A N EXPLORATORY STUDY IN HIGH TECHNOLOGY MARKETS

T ^HE R ^EASONING P ^{ROCESS OF} E ^XPERT E NTREPRENEURS

A N EXPLORATORY STUDY IN HIGH TECHNOLOGY MARKETS

BY

A RJAN K LUNDER

U

S

U

G

27

A

, 2008

University of Sydney University of Groningen

II

The Reasoning Process of Expert Entrepreneurs

Author:

Arjan Klunder

27

of August, 2008

Program: Master Technology Management

Faculty of Economics and Business

Supervisors:

Dr. R.G. Seymour, University of Sydney

Prof. Dr. R.J.J.M. Jorna, University of Groningen Drs. K. Peters, University of Groningen

Conducted at: International Entrepreneurship Research Group

Faculty of Economics and Business

University of Sydney

Keywords:

Entrepreneurship, Entrepreneur, Decision Making, Reasoning, Expert, Expertise, Performance.

University of Sydney University of Groningen

III

P ^REFACE

Having started two ventures and pursuing several entrepreneurial opportunities myself, I often wondered why some entrepreneurs are clearly better than the rest.

This was the main motivation for choosing to investigate the reasoning process of expert entrepreneurs for my master thesis Technology Management. I learned a great deal during this project and I am pleased to present this final report. The area proved to be very challenging. Fortunately I received the support, guidance and encouragement from various people whom I would like to thank for this.

First of all I would like to thank Richard Seymour, my supervisor at the University of Sydney for giving me the opportunity to experience this research project at the University of Sydney, but also for his great guidance and selflessness. I would also like to express my gratitude to my supervisors at the University of Groningen, Rene Jorna and Kristian Peters, for giving me a clear focus and helping me not getting lost in the overwhelming jungle of entrepreneurial reasoning. I gained immense benefit from their insightful criticisms.

I wish to thank Cynthia Webster from MacQuarie University for her guidance on numerous academic topics including various methodology aspects. And of course my friends and fellow students in Sydney for both sharing with me their culture and their comments on my work.

I wish to express my sincere thanks to the interviewees for taking the time for my interviews during their busy schedules. All interviewees were truly an inspiration for me.

Others have provided encouragement and valuable support as well. Firstly I wish to thank my business partner and colleagues of my own company for their ongoing understanding and support during my absence. My parents for their never ending encouragement and Marieke for her patience, support and encouragement as well as experiencing the beauty of Australia with me.

Arjan Klunder

27

of August, 2008

IV

A ^BSTRACT

This thesis explores the reasoning patterns used by novice and expert entrepreneurs in their decision making process. The area of reasoning by entrepreneurs is still in its infancy, significant gaps remain and often there is no distinction made between novice and expert entrepreneurs. The purpose of this thesis is to contribute to the theory development on these topics. This research pursues its goal through in-depth, multi method interviews and an exploratory qualitative methodology.

First, a literature review on entrepreneurship, reasoning and reasoning by expert entrepreneurs is given. After this, the reasoning process of three cases is further explored through in-depth interviews. A naturalistic approach is taken. The interviews are based on a combination of naturalistic techniques. It is primarily based on the Critical Decision Method (CDM) developed by Klein, Calderwood and MacGregor (1989) and it is further extended with probes from Applied Cognitive Task Analysis (ACTA) by Militello and Hutton (1998). The interviews have been analyzed using NVivo, a computer assisted qualitative data analysis package.

The results suggest that expert entrepreneurs do indeed use different reasoning patterns than novice entrepreneurs and that this is a key element in the performance of expert entrepreneurs. Expert entrepreneurs have an innate sense of information relevance, are better at choosing the right style of reasoning for the right moment and they use more information and analytical tools in their reasoning process. It seems that, although they are biased, the overall negative effect of biases by expert entrepreneurs is less than that of novice entrepreneurs.

This study is one of the first to explore the complex domain of reasoning by

expert and novice entrepreneurs. Further research in this area is recommended

since it poses academic as well as practical value. A better understanding of the

reasoning process of expert entrepreneurs can lead to a better education of novice

entrepreneurs, allowing them to advance faster to a more expert stage.

V

T ^{ABLE OF} C ^ONTENTS

Preface III

Abstract IV

Table of Contents V

List of Figures VIII

List of Tables VIII

1. Introduction 1

1.1 Research background 1

1.2 Research goal 2

1.3 Type of research 3

1.4 Outline of this thesis 4

2. The Entrepreneur 5

2.1 Introduction 5

2.2 A short history 5

2.3 The German tradition 6

2.4 The Austrian tradition 6

2.5 The Chicago tradition 6

2.6 Modern view of entrepreneurship 7

2.7 Complexity of entrepreneurship 9

2.8 Conclusion 9

3. Reasoning & Decision Making 10

3.1 Introduction 10

3.2 Classical & neoclassical theory 10

3.3 Bounded reality 11

3.4 Heuristics & biases 11

3.5 Recent theories 13

3.7 Conclusion 15

VI

4. Reasoning by Expert and Novice Entrepreneurs 16

4.1 Introduction 16

4.2 What is an expert? 16

4.3 Reasoning by entrepreneurs 17

4.3.1 Input perception and structuring 17

4.3.2 Decision style 18

4.3.3 Heuristics 19

4.3.4 Affected by biases and avoiding biases 20

4.4 Key differences between reasoning of novice and expert entrepreneurs 22

4.5 Conceptual model 24

4.6 Conclusion 25

5. Methodology 26

5.1 Introduction 26

5.2 Interview methods 27

5.3 Selection of interviewees 27

5.4 Other sources 28

5.5 Data analysis 28

5.6 Robustness of methodology 30

5.6.1 Reliability & validity 30

5.6.2 Neutrality 31

5.6.3 Generalizability 31

5.6.4 Ethical considerations 31

5.7 Conclusion 31

6. Results 33

6.1 Introduction 33

6.2 Perception and structuring of inputs 33

6.2.1 Results 33

6.2.2 Conclusion 34

VII

6.3 Use of heuristics 36

6.3.1 Results 36

6.3.2 Conclusion 36

6.4 Affected by & avoiding biases 38

6.4.1 Results 38

6.4.2 Conclusion 38

6.5 Use of decision making styles 40

6.5.1 Results 40

6.5.2 Conclusion 40

6.6 Differences and similarities between the two expert entrepreneurs 42

6.7 Conclusion 42

7. Discussion 43

7.1 Introduction 43

7.2 Use of information 43

7.3 Self-regulation 43

7.4 Heuristics 44

7.5 Entrepreneurial expert domain 44

7.6 Model of expert entrepreneurial performance 45

7.7 Recommendations for further research 46

7.8 Contribution to theory 46

7.9 Practical relevance 47

8. Conclusion 48

Appendix 1 – Interview schema 50

Appendix 2 – Initial coding framework 56

Appendix 3 – Results 58

Bibliography 61

VIII

L ^{IST OF} F ^IGURES

Figure 1 – Outline of this thesis ... 4

Figure 2 – Overview of the classical history of entrepreneurship ... 7

Figure 3 – Effect of identified themes on performance ...22

Figure 4 – Conceptual model ...24

Figure 5 – Model of expert entrepreneurial performance ...46

L ^{IST OF} T ^ABLES Table 1 – Overview of various roles of the entrepreneur ... 8

Table 2 – Key contextual factors that affect real-world decision making ...14

Table 3 – Effect on performance of identified reasoning aspects ...22

Table 4 – Key differences between novice and expert entrepreneurs ...23

Table 5 – Overview of interviewees ...28

Table 6 – Results of ‘perception and structuring of inputs’ ...34

Table 7 – Results of ‘use of heuristics’ ...36

Table 8 – Results of ‘self-regulation’...36

Table 9 – Results of ‘affected by & avoiding biases’ ...38

Table 10 – Results of ‘use of decision making styles’ ...40

Table 11 – Initial coding framework ...57

Table 12 – Results ...60

1. Introduction - 1

T HE REASONING P ROCESS OF E XPERT E NTREPRENEURS

1. I NTRODUCTION

1.1 R

In the last few decades, research on entrepreneurs has undergone significant development (Gustafsson 2006). Where it first mainly was studied by economics in a rational setting; now it is studied by researchers in various disciplines with various tools and methodologies. The main reason for this attention is that entrepreneurs are increasingly being seen as an essential part of the economy. They induce innovativeness, competitiveness, wealth creation and both local and regional development (Reynolds, Storey et al. 1994; Westhead and Wright 1998). They also contribute heavily to job growth (Reynolds and White 1997; Shane 2003).

Therefore, the birth of new ventures is often seen as the critical driving force of economic growth (Low and MacMillan 1988; Cassis and Minoglou 2005). Shane (2003) even notes that entrepreneurship is the cornerstone of every business exploitation, and for that matter, even capitalism itself.

Entrepreneurs operate in complex, dynamic and uncertain environments (Slevin and Covin 1997; Baron 1998; Sarasvathy 2001). Making decisions in such environments means that the entrepreneur is constantly facing a variety of complex decision tasks. Not surprisingly, making these decisions correctly is very hard and most entrepreneurs do not succeed in creating lasting organizations (Aldrich and Martinez 2001; Shane 2003). While most entrepreneurs fail within two years, some entrepreneurs show the ability to start multiple high performing ventures in a row.

These entrepreneurs are referred to as experts and are distinguished from the novice entrepreneurs by their high performance and their years of experience (Foley and Hart 1992).

A frequently asked question is why these expert entrepreneurs are better at making decisions in these complex environments than others. Do they have certain skills, traits or are their demographics characteristic for their better performance as an entrepreneur?

In the last three decades researchers have tried to find these traits. However the

results of these studies were meager. Empirical research found it hard to prove that

1. Introduction - 2 novice or expert entrepreneurs possess different psychological or any other type of statistically significant traits (Low and MacMillan 1988). Although entrepreneurs do share some common characteristics as over-optimism, high tolerance for ambiguity, internal locus of control and the desire for autonomy (Delmar 2000), these traits do not distinguish entrepreneurs from non entrepreneurs, nor did they provide an explanation or predictor of high performance (Gustafsson 2006).

Instead of their personality traits or demographic characteristics, recent literature (e.g. Sarasvathy 2001; Baron 2004; Mitchell, Busenitz et al. 2007) suggests that differences between the reasoning process of expert entrepreneurs and novice entrepreneurs might play a crucial role in their performance. Ucbasaran et al.

(2003) and Gustafsson (2006) note that such differences are likely to exist. For instance, research shows that expert entrepreneurs use a more heuristic based reasoning in their decision making process (Busenitz and Barney 1997; Baron 2000;

Simon, Houghton et al. 2000) and Sarasvathy et al. (2001; 2007) note that expert entrepreneurs more frequently use effectual reasoning besides the more common causal reasoning than novice entrepreneurs.

1.2 R

The aim of this research is to identify whether the reasoning patterns of expert and novice entrepreneurs differ and whether these potential differences have a systematic effect on the performance of the entrepreneur.

MAIN RESEARCH QUESTION:

1) D

/

?

RESEARCH SUB QUESTIONS:

The main subject of this research is the entrepreneur. Although the entrepreneur has gained a considerable amount of attention in the last few decades (Shane 2003), there is still no easy answer to what an entrepreneur really is. The first sub question therefore is:

A) W

?

1. Introduction - 3 There are several research approaches to study the reasoning patterns of individual decision makers. In order to correctly answer the main question, the most suitable approach for studying the reasoning process of entrepreneurs should first be identified. Hence the following sub question:

B) W

?

In order to assess why the reasoning patterns used by novice or expert entrepreneurs lead to systematic different performances, the reasoning patterns used by both type of entrepreneurs should first be known:

C) W

/

?

Having identified the different reasoning patterns of novice entrepreneurs and expert entrepreneurs, the systematic effects they have on the performance can be further examined:

D) W

?

1.3 T

Literature on reasoning, experts and entrepreneurs as separate fields of study is very extensive. However, the intersections of these three fields are practically unexplored. Theories on reasoning in entrepreneurship started a decade ago (Busenitz and Barney 1997; Baron 1998). The expert entrepreneurship literature is even more recent. Read, Wiltbank et. al. (2003) were one of the first who combined expert literature with entrepreneurship. This research explores the various aspects of the reasoning patterns entrepreneurs use and how these affect their performance.

Since current theories in decision making, reasoning and expert literature could

be a good foundation for developing new theories about the reasoning process of

expert entrepreneurs (Low 2001; Shane 2003; Davidsson 2004), this research will

begin with identifying these aspects through an extensive literature review. Beside

the literature review this research will also explore the reasoning patterns of novice

and expert entrepreneurs in an empirical setting. The reasoning processes of three

1. Introduction - 4 entrepreneurs have been investigated through in-depth interviews. All entrepreneurs operated in high technology markets.

1.4 O

Chapter two will begin with the literature about the entrepreneur and entrepreneurship. The first sub question ‘What is an entrepreneur?’ will be answered.

Chapter three will deal with the more general literature on decision making and reasoning. It will give an overview of various approaches for studying the reasoning process of decision makers. It will also identify the most suitable approach for studying the reasoning process of entrepreneurs, thereby answering the sub question ‘What approach should be used to study the reasoning process of entrepreneurs?’.

Chapter four will deal with the expert- novice literature and combined with literature handled in the chapters two and three it will focus more on the last two sub research questions. Based on the literature, chapter four identifies how the reasoning process of expert and novice differs and how it affects their performance.

In chapter five, the empirical research process of this research is outlined and the methodology is defined. Chapter six contains the results from the analysis with NVivo.

After the results, chapter seven and chapter eight will handle respectively the discussion and the conclusion of this research.

Figure 1 – Outline of this thesis Chapter 1 - Introduction

Chapter 2 – The entrepreneur

Chapter 3 – Reasoning & Decision Making

Chapter 4 – Reasoning by Novice and

Expert Entrepreneurs

Chapter 5 - Methodology

Chapter 6 - Findings

Chapter 7 - Discussion

Chapter 8 - Conclusion

2. The Entrepreneur - 5

2. T ^HE E NTREPRENEUR

2.1 I

According to the Oxford’s dictionary an entrepreneur is a person who sets up a business or businesses (Soanes 2002). The academic literature on this topic is however somewhat more complicated. Some see the entrepreneur as an individual who creates a new venture in order to create value, while others argue that even people who are employees within established firms can be described as entrepreneurs, because they also identify and exploit new growth opportunities (Shepherd and Krueger 2002; Shane 2003). This chapter will give an overview of literature on how the entrepreneur can been seen and how the concept has been studied.

Oxford's dictionary definition of an entrepreneur

2.2 A

The Irish economist Richard Cantillon (c. 1680-1734) was the first to use the term entrepreneur in economic literature (Hébert and Link 1989; Bruyat and Julien 2000; Casson 2003). He defined the entrepreneur as someone who assumes risk and may legitimately appropriate any profits. The French economist Jean-Baptiste Say (1845) stated that the entrepreneur was in fact a coordinator. According to Say entrepreneurs bring people together in order to build a single productive organism (Schumpeter and Clemence 1951). The term was recognized by various classic works throughout the 18

and 19

century, including “Principles of Political Economy” by John Stuart Mill (1848) and “The wealth of the nations” by Adam Smith (1776). A significant step forward in the theory of entrepreneurship was made by Johann Heinrich von Thünen. In his book “The isolated state” (1850) he depicted the entrepreneur as an innovator as well as a risk-bearer (Hébert and Link 2006). At the end of the 19

century the interest in entrepreneurship declined. The main

entrepreneur /ontreprenör/

 noun a person who sets up a business or businesses.

- DERIVATIVES entrepreneurial /ontreprenöriel, -nyooriel/ adjective entrepreneurialism noun entrepreneurially adverb entrepreneurism noun.

-

2. The Entrepreneur - 6 reason for this development was that the static approach of the emerging classical school did not readily accommodate a dynamic concept like the entrepreneur (Casson 2003).

In the 20

century the term entrepreneur slowly revived. Hébert and Link (1989) identified three intellectual branches, or traditions, of entrepreneurship in this century: (1) The German Tradition (Thünen-Schumpeter), (2) The Chicago Tradition (Knight-Schultz) and (3) The Austrian Tradition (Mises-Kirzner-Schakle).

2.3 T

G

It was Thünen who first saw the entrepreneur as an innovator, but it was Joseph Schumpeter who extensively elaborated on this idea. Schumpeter (1934) unveiled his concept of the entrepreneur in his book “Theory of Economic Development”

(1934). He saw the entrepreneur as the persona causa of economic development (Hébert and Link 1989). The entrepreneur performs the functions of innovation enabling the liberal system to persist by going beyond its contradictions (Bruyat and Julien 2000). According to Schumpeter (1934) the entrepreneur is the innovator (e.g. by introducing new products, new methods or new markets) who moves the market away from its equilibrium.

2.4 T

A

The Austrian tradition is dominated by Israel Kirzner (1973) who followed up on work by Mises (1949) and Schackle (1955). Kirzner sees the entrepreneur as one who recognizes and acts on opportunities. The entrepreneur is essentially an arbitrageur. In contrast with the view of Schumpeter, Kirzner states the market is in constant disequilibrium. The entrepreneur recognizes market errors or inefficiencies and acts on them thereby moving the market toward its equilibrium.

2.5 T

C

The Chicago tradition started with Frank Knight (1921). He re-introduced the

entrepreneur in the 20

century. Knight stated that the role of the entrepreneur is

that of a risk-bearer in the face of uncertainty and imperfect information. A strong

filiation between his theory and that of Cantillon is present, however Knight did not

openly acknowledge Cantillon as the progenitor of his own theory of

entrepreneurship (Hébert and Link 1989). Schultz (1980) is one of the more recent

authors of the Chicago tradition. He believes that the entrepreneur has the ability to

2. The Entrepreneur - 7 deal with the disequilibria of the market, comparable to the equilibrium approach of Kirzner. However, in contrast with Kirzner, Schultz’s approach to entrepreneurship is fully within the neoclassical tradition. He has developed several economic theories on entrepreneurship rooted in theory of human capital (Hébert and Link 1989).

An overview of the classical history is illustrated in figure 2. As noted by Hébert and Link (1989) this classification of three traditions requires certain obiter dicta.

First there are several linkages between various authors in different traditions and secondly some linkages (Thünen-Schumpterer and Cantillon-Knight) are contrived on basis of common emphasis rather than direct intellectual lineage.

Say (c. 1767 - 1832) Cantillon

(c. 1680 – 1734)

Frank Night (1921) Schultz (1980) Johann Heinrich (1850)

Schumpeter (1934)

German Tradition

Chicago Tradition

Austrian Tradition

Mises (1949) Schakle (1955) Kirzner (1973)

Figure 2 – Overview of the classical history of entrepreneurship

2.6 M

The last three decades entrepreneurship is not only studied by economists but has attracted interest from various disciplines. Entrepreneurship now is studied more intensely than ever before, several thousand articles per year are published on this subject (Shane 2003). However, the understanding of entrepreneurship is still quite limited (Aldrich and Baker 1997; Busenitz, West Iii et al. 2003; Shane 2003).

Several problems plague the field of entrepreneurship:

First of all, entrepreneurship is suffering from a high amount of fragmentalism: A great deal of research has been carried out by scholars in various disciplines.

However, the results are unlinked, also referred to as a “multidisciplinary jigsaw”

(Harrison and Leitch 2005). Shane (2003) and Aldrich and Baker (1997) note the

lacking of a necessary overarching framework or ruling paradigm.

2. The Entrepreneur - 8 Secondly, results of past research, especially empirical, are often questionable (Shane and Venkataraman 2000). Studies on entrepreneurship tend to be less sophisticated in sampling frames, statistical analysis and longitudinal analysis (Aldrich and Baker 1997). Some scholars opt for a more qualitative and longitudinal approach for studying entrepreneurship (e.g. Gartner and Birley 2002)

Furthermore, there seems to be no consensus on how to treat entrepreneurship.

Some academics argue for a focus on the individual where others see the environment or a system-level approach as more important. Also the debate on what an entrepreneur exactly is still continues; entrepreneurship is plagued by multiple definitions (Morris 1998; Shane and Venkataraman 2000; Hitt 2002; Shane 2003; Seymour 2007). In a period of five year more than 77 different definitions have been identified (Morris 1998). Aldrich and Baker (1997) note that distinctive boundaries for the field must yet be established. Table 1 shows the various roles or definitions theorists give to entrepreneurs. These roles were identified by Hebert and Link (1989).

Roles

Assumer of the risk associated with uncertainty Arbitrageur

Supplier of financial capital Owner of an enterprise

Innovator Employer of factors of production

Decision Maker Contractor

Industrial leader Allocator of resources among alternatives used Manager or superintendent Organizer and coordinator of economic resources

Table 1 – Overview of various roles of the entrepreneur (Hébert and Link 1989)

In short there is consensus about the importance of entrepreneurship (Aldrich and Martinez 2001) but there is no consensus about what entrepreneurship is and how to study it. Sexton and Kasarda (1992) note that although there is no generic definition for the entrepreneur, it essentially refers to an individual who performs an opportunistic activity that creates value, bears risk and is strongly associated with innovation. This research does not try to add an extra definition for an entrepreneur. Instead this research will follow the notation of Sexton and Kasarda (1992) and focus on the following group of entrepreneurs:

The entrepreneurs who are owner and founder of an innovative startup and are

heavily involved in the management of their own firms and therefore assume risk and

may legitimately appropriate any profits.

2. The Entrepreneur - 9 2.7 C

One of the reasons why there is so much debate on entrepreneurship is that the phenomenon under study is utterly complex (Gustafsson 2006). Many locate decision making by entrepreneurs in dynamic, uncertain environments that are characterized by change and disequilibrium (Slevin and Covin 1997; Baron 1998;

Sarasvathy 2001). Entrepreneurs act in environments where various forces and actors are present (e.g. investors, government organizations, competitors). These forces and actors all play a role in the company’s performance by presenting opportunities and imposing threats on its activities (Kotler 1988). Furthermore, entrepreneurs act under high time constraints, often with limited resources. As indicated before, some entrepreneurs are able to perform relatively well under such conditions. Previous research shows that personality traits or demographic characteristics do not distinguish entrepreneurs from non-entrepreneurs, nor did they provide an explanation or predictor of high performance (Gustafsson 2006).

However, as several scholars (e.g. Sarasvathy 2001; Baron 2004; Mitchell, Busenitz et al. 2007) have argued the reasoning and decision making process of entrepreneurs might play a crucial role in their performance.

2.8 C

Various definitions and roles are applicable to the term entrepreneur. Although

some do conflict, they also share a great deal of aspects. Most see the entrepreneur

as an innovator, a coordinator and a bearer of risk and uncertainty. There is

consensus on the importance of entrepreneurship but not on the way how it should

be studied. Performed studies are often questionable and therefore some scholars

opt for a more qualitative and longitudinal approach to explore the greater

complexities of entrepreneurship. Since entrepreneurs cope with uncertainty, risk

and innovation, the reasoning and decision making process of entrepreneurs is

gaining increasingly attention from various scholars. The next chapter will give an

overview of the literature on reasoning and decision making in general and how

reasoning and decision making in these entrepreneurial environments can be

studied.

3. Reasoning & Decision Making - 10

3. R ^EASONING & D ^ECISION M ^AKING

3.1 I

Throughout history mankind has struggled with making decisions under uncertainty. A dichotomy can be made to distinguish the normative (how people ought to make decisions), descriptive (how people make decisions) and the prescriptive (how can we help people to make better decisions) side (Bell, Raiffa et al. 1988). The normative side is mostly studied by economics and mathematicians.

They are best known for their Bayesian and logico-deductive models (i.e. utility theory, game theory and operations research). However, the descriptive side, mostly studied by psychologists, tells us that these models are mostly not compatible with the way people are actually reasoning. This chapter will give an overview of methods and theories about individual reasoning and decision making. It will also identify the most suitable method to explore the reasoning process of novice and expert entrepreneurs.

3.2 C

&

In early classical literature reasoning and decision making was mostly studied by mathematicians and economics, the dominating paradigm was that of the rational man, or homo economicus. It assumed the individual as one who reasons rationally i.e. the maximization of value. Although some economists moonlighted as psychologists of their time (i.e. Adam Smith, Jeremey Bentham) the psychological elements of decision making were mostly neglected (Camerer and Loewenstein 2004). In this omniscient rational approach the environment, combined with the assumptions of perfect rationality, fully determines the behavior of people and therefore was easily determined (Simon 1979). This rational theory flourished in the first half of the 20

century, were the utility theory dominated the analysis of decision making (Kahneman and Tversky 1979).

Utility theory assumes this omniscient rational approach mentioned earlier. It identifies the best decision by assigning a number (utility) to each alternative so that through a Bayesian logico-deductive method the best alternative can be selected.

Currently theories like game theory and expected utility theory are still frequently

used and studied.

3. Reasoning & Decision Making - 11 3.3 B

It was Herbert Simon (1959) who addressed the limitations of this classical approach through his notation of bounded rationality. Simon noted that this approach did not even remotely describe the reasoning process that people use for making decisions in complex situations. He asserts that the individual only has limited problem solving capacities and often does not have time, motivation or the ability to explore all possible decision outcomes in advance. Furthermore he states that the individual is not looking for the best or optimal solution, but for a satisfying solution. This is especially true for the entrepreneur. Since he operates in uncertain and complex environments with high time constraints. It would be impossible for the entrepreneur to examine all possible outcomes.

3.4 H

&

In order to make decisions in such uncertain environments, many scholars believe that entrepreneurs heavily use heuristics and biases in their decision making process (e.g. Busenitz, West Iii et al. 2003; Baron 2006; Mitchell, Busenitz et al.

2007). Heuristics and biases were popularized by Daniel Kahneman and Amos Tversky in the late 1960s and 1970s. Heuristics refer to simplifying strategies, decision rules and cognitive mechanisms that individuals use to make decisions (Tversky and Kahneman 1974; Busenitz and Barney 1997). The use of heuristics, causes people to be biased in their decision making process; they can decide against their rational economic interest even when they know better (Kahneman and Tversky 1979).

People rely on a limited number of heuristic principles which reduce the complex tasks of assessing probabilities and predicting values to simpler judgmental operations (Tversky and Kahneman 1974). Tversky and Kahneman initially identified three heuristics:

(1) The representative heuristic; people interpret a sample to be more representative of the parent population than it actually is.

(2) The availability heuristic; people attempt to frame a decision based on prior confronted and successfully negotiated situations.

(3) The anchoring and adjustment heuristic; people start at one place in a decision

matrix and adjust from that initial point. They try to get “close” and then

adjust from this initial point by obtaining and using additional information.

3. Reasoning & Decision Making - 12 Besides these three heuristics various scholars have identified several other heuristics (e.g. affect heuristic, familiarity heuristic, similarity heuristic). There is a broad range of empirical findings that suggest that decision-makers use such heuristics and biases (i.e., Kahneman, Slovic et al. 1982; Jackson and Dutton 1988;

Bateman and Zeithaml 1989; Zajac and Bazerman 1991; Busenitz and Barney 1997).

However not every decision maker uses and is affected by these heuristics and biases in the same way. Decision makers all have their own cognitive traits.

(Bazerman and Neale 1983; Haley and Stumpf 1989; Stumpf and Dunbar 1991;

Busenitz and Barney 1997).

Gigerenzer (Gigerenzer 1996; 2002) notes that in the last thirty years heuristics were often seen as strategies that prevent one from finding out or discovering correct answers to problems. In other words, they were often seen as a negative element in the reasoning process of the people. However the use of these heuristics can be quite useful; it can yield acceptable solutions to problems for individuals, in an effective and efficient manner (Tversky and Kahneman 1974; Gigerenzer 1996;

Busenitz and Barney 1997). Especially when heuristics are used by skilled persons in time-pressured and uncertain settings where rational methods do not suffice (Klein 1997). Several empirical studies by Gigerenzer and Goldstein show that some heuristics (e.g. ‘take the best’ heuristic) out-performed systematic analysis in situations with a high degree of uncertainty.

Various scholars in the field of entrepreneurship also recognize the positive effect heuristics can have on the decision making process of the entrepreneur (e.g.

Busenitz, West Iii et al. 2003; Baron 2006; Mitchell, Busenitz et al. 2007). Some propose that entrepreneurs may regularly find themselves in situations that tend to maximize the potential impact of a more heuristic-based logic (Mitchell, Busenitz et al. 2007).

Much of human reasoning and decision making can be modeled by heuristics

(Gigerenzer and Todd 1999) but decision makers also use more systematical styles

of reasoning. The various styles individuals use in their decision making process can

be divided into two broad categories: systematic styles and intuitive styles. The

systematic decision styles are ordered and rule-based. They involve information

3. Reasoning & Decision Making - 13 gathering, the logical analysis of information and reasoning towards decision outcomes.

Intuitive styles rely on limited or representative information, non-analytical modes of judgment and the selective choice of decisions outcomes (Thunholm 2004). The use of heuristics would fall into this category. It is often suggested that entrepreneurs use a more intuitive style of reasoning (e.g. use of heuristics, rely on gut feel) in order to cope with the complex and uncertain environments (Allison, Chell et al. 2000). However literature suggests that both styles are common in decision making.

3.5 R

Most recent theorists in the area of decision making by entrepreneurs accept the practical limitations of the classical approach and focus more on the behavioral and cognitive complexities of actual decision making. They accept the concepts of heuristics and bounded reality (Schwartz 2002; Slovic, Finucane et al. 2004).

Theories of naturalistic decision making are broadly similar, they focus on how the features of actual decision making situations affect the decision itself (Hammond 2000; Payne and Bettman 2001).

Whether using a heuristic style of reasoning or a more systematical way of reasoning, the individual decision makers always use their knowledge and experience. Gary Klein et al. (1993) notes that previous models did not describe how people actually make decisions in more complex and demanding situations and how they use their knowledge and experience in this process. Gary Klein et al.

(1993) sought to address these issues with their theory of Naturalistic Decision Making (NDM). NDM aims to understand how people use their experience to make decisions in complex and dynamic environments (Meso, Troutt et al. 2002). Klein and Zsambok (Klein and Zsambok 1997) define NDM as:

The study of NDM asks how experienced people, working as individuals or groups in dynamic, uncertain, and often fast-paced environments, identify and assess their situation, make decisions and take actions whose consequences are meaningful to them and to the larger organization in which they operate (Klein and Zsambok 1997).

NDM was born out of criticism that traditional paradigms did not handle the key

contextual factors that affect real-world decision making. I.e. traditional research

3. Reasoning & Decision Making - 14 assumes that the goal/problem is always well structured and known and that the environment is more or less static. Feedback loops are often disregarded. These factors along with counterparts in traditional decision research are given below in table 2:

Key contextual factor Traditional decision research counterpart Ill-structured problems Artificial, well-structured problems Uncertain, dynamic environments Static, simulated situations Shifting, ill-defined, or competing goals Clear and stable goals

Action/feedback loops One shot decisions

Time stress Ample time for tasks

High stakes Situations devoid of true consequences for the

decision maker

Multiple players Individual decision making

Organizational goals and norms Decision making in a vacuum

Table 2 – Key contextual factors that affect real-world decision making (Orasanu and Connolly 1993)

Compared to other decision makers, the key contextual factors identified by

Orasanu and Connolly (1993) are especially relevant for entrepreneurs: Along with

the uncertain, time pressured and dynamic environments described earlier,

entrepreneurs are also influenced by various players (e.g. consumers, business

advisors, mentors) and there are often high personal stakes. If the company fails the

entrepreneur is much more affected than a manager. Looking at these aspects of

entrepreneurial decision making, the reasoning process of entrepreneurs should be

studied in a naturalistic way. Furthermore NDM also takes into account the degree

knowledge and experience of the individual decision maker. Since this research sets

out to find differences between novice and expert entrepreneurs, tools and

methodologies from NDM are particular interesting.

3. Reasoning & Decision Making - 15 3.7 C

When studying people who make fast decisions in complex environments the classical methods do not suffice. One cannot presume that these individuals have unlimited information, unlimited time and will act rationally under all conditions.

This is especially true for entrepreneurs since they operate in complex and

uncertain environments and are often faced with time constraints. The studying of

their reasoning and their decision making process therefore cannot be done with the

classical models; a more naturalistic perspective should be taken. The naturalistic

decision making framework by Klein et. al. seems particularly interesting since it not

only tries to cope with the complex and uncertain environments but also with the

degree of knowledge and experience the individual decision maker has.

4. Reasoning by Expert and Novice Entrepreneurs - 16

4. R EASONING BY E ^{XPERT AND} N ^OVICE E NTREPRENEURS

4.1 I

The previous two chapters gave an overview of the more general literature on entrepreneurship and reasoning and decision making. They identified what an entrepreneur is and what the best approach is for studying the reasoning process of entrepreneurs. Before examining the reasoning process of novice and expert entrepreneurs in an empirical setting, a literature review on how the reasoning process of novice and expert entrepreneurs differs and how these differences affect the performance is needed. This chapter gives this overview. It will also present a conceptual model showing the (potential) differences between novice and experts entrepreneurs in their reasoning process and the systematic effects they have on the performance.

4.2 W

?

In order to further examine the difference of novice and expert entrepreneurs, we first need to know what an expert really is. Foley and Hart (1992) define an expert as:

“Someone who has attained a high level of performance in the domain as a result of years of experience” (Foley and Hart 1992)

In other words, experts have a deep personal ability and knowledge that has been derived from extensive practice and experience (Read, Wiltbank et al. 2003).

Expertise is contextual, i.e. the superiority of expert is very domain specific and the ability to transfer their knowledge outside their narrow area of expertise is surprisingly limited (Ericsson and Lehmann 1996). They do not necessarily exceed in better speed, memory or intelligence (Ericsson 1996). The cognitive process of experts are tailored to the unique characteristics of a particular problem area (Shanteau 1992). For instance research by Doll and Mayr (1987) showed that intelligence did not distinguish expert chess players from novice chess players.

Experts are typically distinguished from novices through their performance as a

result of their years of experience. High task performance is often associated with

experts, they solve complex problems in their domain faster, more easily, and more

accurately than novices (Read, Wiltbank et al. 2003). However decisions made by

4. Reasoning by Expert and Novice Entrepreneurs - 17 experts do not always have to be more accurate than decisions made by novices with simple decision aids (Camerer and Johnson 1991; Bolger and Wright 1992;

Ericsson and Lehmann 1996).

Novices move from experts through active, reflexive experience (Mieg 2001);

they learn from doing. Ericsson and Lehmann (1996) note that individuals who start in a specific domain change their behavior and increase their performance through experience for a limited time until they reach an acceptable level. Deliberate practice is needed to further enhance the performance of an individual. More generally, the accumulated amount of deliberate practice is closely related to the attained level of performance of many types of experts (Ericsson 1996). In order to become an expert complete focus and immersion in the activity is needed for a long period. This immersion enables the cognitive adaptation through learning and skill acquisition (Read, Wiltbank et al. 2003). One key implication of Ericsson’s work is that experts, including entrepreneurs, are made, not born (Krueger 2007).

4.3 R

Read, Wiltbank et al. (2003) indicate that the general characteristics of experts also apply to expert entrepreneurs. The entrepreneurial environments may be more or less comparable to that of medical or firefighter experts who also face uncertainty, ill structured problems and high time constraints. Five themes have been identified where expert and novice seem to differ in their reasoning process.

The first is the perception and structuring of inputs.

4.3.1 I

Entrepreneurs have a great deal of information at their disposable. This

information however is still mostly incomplete. Research shows that experts and

novices model problems, organize knowledge and reasons in fundamentally

different ways (Ericsson and Smith 1991; Patel, Kaufman et al. 1996). As indicated

by Krueger (2007) this also counts for expert entrepreneurs. Expert entrepreneurs

follow complex, cognitive behaviors and processes in which they organize and

structure information differently than novice entrepreneurs. Furthermore experts

have highly developed perceptual abilities which enable them to notice patterns

very rapidly (Shanteau 1992; Read, Wiltbank et al. 2003). As a result the attention of

experts is higher than that of novices (Shanteau 1992). This closely resembles the

alertness theory of entrepreneurs, which states that expert entrepreneurs have a

4. Reasoning by Expert and Novice Entrepreneurs - 18 distinctive set of perceptual and information processing skills to identify new opportunities (Gaglio and Katz 2001). Research by Baron and Ensley (2006) suggest that expert entrepreneurs have developed cognitive frameworks which allow them to recognize patterns better than novice entrepreneurs. These frameworks allow experts entrepreneurs to notice connections between seemingly independent events or trends (e.g. advances in technology, shifts in markets, changes in policies, etc.) and to detect meaningful patterns in these connections (Baron and Ensley 2006).

New products or services could emerge out of the perception of such patterns. The result of the research by Baron and Ensley (2006) was that expert entrepreneurs were able to more clearly define potential opportunities and they were more concerned with factors and conditions related to actually starting and running these new opportunities.

There are also some negative effects in the perception and structuring of inputs by experts. Various studies have reported that experts use surprisingly low amount of information (Shanteau 1992). Underuse of information has been reported for experienced criminal court judges (Ebbesen and Konecni 1975), medical experts (Einhorn 1974) and experienced psychologists (Goldberg 1970). However examples of competent performance involving the handling of large amount of information have been also reported but mostly neglected (Christensen-Szalanski and Beach 1984). Regarding the information handling by expert entrepreneurs, Read et al.

(2003) found that expert entrepreneurs did not significantly differ from novice entrepreneurs with respect to information search, although they used slightly more information sources than novice entrepreneurs. (Read, Wiltbank et al. 2003).

4.3.2 D

Besides the perception and structuring of inputs, experts also seem to differ in the use of decision making styles. Novices tend to reason backwards from the unknowns to the given. Experts, in contrast, reason forwards using stored

“functional units” from the givens to the goals (Shanteau 1992). As already noted by

Read et al. (2003; 2007) this way of reasoning closely resembles the effectuation

theory by Sarasvathy (2001). Backward or causal reasoning is the way most

students are taught. You begin with a pre-determined goal and selected the various

means to get there. An example would be a chef who decides which dish he is going

to prepare and then goes to the grocery to get the ingredients. With forward or

effectual reasoning the person identifies various means and imagines a possible end

4. Reasoning by Expert and Novice Entrepreneurs - 19 or goal for these means. In this case, the chef would look at the ingredients in his storage cabinet and based on these ingredients prepares a new dish.

A recent empirical study by Sarasvathy et al. (2007) indeed indicated that expert entrepreneurs use effectual reasoning in their decision making process much more than novice entrepreneurs. However they do not use effectual reasoning all the time.

Just like novices they also use analytical and systematical approaches to validate their decisions. Furthermore, when the environment of an entrepreneur reaches a more stable level a more causal way of reasoning is both useful and necessary (Sarasvathy, Dew et al. 2007). In other words, the entrepreneur has to act more as an manager.

4.3.3 H

Experts also more frequently use heuristics compared to novices. In expert literature the use of heuristics is often seen as a negative element. They induce biases and judgment errors (Shanteau 1992). Through the use of heuristics experts may make errors, but altogether they make less severe errors than novices and avoid making large mistakes. They are also better at correcting their errors (Chi, Feltovich et al. 1981; Read, Wiltbank et al. 2003)

As already noted earlier, the use of heuristics can also yield acceptable solutions to problems for individuals in an effective and efficient manner (Tversky and Kahneman 1974; Gigerenzer 1996; Busenitz and Barney 1997) especially in the uncertain, unpredictable, complex and high time constraint circumstances where entrepreneurs operate where more rational ways of thinking are not working.

Moreover, entrepreneurs often require the use of heuristics to make sense of uncertain and complex situations quickly (Baron 1998; Mitchell, Busenitz et al.

2007). The commitment of entrepreneurs to their new ventures is often intense, so they may also experience powerful emotions in connection with their activities. In combination with the complexity and uncertainty factors they are even more likely to use heuristics to guide their decision making (Baron 2000). Without a heuristic based logic, the pursuit of new opportunities can become too overwhelming and costly for decision makers who seek a more factual base (Ucbasaran, Wright et al.

2003).

Research shows that both novice and expert entrepreneurs use heuristics in their

decision making process. However experts appear to use heuristics more frequently

4. Reasoning by Expert and Novice Entrepreneurs - 20 and through their extended knowledge and experience experts they are better equipped to use them (Klein and Zsambok 1997). Furthermore expert entrepreneurs are better at switching between analytical and heuristic style decision making; they use heuristics in situations where more rational methods do not suffice and use systematical methods whenever they are possible (Baron 2004).

Since experts more frequently use heuristics it is often thought that experts are more affected by biases (Shanteau 1992).

4.3.4 A

Empirical findings indeed show that entrepreneurs are more likely to use heuristics than other people and fall prey to various forms of cognitive error. In a study by Busenitz and Barney (1997) it is found that entrepreneurs are significantly more likely to make use of the representativeness heuristic than other people. This means that entrepreneurs are likely to generalize from small, non-random samples.

Due to their entrepreneurial setting there is rarely time or institutional support to obtain large random samples even if they do exist.

Palich and Bagby (1995) have shown that entrepreneurs do not prefer risk, rather they tend to associate business situations with cognitive categories that suggest more favorable attributes. In other words, entrepreneurs are more likely to see the business world through ‘rose-colored glasses’. These findings are supported by a study by Busenitz and Barney (1997). They note that entrepreneurs do not prefer risky situations but they do tend be more affected by the overconfidence bias in their decision making process than non-entrepreneurs. In other words, they are overly optimistic (Busenitz and Barney 1997). Earlier research by Cooper et al.

(1988) already showed similar results, namely that entrepreneurs perceive their chances for success to be much higher than fellow competitors in the same market.

Overconfidence emanates from the anchoring and adjustment biases (Tversky and Kahneman 1974). However, there is no reference in the literature that entrepreneurs do use anchoring and adjustment biases more than other people.

Furthermore there is no evidence that expert entrepreneurs significantly differ from novice entrepreneurs in the use of these heuristics.

However expert entrepreneurs are not perfect. Just as novices they are subject to

the pitfall of inferring too much of too little information and misreading evidence

which confirms prior beliefs (Rabin 1998). Experts are probably more subject to

error making than novices, they may become so mechanical that they overlook

4. Reasoning by Expert and Novice Entrepreneurs - 21 certain issues (Rabin 1998). Johnson (1988) also notes that experts could be more subject to errors. He indicates that experts can be biased, resulting in using the wrong information, disregarding correct information or just interpreting the information the wrong way. These biases in expert decision making can lead to a lack of validity and reliability in judgment (Shanteau 1992). Although experts are not infallible and are biased by their own expertise, overall they are more able than novices to avoid making large mistakes, and are able to correct their course more quickly through their increased knowledge and expertise (Read, Wiltbank et al.

2003)

There is evidence that the use of self-regulation limits the errors arising from

bias in decision making (Gigerenzer 2000; Bryant 2007). Self-regulation is a process

where the individual sets goals and direct their own behavior and thought to

achieve these goals (Zeidner, Boekaerts et al. 2000). Bryant notes that self-

regulation by entrepreneurs has an important positive effect on the decision making

process of entrepreneurs and that self-regulation often strengthens after a person

embarks on an entrepreneurial career.

4. Reasoning by Expert and Novice Entrepreneurs - 22 4.4 K

This chapter has identified five themes where the novice and expert entrepreneur differ in their reasoning process: 1) Perception and structuring of inputs. 2) Use of heuristics. 3) Affected by biases. 4) Avoiding biases and 5) Use of decision making styles. On all themes, except affected by biases experts are better performing than novices. The following model and table illustrates these themes and the effect on their performance.

Perception &

structuring of inputs

Use of Heuristics

Affected by biases

Avoiding biases

Selecting styles

Performance

+ -

+ +

- - + ±

± -

Effect on performance by expert entrepreneurs

Effect on performance by novice entrepreneurs Legend

The table shows the effect of the identified themes on the performance of novice and expert entrepreneurs.

Novice performance Expert performance Perception &

structuring of inputs

- +

Use of Heuristics

± +

Affected by biases

± -

Avoiding biases

- +

Use of decision making styles

- +

Table 3 –Effect on performance of identified reasoning patterns Figure 3 – Effect of identified themes on performance

4. Reasoning by Expert and Novice Entrepreneurs - 23 The table below shows a detailed description of the individual elements of these themes.

Key Difference Literature

Perception &

structuring of inputs

Expert entrepreneurs are able to recognize patterns better than novice entrepreneurs.

Krueger (2007); Baron (2006)

Expert entrepreneurs have higher alertness for threads and opportunities.

Shanteu (1992); Gaglio &

Katz 2001); Ucbasaran &

Westhead (2003) Experts have an innate sense of information

relevance.

Ucbasaran & Westhead (2003)

Use of heuristics Experts entrepreneurs use heuristics more frequently and can use heuristics better through their expertise.

Baron (2001,2006);

Expert entrepreneurs employ heuristics in an effective fashion by using skills of self- regulation.

Bryant (2006)

Affected by biases Although expert entrepreneurs are likely to make errors, they are better at avoiding large mistakes and to correct their course more quickly than novice entrepreneurs.

Read et. al. (2003);

Feltovich, Johnson et al.

(1984)

Avoiding biases Through strengthened self-regulation expert entrepreneurs are less subject to biases.

Bryant (2007)

Use of decision making styles

Expert entrepreneurs are better at switching between heuristic and systematic processing style; i.e. to select the right style at the right time.

Baron (2004)

Expert entrepreneurs use effectual reasoning more than novice entrepreneurs causing them to recognize new opportunities better.

Sarasvathy (2001,2007);

Baum et al (2003) Table 4 – Key differences between novice and expert entrepreneurs

4. Reasoning by Expert and Novice Entrepreneurs - 24 4.5 C

This chapter has identified several patterns in which experts differ from novices.

The conceptual model below shows these patterns modeled from an expert perspective. It displays the different patterns experts use and how it affects their performance. The top part contains the patterns which have a positive effect on their performance, the bottom part contains the patterns which have a negative effect on their performance.

Perception &

structuring of inputs

Use of Heuristics Affected by biases Avoiding biases Use of decision making styles

Perception &

structuring of inputs Use of Heuristics Affected by biases Avoiding biases

Use of decision making styles

Higher alertness for threads & oppurtunities

Ability to select most suitable decision making style Innate sense of

information relevance

Use of more evolved heuristics

Affected by biases

Using self regulation to minimize effect of biases

Ability to recognize patterns

PERFORMANCE Use of heuristics in an

effective fashion by using skills of self regulation

Use of effectual reasoning Ability to avoid large

mistakes

Underuse of information

PATTERNS WHICH HAVE A POSITIVE EFFECT ON THE PERFORMANCE

PATTERNS WHICH HAVE A NEGATIVE EFFECT ON THE PERFORMANCE

+ + + + +

- - - - -

Figure 4 – Conceptual model

4. Reasoning by Expert and Novice Entrepreneurs - 25 4.6 C

According to the literature, expert entrepreneurs do indeed reason differently

than novice entrepreneurs. They perceive information differently and have higher

alertness for new opportunities and threats. It seems that they are better at

selecting the right style at the right moment and are better equipped to use

heuristics through their knowledge and experience. However experts are more at

risk of being biased. This chapter has presented a conceptual model in how expert

entrepreneurs differ from novice entrepreneurs. The next part of this thesis aims to

further explore the reasoning process of expert and novice entrepreneurs through

an empirical research. The next chapter will begin with this part by explaining the

methodology used.

5. Methodology - 26

5. M ^ETHODOLOGY

5.1 I

The literature review in the previous chapter already indicated how the reasoning process of expert entrepreneurs differs from novice entrepreneurs and its systematic effect on their performance. However this picture is probably incomplete and could even be false on some points. The main reason for this lies in the fact that the literature on this area is very nascent, it is a intersection of three fields (reasoning, entrepreneurship and expert literature) and although these fields as standalone areas are very mature, the intersection of these fields are practically unexplored. Theories on reasoning in entrepreneurship started a decade ago (Busenitz and Barney 1997; Baron 1998) and the expert entrepreneurship literature is even more recent. Read, Wiltbank et. al. (2003) were one of the first who combined expert literature with entrepreneurship. Indeed, although there is a need to understand the difference between novice and expert entrepreneurs, there are still significant gaps in this area (Shane and Venkataraman 2000; Ucbasaran, Wright et al. 2003).

With the conceptual model from chapter four, I have created a picture on how the reasoning process of expert entrepreneurs differs and what systematical effect it has on the performance. The empirical part of this research sets out to explore neglected angles, nuances and patterns in this picture to enhance the understanding of the reasoning process of entrepreneurs. It seeks answers to the following two questions: 1) Is the conceptual model consistent with real life? and 2) Is the conceptual model missing something? Shank (2006) notes that this can best be done through qualitative research. Several other scholars also opt for more qualitative methods to explore the complexities of entrepreneurial behavior and reasoning (Ucbasaran, Westhead et al. 2001; Gartner and Birley 2002; Davidsson 2004).

Furthermore, qualitative methodology utilizes a set of methods which can provide

description and theory building while emphasizing the fine-grained process

orientated understanding of complex phenomena (Miles and Huberman 1994).