making

• High-stake decisions that involve a high degree of uncertainty and complexity– Decision-makers’ behavior deviates from what normative theories

predict• 50% chance of winning $10 Est. = $5.00• 1% chance of winning $250 Est. = $2.50

• Entrepreneurs tend to accept risks, resist norms, and be less predictablein decisions– And may “see” things differently than others

Risk propensity

• Risk propensity: attitudinal component referring to the tendency to take risks that varies across distinct decision contexts– Scenario driven + Individual tendencies

• Win one round of golf to earn an ‘A’ in the course?

The Story of Facebook

1. On February 4, 2004 Mark Zuckerberg launched The Facebook, a social network that was at the time exclusively for Harvard students.

2. The original idea for the term Facebook came from Zuckerberg’s high school (Phillips Exeter Academy).

3. It was a huge hit at Harvard. In 2 weeks, half of the student body had signed up.

The Story of Facebook4. Other schools Boston began demanding a Facebook network.

Zuckerberg immediately recruited his friends to help grow Facebook, and within four months, Facebook added 30 more college networks.

5. With this success, Zuckerberg, Moskowitz and Hughes moved to Palo Alto, California for the summer and rented a sublet.

6. A few weeks later, Zuckerberg ran into the former cofounder of Napster, Sean Parker. Parker soon moved in to Zuckerberg’s apartment and they began working together.

The Story of Facebook7. Parker provided the introduction to their first investor, Peter

Thiel, cofounder of PayPal and managing partner of The Founders Fund. Thiel invested $500,000 into Facebook.

8. With millions more users, Friendster attempted to acquire the company for $10 million in mid 2004. Facebook turned down the offer and subsequently received $12.7 million in funding from Accel Partners, at a valuation of around $100 million.

9. Facebook continued to grow, opening up to high school students in September 2005 and adding photo sharing.

The Story of Facebook

10. The next spring, Facebook received $25 million in funding from Greylock Partners and Meritech Capital, as well as previous investors Accel Partners and Peter Thiel. The pre-money valuation for this deal was about $525 million.

11. Facebook subsequently opened up to work networks, eventually amassing over 20,000 work networks. Finally in September 2006, Facebook opened to anyone with an email address.

The Story of Facebook12. Viacom attempted to acquire the company for $750 million in

March, 2006. Zuckerberg declined. 13. In the summer of 2006, Yahoo attempted to acquire the

company for $1 billion dollars. Zuckerberg declined. 14. In October 2007. Microsoft invested $240 million into

Facebook for 1.6% of the company. Valuation of $15 billion. 15. In July 2010, Facebook members reach 500 million.16. By August 2010, total capital raised is $836 million with

estimated annual 2010 revenues of $1 billion.

Influence of risk propensity is debated by scholars• While the level of risk propensity in entrepreneurs vs.

managers is arguable, common ground exists with:– Different types of risk exists

• Financial, personal safety, ethical, etc.– Alertness perspective differentiates people

• Entrepreneurs assess risks differently than managers– Company type and size brings different

risks to managers, which can be complexand high-risk

Entrepreneurial motivation

• Motivation: the factors through which goal-directed behavior is initiated, energized and maintained

• For entrepreneurial strategic decision-making, three factors are emphasized:– Self-efficacy– Cognitive motivation– Tolerance for ambiguity

Motivational factors: Self-efficacy

• Set of individual beliefs concerning an individual’s capability to mobilize and use cognitive and motivational resources in order to increase the sense of control over different life events– Related to control and confidence, but tied to a

specific task or activity• Top predictor of individual performance in

a wide variety of tasks

Motivational factors: Cognitive Motivation

• Cognition: the process of thought• Individuals high in need for cognition (thinking) tend to seek,

acquire, think, and reflect on relevant information• Individuals low in need for

cognition tend to rely on experience, assumptions, and others’ expertise

Motivational factors: Tolerance for ambiguity

• Defined as the tendency to perceive ambiguous situations as desirable rather than threatening

• Necessary factor for entrepreneurs based on dynamic nature of markets and competition

• Important to be able to makecomplex decisions quicklywith limited information

Cognitive biases and heuristics common in entrepreneurship

• Overconfidence• Representativeness• Counterfactual thinking

Overconfidence of entrepreneurs

• Refers to an individual tendency to overestimate one’s capabilities, knowledge and skills – Results in being overly optimistic of the future

• Helps entrepreneurs to successfully face multiple hurdles of starting and managing

• Valuable to encouraging and persuading others• Explains why most new ventures fail

Representativeness of entrepreneurs’ decisions• Defined as the tendency of judging the probability of

an event based on how representative that event is for a class or category of events– Stereotyping

• Willingness to generalize based on small and non-random samples of events

• Results in inaccurate perceptions of reality

Counterfactual thinking by entrepreneurs

• Defined as the tendency to think about ‘what might have been if..’ or ‘if only I would have..’

• Often negative in nature, with a sense of regret or disappointment due to missed opportunities

• Can result in pursuing mediocre opportunities for new ventures, for fear that they may ‘miss out’ on a success

Summary

• Entrepreneurial strategic decision-making involves complex psychological factors to include risk and motivation

• Cognitive biases and heuristics play a central role in identifying and analyzing entrepreneurial opportunities