Where Einstein Meets Edison

Exploring the Economic Experiment (II): Hypothesis Testing

Exploring the Economic Experiment (II): Hypothesis Testing

May 11, 2010

Are entrepreneurs scientists of the free market economy, discovering where and how profits can be made? Are entrepreneurs doing the exploration work, running market and technological experiments, while large organizations focus on the exploitation of less risky opportunities?

In the first installment of this two-part series, we explored this idea by proposing that like scientists, entrepreneurs theorize and generate hypotheses to be tested by running the economic experiments of their new ventures. In this second installment, we expand on our initial proposal by discussing how entrepreneurs act like scientists in testing their theories about the market and modifying them in response to market feedback and data.

The Entrepreneur: A Hero or a Scientist?

Entrepreneurs are often described in the media as heroes defying the status quo and taking risks based on a flash of insight, hunch, or gut instinct. In line with this view, we have previously described how having a vision —a theory about the world to be tested— is a crucial success factor for entrepreneurial firms. Still, sticking obstinately to an idea is more often a recipe for failure than one for heroism.

The entrepreneur might better be described as a scientist. Indeed, in entrepreneurship as in science, trial and error is paramount. Entrepreneurs who fail to adapt their theory of the world based on feedback from the market and investors generally fail. The ability to formulate hypotheses based on explicit assumptions, to test them, and to modify them over time is a major source of success. Indeed, the importance of having a flexible approach to entrepreneurial strategy was described well by MIT Sloan Professor Michael Cusumano as “Judo Strategy”1. In science, ideas are often tested in labs by teams with different skills and high levels of education.  Similarly, successful entrepreneurship is more frequently performed by teams with different skills and often with a Master’s level education2. Just as a university environment supports scientific inquiry, an entrepreneurial ecosystem, often centered by a strong university, supports entrepreneurial inquiry3.

Why then should entrepreneurs have a theory –e.g., a strategy– if it is going to change anyway? Noubar Afeyan, founder and CEO of the VC firm Flagship Ventures, recently highlighted in Professor Fiona Murray’s class Managing New Ventures the importance for entrepreneurs of considering their strategies as theories and hypotheses to be tested and modified with data over time. He said, “having a strategy is crucial for entrepreneurs, not because they last – they are generally short-lived – but because they provide focus as well as a standard to detect deviations and try to understand them.”

The practice of Hypothesis Testing

In what ways do entrepreneurs test their hypotheses? Scientists and engineers are well versed in the methods that can be used to test the product and other technical sides of the business.  But how can entrepreneurs test other aspects of venture creation such as the market and customer demand? Mark Pincus, founder of online gaming giant Zynga, noted in a recent speech at Stanford University that his company experiments relentlessly and tests many new ideas before expending significant resources on them. It will even create pages on the site advertising games that do not exist yet and then track the clicks on those links to prioritize development. Pincus says that the biggest mistake that he made in his previous venture was only trying one experiment.

Management academics and practitioners alike have frequently advised aspiring entrepreneurs in the internet and software industries to “release early and often” or to create the “minimum viable product” to get feedback from the market4,5.  As evidence of this, Google is widely known to be extremely data-driven in their management approach and in developing new products, with many beta products being released and then revised based on data from the market. Such a practice is not so surprising when we consider the fact that Larry and Sergey were Ph.D. students when they started Google.

The idea of constantly pulling information from the market is not new, but can perhaps best be described as part of a more comprehensive and systematic conception of the entrepreneurial process as a type of hypothesis generation and testing, rather than viewing it as advice for product development only.  The image of entrepreneurial strategy as a series of explicitly defined hypotheses to be tested and modified can be a powerful tool for the practice of this “economic experiment.”

The Scientist of the Economy

Considering entrepreneurial strategy and hypothesis testing and modification can potentially bring important insights into the practice of entrepreneurship. The development and testing of hypotheses is an important way to deal with very high levels of uncertainty. Clearly-developed hypotheses should be ranked according to importance (if X is false, then the whole venture will fail) and testing in this way will eliminate the largest sources of risk first, while also saving resources and increasing the value of the firm along the way.

Like a good scientist, a good entrepreneur must be passionate about his ideas and committed to demonstrating their veracity, but also open to dropping them or revising his theory if reality does not fit the predictions. In science, a successful experiment can yield fame and the respect of peers.  Entrepreneurship is not so different, except that a successful experiment can also create jobs as well as wealth for the entrepreneur and economic growth for society at large. Clearly, these are experiments to be encouraged: entrepreneurs should be respected as the scientists of the economy.

This is the second part of a 2-part series (Part I).

This article has been written jointly by Charles E. Eesley (MIT Sloan Ph.D.’09) and Michaël BikardCharles E. Eesley is an Assistant Professor at Stanford University. Michaël Bikard is a Founding Editor of the MIT Entrepreneurship Review.


References

  1. Yoffie, David B., and Michael A. Cusumano. 1999. JUDO STRATEGY. Harvard Business Review 77, no. 1 (January): 70-81. doi:Article.
  2. Roberts, Edward B. 1991. Entrepreneurs in High Technology: Evidence from MIT.
  3. Roberts, Edward B. and C.E. Eesley. Entrepreneurial Impact: The Role of MIT. Kauffman Foundation. Available at: http://www.kauffman.org/newsroom/mit-entrepreneurs.aspx
  4. MacCormack, Alan, Roberto Verganti, and Marco Iansiti. 2001. Developing Products on “Internet Time”: The Anatomy of a Flexible Development Process. Management Science 47, no. 1 (January): 133-150. doi:10.2307/2661564.
  5. Cusumano, M. A, and R. W Selby. 1998. Microsoft secrets: how the world’s most powerful software company creates technology, shapes markets, and manages people. Free press.

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