Embracing Uncertainty. How Heuristics Can Assist Entrepreneurs in their Long-Term Strategic Decision-Making to Enhance Firm Performance


Bachelor Thesis, 2021

22 Pages


Excerpt

Table of Contents

1. Introduction

2. Literature Review
2.1. Strategic decision-making in times of uncertainty
2.2. The role of heuristics in the decision-makingprocess
2.3. Assessment ofprevious literature
2.4. Hypothesis development: the value ofheuristics

3. Methodology and Research Design
3.1. Sample Design and Data Collection
3.2. Variables andMeasurement
3.2.1. Independent Variable: Heuristics
3.2.2. Dependent 'Variable: Firm performance
3.2.3. Control 'Variables
3.3. Reliability Constructs
3.4. Data Analysis

4. Potential Results

5. Discussion
5.1. Theoretical Implications
5.2. Practicallmplications
5.3. Limitations and Future Research

6. Conclusion

7. References

8. Appendix
8.1. Appendix A: Business cases

1. Introduction

A well-known proverb states: “There is nothing certain, but the uncertain.” Given the developments of globalization, the ever-changing environment, and the recent outbreak of the COVID-19 pandemic, uncertainty has become a factor influencing everybody’s decision­making. This is even more relevant in the entrepreneurial setting, as entrepreneurs face a high level of uncertainty on an everyday basis and their strategic decisions of today have major implications for the profitability and sustainability of their business in the future. Consequently, the entrepreneur must find a way to deal with this uncertainty in the most effective way to decide on the most value-adding long-term strategic decision (McMullen & Shepherd, 2006). Despite its negative connotation, uncertainty can also derive positive outcomes. In order to deal with uncertainty, professionals often use heuristics. Entrepreneurs, as they are often generalists, use heuristics even more frequently (Alvarez & Busenitz, 2001). These heuristics help the entrepreneur make faster decisions while having limited information and uncertain outcomes as they make use of previous experiences to derive the next best decision (Wright et al., 2000). Cossette (2014) argues that heuristics are not rational, as they are based on simple strategies and limited or invalid information. However, he also states that this does not mean that heuristics will lead to negative decision-making outcomes. In fact, heuristics enable the entrepreneur to make decisions that help exploit brief windows of opportunities by assessing the situation quickly, thus, leading to first-mover advantages (Busenitz & Barney, 1997).

However, prior research mainly focused on biases and did not investigate the effects of heuristics (Cossette, 2014). In case heuristics were investigated, they were mostly associated with a negative connotation (Artinger et al., 2015). As effects of the usage ofheuristics on firm performance are fairly understudied, this research proposal addresses this research gap by analysing the following research question:

How does the use of heuristics by entrepreneurs in their long-term strategic decision-making influencefirmperformance?

This research proposal suggests a positive relationship between the use of heuristics in decision-making and entrepreneurial firm performance. Consequently, the findings of this study could have important implications for the academic area concerned with heuristics. These findings could also provide meaningful implications for the success and sustainability of entrepreneurial firms that are currently facing substantial challenges. Moreover, this study provides valuable information for entrepreneurial and strategic decision-making, and given the economic importance of entrepreneurial activity, strongly benefits society as a whole.

To answer the research question at hand, this paper is structured as follows. Firstly, the literature review will incorporate existing research on strategic decision-making, heuristics, and the research gap, after which the proposed hypothesis will be derived. Secondly, the methodology and research design will be outlined. This section is followed by a description of how to execute the data analysis of the research model. Afterwards, this paper outlines potential findings and contributions in terms of theoretical and practical implications. Moreover, possible limitations will be examined, and an outlook for future research will be provided. Lastly, a brief conclusion will be given.

2. Literature Review

The literature review firstly examines strategic decision-making and its environment and effects within an entrepreneurial setting. Then it discusses how heuristics can help or hinder the decision-making process. Afterwards, a clear assessment of gaps and limitations in the past literature is provided. Finally, the hypothesis will be developed based on the findings of prior research.

2.1. Strategic decision-making in times ofuncertainty

Good strategic decisions are the basis for the success of every enterprise, and strategy is defined as the outcome of a firm’s decision-making in relation to its external and internal environment (Krabuanrat & Phelps, 1998). Consequently, a firm’s long-term strategic decision-making process is strongly influenced by how well its organisational processes deal with the external environment’s ambiguity (Bingham & Eisenhardt, 2011). However, strategic decision-making is not an easy practice in real life, as strategic decisions generally lack structure and are characterized by complexity and open-endedness (Mintzberg et al., 1976). In addition to the general complexity of strategy decisions, Krabuanrat and Phelps (1998) argue that because of the increasing amount of information, increasing pace of change, increasing variability and options of decisions, and the need for quick decisions in order to adapt to the firm’s environment, it is becoming increasingly difficult to derive appropriate strategic decisions. Enterprises who want to stay in a competitive position need to adapt fast and proactively influence their external and internal environment (Krabuanrat & Phelps, 1998).

Likewise, similar effects on decision-making have been found in the area of entrepreneurship (Makings & Barnard, 2019; Artinger et al., 2015; Busenitz & Barney, 1997). However, in entrepreneurship, the previously discussed effects appear to be more substantial and are accompanied by high uncertainty levels (Artinger et al., 2015). Uncertainty arises from constant changes in technology, people, and markets (Pich et al., 2002). Knight (1921) defines uncertainty as a situation in which the probabilities of certain alternatives’ outcomes are unknown and unknowable. Therefore, classical strategic decision-making models are neither effective nor appropriate to use in this environment (Gigerenzer & Gaissmaier, 2011). A recent paper by Camuffo et al. (2020) states that uncertainty in the entrepreneurial and management domain grows steadily, and it suggests that resolving uncertainty depends on actions. That is consistent with Alvarez and Busenitz (2001) view, who argue that entrepreneurs are generalists who deal with their whole business and therefore need to decide and consequently act fast to secure an excellent strategic position. Generally, long-term strategic decision-making on a firm and an entrepreneurial level are highly influenced by the continually changing environment, the uncertainty which derives from that, and the fast pace and complexity of the decisions (Busenitz & Barney, 1997). Therefore, the decision-making process is extremely demanding and challenging for its actors (Schwenk, 1984). In addition, human cognitive capacities are limited, as described by the concept of ‘bounded rationality’ (Steiner & Miner, 1977). This strongly influences decision-makers’ ability to assess the complex and fast-changing circumstances under which strategy decision-making occurs (Schwenk, 1984). Consequently, to resolve this conflict, decision-makers often use heuristics (Makings & Barnard, 2019).

2.2. The role ofheuristics in the decision-makingprocess

Many definitions ofheuristics exist. Makings & Barnard (2019, p.179) define heuristics as “strategies, that enable the entrepreneur to make a focused decision based on previous experience”. Cossette (2014) states in his review that heuristics entail golden rules of thumb. This paper adopts the following definition: “A heuristic is a strategy that ignores part of the information, with the goal of making decisions more quickly, frugally and/or accurately than more complex methods” (Gigerenzer & Gaissmaier, 2011, p.454). Therefore, heuristics can be seen as simplification strategies, helping decision-makers to reduce cognitive overload and deal with the phenom ofbounded rationality (Krabuanrat & Phelps, 1998).

There are several different types of heuristics, and the following four heuristics are considered highly relevant and common in the decision-making process (Cossette, 2014). Firstly, decision­makers often make use of the representativeness heuristic, which describes that the decision­maker uses a familiar situation based on past experience as a shortcut (Wadeson, 2009). Moreover, decision-makers often employ the availability heuristic, which refers to making judgments about the probability of events based on the facility the decision-maker can recall the necessary information (Cossette, 2014). Lastly, the anchoring and adjustment heuristics prove to be important, which are often explained together as the two heuristics, are closely interlinked (Fay & Montague, 2015). This heuristic describes that the decision-maker anchors his or her decision on an initial value to compare the object at hand and then adjusts from this starting point until the final decision is made (Cossette, 2014). Given their frequent use and relevance demonstrated by previous research, these four basic heuristics will consequently serve as the focal point of this paper. However, it is crucial to consider a clear distinction between heuristics and biases, which are often confused because of their close proximity (Cossette, 2014). Tversky & Kahneman (1974) state in their influential research that heuristics can be useful for decisions, but they can also lead to severe and systematic errors, defined as biases.

There is much debate about the effects ofheuristics in the decision-making process, called the ‘great rationality debate’ (Zhang & Cueto, 2017). On the one hand, studies suggest that heuristics imply errors and are therefore harmful to decision outcomes, as decision-makers overestimated or underestimated probabilities (Tversky & Kahneman, 1974). Proponents of this view argue that heuristics and biases lead to inaccurate estimations of demand and competition (Simon & Houghton, 2002). Moreover, several studies in the entrepreneurial domain conclude that heuristics lead to underestimating risk and decreasing performance (Simon & Houghton, 1999). Generally, literature in entrepreneurship and strategy focuses on the limitations of heuristics and their abilities to assess situations (Ayal & Zakay, 2009). On the other hand, several studies argue for a positive effect of heuristics on many dimensions (Zhang & Cueto, 2017). Gigerenzer and Gaissmaier (2011) report that fast and frugal heuristics are superior to statistical models and lead to higher accuracy while reducing complexity and effort. Likewise, Eisenhardt and Sull (2001) suggest that heuristics enable flexibility while still being coherent in capturing opportunities in areas such as product development. This study is empirically supported by Bingham et al. (2007), who found evidence that heuristics can lead to higher performing organisational processes. Moreover, the use of heuristics is associated with higher levels ofinnovations (Busenitz & Barney, 1997).

Despite the many articles which argue for a positive view, the strategy and entrepreneurship literature largely adopted the negative view and focused on heuristics as a reason for failure in long-term strategic decision-making (Bingham & Eisenhardt, 2011; Zhang & Cueto, 2017). Therefore, the ‘great rationality debate’ remains unsolved. Consequently, this paper sets out to further investigate this relationship and add to this debate.

2.3. Assessment of previous literature

Although several papers argue for different relationships, the effects on the entrepreneurial world remain still unclear. A recent review by Zhang and Cueto (2017) reports that the research on biases in entrepreneurship has increased rapidly. However, only a few papers deal with the topic of heuristics in entrepreneurship. This is supported by Cossette (2014), who argues that little research on the use of heuristics by entrepreneurs has been done. Furthermore, Zhang & Cueto (2017) state that previous research mainly focused on a small number ofbiases, such as the overconfidence bias, which describes that humans perceive a subjective certainty higher than the objective accuracy. Moreover, they call for stronger empirical evidence, as most studies have focused solely on a theorizing strategy. In line with this, Cossette (2014) found that prior studies consist of little empirical work. Furthermore, he provides evidence that the entrepreneurship literature lacks consensus on how heuristics and biases are treated and are significantly distinct in classification and results. Therefore, Cossette (2014) states that prior research only focused on specific heuristics and biases and never examined a combined approach. Moreover, very few previous studies linked the use of heuristics directly to firm performance, which is why direct effects cannot be assessed (Zhang & Cueto, 2017; Cossette, 2014).

2.4. Hypothesis development: the value ofheuristics

The use of heuristics in the entrepreneurial world might yield multiple positive implications for the firm’s success. Krabuanrat & Phelps (1998) state that heuristics, which are embodied in a firm’s organizational routines, might lead to a strong competitive advantage from the resource-based view. Moreover, the use of heuristics provides multiple effects on the decision­making process. Due to simplifications, decisions can be made faster, which allows the firm to react quickly and deal better with the current fast-changing environment (Makings & Barnard, 2019). Therefore, heuristics can increase the chance of successful implementation of a decision (Schwenk, 1984). This is especially important in the entrepreneurial setting as opportunities often arise for a short time. Therefore, heuristics can help entrepreneurs act on them accordingly, as they are not easily overwhelmed by opportunities and can assess them fast (Makings & Barnard, 2019). Furthermore, this can lead to first-mover advantages, which are widely associated with a better strategic positing (Simon & Houghton, 1999). Moreover, Gigerenzer & Gaissmaier (2011) argue decisions based on heuristics often lead to a more accurate decision and therefore enhance the quality of the decisions, as they are not so strongly affected by noise and variance in the data in contrast to statistical models. Therefore, heuristics might be rational to use when making decisions in an environment where high uncertainty, high heterogeneity, and complexity are in place. Consequently, this paper proposes the following hypothesis:

Hl: The use of heuristics in the decision-makingprocess has apositive influence onfirm performance

Taken together prior research, the effect of heuristics in the entrepreneur’s strategic decision­making process on firm performance is not entirely conclusive. One reason for this is little research on heuristics in an entrepreneurial setting. Another reason is the lack of bundling of the different types of heuristics so that heuristics are treated as one distinct variable. Furthermore, prior research shed only limited light on the direct relationship of heuristics on performance. Therefore, it remains an empirical question ifheuristics can positively influence firm performance in the entrepreneurial setting. Consequently, this study sets out to examine this by proposing a research design of explanatory nature, further described in the next section.

3. Methodology and Research Design

As this study investigates the effect of the use of heuristics in the strategic decision-making process on firm performance in the entrepreneurial world, a quantitative research design is suggested. This quantitative research design enables higher objectivity and efficiency in testing the hypothesized relationship than qualitative research (McCusker & Gunaydin, 2015). Therefore, data on entrepreneurs and their use ofheuristics and their firm performance will be collected through a self-administered questionnaire. The data will consequently be prepared and analysed using a linear regression model, examining the hypothesized relationship’s significance and direction. Figure 1 displays the hypothesis graphically and demonstrates the proposed research model.

Abbildung in dieser Leseprobe nicht enthalten

3.1. Sample Design and Data Collection

The proposed research model requires an appropriate and representative sample of entrepreneurs. To achieve a broad selection while remaining in a similar institutional setting, sampling will take place on a European scope. The entrepreneurs will be selected and contacted using the reach of the European Startup Network (ESN), which is a European-wide organisation that unifies different national start-up networks and has access to more than 30,000 entrepreneurial ventures (ESN, 2021). As the founder of the company, entrepreneurs should be targeted as this study aims to assess the extent to which they use heuristics in their decision-making and how it influences firm performance. Hair et al. (2014) suggest that a sample-size to measurement-item ratio is a useful tool for defining a suitable sample size. They propose that an ideal threshold ratio is 10:1. As this study uses eight measurement items, a suitable sample size of at least 80 participants is appropriate. Assuming a 20 % response rate, then at least 400 entrepreneurs should be invited to fill out the survey.

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Details

Title
Embracing Uncertainty. How Heuristics Can Assist Entrepreneurs in their Long-Term Strategic Decision-Making to Enhance Firm Performance
College
Maastricht University
Author
Year
2021
Pages
22
Catalog Number
V1119132
ISBN (eBook)
9783346485113
ISBN (Book)
9783346485120
Language
English
Tags
Uncertainity, Heuristics, entrepreneurship, entrepreneur, long-term decision making, strategic decision making, firm performance
Quote paper
Felix Pütz (Author), 2021, Embracing Uncertainty. How Heuristics Can Assist Entrepreneurs in their Long-Term Strategic Decision-Making to Enhance Firm Performance, Munich, GRIN Verlag, https://www.grin.com/document/1119132

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