Blog

Credit of trust

Credit of trust

“The intuitive mind is a sacred gift and the rational mind is a faithful servant. It is paradoxical that in the context of modern life we have begun to worship the servant and defile the divine.” Today, over 60 years after these words were spoken by Albert Einstein, the role of intuition in business decisions is still very much underrated. While rational and deliberate weighing of options is still the go-to course of action, studies on decision-making validate Einstein’s claim.

Apparently, in many business processes intuition is a better decision-making tool than rational, model-based calculations. This also applies to innovation. Hence, putting a business on the track towards innovation poses quite a challenge as it requires trust in expert intuition. When we set out to repeat or improve on what others have successfully completed before us, we know from the onset that we are dealing with a proven solution. Navigating the realm of working solutions and technologies, we are able to measure and assess the risk associated with our project. While assessment of the economic viability of a project does not guarantee success, it upholds our conviction that the investment is based on solid rationale.

In the case of innovation projects, though, things are vastly different. Given the scarcity of information, their economic viability cannot be assessed, nor is it possible to estimate the associated costs and future revenue streams. A new business project is so unique that it cannot be subject to, or based on, a rational and systematic assessment. In such decision-making processes, investors are left to rely on their intuition alone. As far as traditional projects go, a decision based solely on intuition would be a case of economic folly and business mismanagement. However, innovation projects belong to a sphere where reliance on intuition is a must.

Resorting to intuition in business decisions relates to expert intuition − an expert hunch, if you will. While studying the spirit of entrepreneurship, Friedrich Hayek, an Austrian economist and Nobel Prize winner (1974), found that entrepreneurs form their distinctive opinions through personal experience and personal knowledge derived from it. The majority of knowledge they use does not exist in any readily available form. Rather, it comprises a thinking method which allows entrepreneurial individuals to find new solutions. Hayek called this tapping into tacit knowledge (as opposed to formal, codified knowledge), because we all know more than we are able to articulate.

Research into decision-making confirms Hayek’s observations. As it turns out, in 50% of all cases the allocation of capital is decided on through expert intuition. We rely on it even when formal tools are available and employed to support decision-making. Since business in general values rational thought, few decision-makers will ever admit to placing their trust in expert intuition, with calculations serving only to convince others of the validity of their choice.

The role of intuition in business decisions may also be considered in terms of uncertainty, which stems from incomplete information and is an inherent element of investment in innovation. The distinction between uncertainty and risk in business decisions was first made by Frank H. Knight, an American economist, representative of the Chicago School. According to Knight, we are facing risk when, based on known information, we are able to determine the likelihood of future events, e.g. future return on investment. Risk can be measured and, on that basis, assessed. On the other hand, uncertainty is the inability to make a rational decision due to absence of information about future events. And so when playing dice, we are faced with risk, but when considering investment in an innovative start-up, we are dealing with uncertainty. Knight argued that most business decisions, in fact all those with a bearing on the decision-maker’s financial profit, are made in conditions of uncertainty. Such uncertain situations involve too many unknowns and are too complex to lend themselves to statistical analysis. No matter how hard we try, we will never be able to limit uncertainty to the level of measurable risk. The same decision-making environment applies to innovation projects.

Thus, the success of a strategy to innovate a company or a country hinges on credit of trust being given to decision-makers − executive managers equipped with the requisite expertise. However, placing trust in an innovation manager does not come lightly, especially at companies just starting out on the path to innovation. A manager’s expertise grows with the number of projects under their belts, regardless of whether the aim of such projects was innovation or merely improvement. The trouble is that an experienced manager in an innovative business has disproportionately more failed projects to his name than his equally experienced counterpart who just improves on existing solutions. This is due to the objectively high failure rate of innovation projects, compared with the high probability of success of improvement projects. All this said, giving a credit of trust is not easy.

Things get even more complicated in the case of public companies. The work of Edmund Phelps, an American economist, who received the 2006 Noble Prize for his contribution to the theory of innovation, deals with the relationship between appetite for risk and form of ownership. The point is that in classic forms of private ownership, the owner is the sole party exposed to innovation uncertainty. In a private enterprise it is the owner who takes on the entire risk, while large corporations, usually publicly traded, are confronted with the separation of ownership from management. A CEO who gets too comfortable with uncertainty can be replaced if shareholders find his performance ‘sufficiently disappointing’.

How then do we rise to the challenge of transitioning the economy towards innovation? We must trust business and expert intuition, because in fact there is no other way.

Up