Knightian Uncertainty, Entrepreneurship, and Golf

Entrepreneurship Means Managing Risk and Overcoming Uncertainty

There are many amusing stories around us that compare business management to golf. But while golf and the world of entrepreneurs do share some similarities, they also differ in many ways. First, in golf, there is rough agreement on what constitutes the exemplary “textbook swing.” Most golfers have probably had the experience at least once or twice of being shocked after watching a video of their own swing. Many golfers—not just this writer—have thought they were swinging like a PGA pro, only to be stunned by how ridiculous they looked on video.

Such self-awareness is possible because there is a benchmark for the ideal golf swing. Of course, there are slightly different theories about golf swings, and even among PGA players there are some with unusual backswings. Still, most golfers would agree that there is at least a general consensus on the downswing motion needed to make solid contact before impact.

By contrast, it is hard to say that there is any model answer or textbook method for managing a business. There are many ways to make solid contact. Compared with the more standardized world of golf, the business environment changes far more rapidly, and accordingly the path to success differs from one case to another. Where does this difference come from? It is likely because golf contains more elements of risk, while business activity contains relatively more elements of uncertainty. The words “risk” and “uncertainty” are often used similarly in everyday language, but there is a difference between them.

The first person to clearly distinguish the two was Professor Frank Knight, a leading figure of the Chicago school of economics. In his book Risk, Uncertainty, and Profit (1921), he defined a situation as “risk” if a firm can identify the relevant variables and calculate the probabilities involved. By contrast, he defined “uncertainty” as a situation in which there is no information at all, the relevant variables cannot even be identified, and probability calculation is impossible—leaving one completely in the dark.

Professor Knight argued that in the case of risk, people created the institution of insurance and effectively converted risk into a fixed cost, whereas uncertainty cannot be dealt with in that way. Thus, gambling or lotteries fall under “risk” because probabilities can be calculated, while a decision to acquire a company one knows little about, or a decision to marry someone one has known for only a week, belongs to the realm of “uncertainty,” where calculation by probability is difficult. Put simply, uncertainty that can be expressed in probabilistic terms is risk, while the rest belongs to the domain of Knightian uncertainty.

By this standard, golf contains more elements of risk than uncertainty, while the world of business contains more elements of uncertainty. In golf, the key variables golfers worry about include OB, hazards, and bunkers, and because they have some knowledge of their own past data, they can think in terms of rough probabilities. For example, a weekend golfer may know from experience that when swinging a driver from the first-hole tee box, there is about a 20% chance of mishitting the ball and sending it OB or into a hazard.

But what about a sudden situation such as rain unexpectedly stopping play—is that not in the realm of uncertainty? Even weather, however, can now be understood probabilistically through forecasts. The odds of an amateur making a hole-in-one are said to be 1 in 12,000. A hole-in-one is obviously a good thing, so one might think it is not a risk, but depending on one’s personality, even a hole-in-one may be regarded as a risk (the existence of insurance against hole-in-one risk proves the point).

The reason countless weekend golfers are still sweating it out at local practice ranges even now is that they want to produce consistent shots that do not break down under any circumstances, thereby avoiding risks such as hazards, OB, and bunkers. In other words, they aim to reduce the risks of golf and increase predictability by mastering a perfect form like that of a professional. The reason golf swings tend to converge toward a model professional swing is precisely because doing so reduces risk.

But while an entrepreneur’s business certainly contains elements of risk, it contains even more uncertainty. Professor Knight described entrepreneurs as “uncertainty bearers.” In particular, entrepreneurship—developing a new product that no one has ever made before or entering a new line of business—is an area with very high uncertainty, where the probability of success is unknowable. Knight argued that in a business environment marked by high uncertainty, entrepreneurs pursue success not through calculated probabilities but through subjective judgment. And when that succeeds, the resulting profit is defined as the reward for bearing uncertainty.

This suggests that there is no standard model answer or “perfect form” in business management. The environment facing each company is different. Even competing firms in the same industry producing the same product category face subjectively different situations. Accordingly, their management styles in response must also vary. Sociologists, of course, argue that when organizational environments are uncertain, an isomorphism strategy of imitating other organizations emerges. But from the standpoint of managers, such imitation is not a solution for securing a competitive advantage; it merely enables a firm to achieve competitive parity, a level similar to that of other companies. By contrast, it is already common wisdom that the entrepreneurial spirit needed to break through uncertainty above all requires creativity and innovation that others do not have.

Of course, companies also engage in risk management just as golfers do. Detailed risk management is usually handled by professional managers, though some founders and entrepreneurs may also be risk-management-oriented types. But to stress the point again, there is no special royal road to business success. One may succeed with the kind of hard-charging style associated with Chung Ju-yung, or one may succeed through micro-management that carefully calculates and attends to every risk. What matters is that “entrepreneurship” means the managerial will to overcome uncertainty in innovative and differentiated ways, not by doing things the same way as everyone else.

There are many reasons businesspeople like golf. Businesspeople who wrestle with uncertainty every day may find a more comfortable sense of achievement in playing golf, as they overcome relatively manageable risks. But if one takes on the challenge of the exemplary golf swing while pursuing some uniquely differentiated and innovative swing style of one’s own, that “entrepreneurial spirit” may not help one’s golf score in the long run. Though not an entrepreneur myself, as someone who teaches entrepreneurship and innovation strategy at a university, I belong to that category as well.

Woonghee Lee, Professor, Hanyang University Business School

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Original title: 나이트의 불확실성(Knightian Uncertainty), 기업가정신, 그리고 골프

Author: Ung-hui Lee

Date: 2023-09-26

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=26044