Rules of thumb play an important role in effective strategy
Pressure is a way of life in many companies – especially high-tech, young and entrepreneurial firms that often make decisions in complex, dynamic environments with limited time and information.
Intriguingly, some companies thrive in such situations. Christopher Bingham, strategy and entrepreneurship professor, looked at their strategy for success, and found that companies that do well frequently rely on heuristics – simple rules of thumb.
“A counter-intuitive insight is that when environments get very complex,” Bingham said, “the best strategies are often the most simple.”
Strategies that succeeded in dynamic environments relied on “simple rule” heuristics for action, which delineated which opportunities to pursue (selection heuristics), how to execute opportunities (procedural heuristics) or how to move from one opportunity to another (timing and priority heuristics).
Bingham’s finding contrasts with other research suggesting that executives use lengthy manuals to spell out strategic growth processes such as acquisitions, product development, internationalization or alliances.
But manuals aren’t much help when executives need to learn from a series of heterogeneous experiences, such as varied acquisition targets, alliance partners or new products or countries. Each experience is different and occurs with different people at different times for different reasons. Executives must learn from these experiences to benefit from efficiency, but also be flexible to adapt to what is unique.
Bingham likens learning from heterogeneous experience to parents who over-generalize lessons from their first child. They come to understand that even though what worked with the first child doesn’t necessarily work with the second, there are still guiding principles that carry from one child to the next.
“As an executive, you’re trying to figure out which guidelines are generalizable across a lot of dissimilar experiences,” Bingham said. “As you start accumulating more and more acquisition, alliance or country entry experiences, you have to pare back structure to focus on the few things that are generalizable. You end up with a core set of simple rules that work across a lot of these varied experiences.”
Bingham wrote “Rational Heuristics: What Firms Explicitly Learn From Their Process Experiences” with Kathleen Eisenhardt of Stanford University. Slated for publication in the Strategic Management Journal in 2011, the paper already has won several prestigious awards.
They used a novel method to measure what tech-based entrepreneurial firms from Singapore, the United States and Finland learned as they entered new countries shortly after they were founded. Firms learn portfolios of heuristics that have a common structure and are readily understood by firm members operating in different parts of the world, Bingham observed. Firm members translate their process experience into specific types of heuristics that relate to opportunity capture. For example, one firm adopted the heuristic of “enter English-speaking markets first.”
“This heuristic put boundaries on which countries to enter and which not to enter,” Bingham said. “But there’s a lot of latitude – they can enter the U.K., Australia or Canada – and there’s flexibility to adapt within that structure.”
Bingham found that firms learn these opportunity capture heuristics in a specific developmental order.
- Firms start with less cognitively sophisticated heuristics that address single opportunities, such as which entry mode or sales approach to use.
- They add more cognitively sophisticated heuristics, such as how to move from one opportunity to another. Learning about relationships among multiple moves requires greater expertise, where as learning about time often begins later because individuals frequently develop temporal understanding by building on prior, non-temporal understanding.
- Finally, firms begin with a few heuristics, introduce more and then eliminate some over time.
Bingham interviewed the executives of these high-growth firms, and walked them through their growth experiences of what they did first, and next, and how they moved from their first sale to their second. Many executives said that the process of thinking about what they’d learned, recognizing patterns and understanding how they were constructed was helpful. “In entrepreneurial firms,” Bingham said, “there’s little time for reflection and post hoc analysis of decisions.”
Bingham also found that executives in successful firms often raise the abstraction of key heuristics over time. (This finding also contrasts with other work that suggests that mental models for action become more specific over time.) The logic is that as leaders experience a flow of heterogeneous opportunities within dynamic environments, abstract thinking helps them to create a unified understanding of seemingly diverse experiences. This enables some degree of efficiency while also preserving significant flexibility such that the firm can take advantage of unexpected events “on the fly.”
For example, leaders of a fast-growing Finnish entrepreneurial firm used heuristics to guide their internationalization process. For their U.S. entry, they used the heuristic: “Hire strong locals based on online resources.” It was highly effective in a previous country entry, but proved ineffective in the United States so they raised its abstraction to continue to emphasize local hiring but not specify the source of those hires. They changed their heuristic from the more concrete (“Hire strong locals based on online resources”) to the more abstract (“Hire strong locals”). The new heuristic focused attention on the overarching similarity of hiring well-qualified locals across countries (efficiency) as it allowed greater autonomy for adjusting hiring specifics according to unique circumstances in each country (flexibility). Therefore, the team turned to their seasoned board of directors to find strong local hires in the United States, but relied on headhunters (not online resources, not board of directors) to do the same in Germany.
Bingham’s research is important because it contradicts the psychology literature on heuristics, which posits that heuristics are biased and lead to non-optimal solutions. He argues that psychologists reached this conclusion by testing people in lab settings and asked binary choice questions that have a definitive correct answer, such as: Which German city has the higher population, Munich or Dusseldorf? Psychologists say that people often base their answer on the city that is most familiar to them, creating a heuristic of answering what first comes to mind, which might not lead to the correct answer.
“Yet in real life, strategists rarely face such clear-cut situations,” Bingham said. Lab studies often stack the deck against heuristics by putting people in unrealistic situations. But by viewing heuristics in the context of the unpredictable environments in which firms compete, Bingham argued that heuristics can be rational and even optimal strategy.
Heuristics provide some structure and take advantage of the limited information people do have. And within that structure, people have room to adjust rather than be hampered by rigidity. People can still process the nuances of situations.
The more fundamental implication, Bingham said, is the existence of multiple kinds of strategic rationality. “Comprehensive logical analysis with extensive information might be the rational approach for decisions when there is high homogeneity in experiences,” he said, “but heuristics might be the rational approach for decisions when there is high heterogeneity in experiences – attributes of most strategic decisions.”
- In complex environments, the best strategies are often the most simple.
- Firms engage in simplification cycling. They begin with a few heuristics, elaborate their heuristics, then pare back their heuristics in later experience. The result is a small, useful, robust heuristic portfolio.
- Firms increase the level of abstraction in key heuristics; creating coherence across an increasingly diverse set of experiences.
Christopher B. Bingham is professor of strategy and entrepreneurship at UNC Kenan-Flagler.