It’s been nearly a decade since I was involved in the private equity business as a principal.  Since then, my experience with, and research into, real options thinking, product development, and entrepreneurship have taught me a lot about venture capital.  All of these fields provide perspective on the challenge of thriving in an unpredictable world.  In each, iterative experimentation and learning is more important than knowing.

Unfortunately, too many community leaders and economic development professionals cling to the dream of a silver bullet: a foolproof, single-factor, unambiguous solution.

No matter how much lip service is paid to the importance of learning from failure, it is a rare organization that actually carries through on this premise¹.

For many charged with promoting economic development, knowing takes precedence over trying and learning.  Prediction is confused with the exploratory process of planning.  As a consequence, innovation is slowed; missed opportunities accumulate; and economic development is inhibited.

Failures should not be confused with mistakes.  Mistakes refer to the wrong actions that result from poor judgment or inattention; they should be avoided because they produce little new or useful information and are therefore without value.

Unless the distinction between failure and mistake is made and concrete steps are taken to remove the stigma of failure, the future of economic development is likely to look a lot like the past.  Economic development professionals need to be as skilled at entrepreneurship as the businesspeople they support.  Similarly, they need to organize for experimentation in an environment characterized by collaboration and transparency rather than secrecy and centralization.

Lessons from Private Equity

Early in my career, I was proud of what I knew.  Consequently, learning came hard².  For the longest time, my discomfort over my role in a handful of failed investments prohibited me from understanding that success in venture capital isn’t primarily about being right.  A successful venture capitalist must be ambidextrous: he or she must have the ability to make investments in the face of uncertainty and the discipline to avoid putting good money after bad.  The likely outcome of the application of these skills is that most resources end up being invested in those projects that actually work.  In other words, a portfolio succeeds not only because you have at least a couple of investments that yield high rates of return, but also because you have your biggest chunk of money in those deals.  That happy coincidence is usually not because you had the a priori wisdom to place the biggest bets on the ultimate winners; it’s usually because you hedged your bets and stopped putting money into deals that weren’t working.

Being smart means knowing.  Being intelligent means adapting to the opportunities the world presents.

It Ain’t Easy

Venture capital can be a rewarding business—but it certainly isn’t an easy one.  Even within the simplifying context of a ten-year limited partnership structure, it is far from easy to discern between what is working and what is not.

Real-world business settings are complex and constantly changing, which makes it difficult to draw meaningful conclusions from the most careful observations.

The world is a lot messier place for politicians and economic developers.  Furthermore, they often operate within incentive systems that reflect inappropriate timeframes and a bias against failure.

Failure exposes gaps in knowledge and can lead to embarrassment, and the people “responsible” are unlikely to be promoted within traditional incentive systems.  Ask yourself: How often are people rewarded for exposing failure early, thus saving their employer from investing precious resources in opportunities with little promise?

In the political arena, the status quo is often the safest bet.  By design, failures are easy to spot, while opportunity cost—while very real—is hard to spot and quantify.  In addition, the best experimentations yield failure early—when they are the least expensive.  Try to get re-elected every two to six years and see what that does to your tolerance for failure³.  The savvy politician doesn’t usually declare his or her intent to “experiment” with public funds.

In addition, perceived scarcity can also inhibit experimentation.

The quest for efficiency and cost reduction often drives out experimentation and testing until small problems become disasters or missed opportunities become competitive threats.

In a world of zero-based budgeting, it’s no mystery why many might choose to engage in fewer, rather than more, experimental projects.  Nevertheless, in an increasingly dynamic—and unpredictable—world, more experimentation is what is required.

Organizing for Experimentation

Removing the stigma of failure, though, usually requires overcoming ingrained attitudes.  People who fail in experiments are often viewed as incompetent, and that attitude can lead to counterproductive behavior.

In Regional Advantage, AnnaLee Saxenian concluded, “systems built on regional networks are more flexible and…dynamic than those in which experimentation and learning are confined to individual firms.”  In regard to Route 128 around Boston, she asserted, “The region’s technology firms inherited a business model and a social and institutional setting from an earlier industrial era.  When technology remained relatively stable over time, vertical integration and corporate centralization offered needed scale economies…In an age of volatile…markets, however, the horizontal coordination [of] networks enables firms to retain the focus and flexibility needed for continuous innovation.”  As my colleagues Jeff Shuman and Jan Twombly at The Rhythm of Business point out, relationship-focused business requires transparency and conversation.  So, to innovate and adapt, you need to experiment, and experimentation entails failure.  To learn at a competitive rate, you need to be willing to fail publicly.

However, the concepts of economies of scale and centralization are embedded.  It’s little wonder, then, why Neil Takemoto at CoolTown Studios is frustrated, “If only [big cities would] focus on tending one smaller economic garden (i.e., a few entrepreneur/gazelle-oriented city blocks) and growing from there rather than trying to fertilize the whole darn city.”  Economies of scale are predicated upon knowing exactly what needs to be done⁴.  In order to allow for prudent experimentation, Takemoto calls for “investing in skunk works neighborhoods.”

In the past, skunk works had a connotation of secrecy.  The new skunk works, I believe, have to be more transparent.  It’s a concept that my colleagues and I forwarded in a past life, and found it to be a dangerous idea (PDF), which suggests to me that it may be a promising one.

Entrepreneurial Skills Required

Organizing for experimentation is a necessary but insufficient condition.  The people who work within skunk works organizations of all kinds must have the mindset, tools, and skills to effectively engage in iterative learning.  In other words, they have to be skilled at entrepreneurial thinking and decision-making.

Rosalie Cates and her team at Montana Community Development Corporation are a case in point.  MCDC is a not-for-profit entrepreneurial support organization that houses a Small Business Development Center and a new “stretch senior” loan fund.  Cates’ potential as a social entrepreneur are recognized nationally, as reflected in her status as a Hesselbein Fellow.

MCDC’s new product, “The Montana Fund.” addresses a perceived funding gap for growing companies between friends-and-family equity and senior, secured bank debt.  More than a decade ago, the State of Montana attempted to address the same gap with a $10 million venture capital fund that was a big mistake.  (That is, good intentions masked a project that was so flawed in its design that little could be learned from its failure.)  In contrast, The Montana Fund was designed from its inception as a prototype—but one with legs.  It is expected to launch with initial funding of between $1 million and $2 million provided by a collaboration of national and regional banks.  If the Fund succeeds, it could become a model that could be emulated nationally.  If it fails, the cost will be relatively low, and it will represent one step closer to finding a solution.

In addition to organizing for experimentation, MCDC is investing in the entrepreneurial skills of its people, as evidenced by the participation of a four-person team from MCDC in a workshop last week titled Leveraging Relationships to Grow Your Company produced collaboratively by The Rhythm of Business, Greer Black Company, and Small World Networks.

Embracing the concepts of entrepreneurship, collaborative networks, experimentation, and learning is an important first step for economic developers, community leaders, and policy makers.  But, as Peter Drucker says, “Plans are only good intentions until they immediately degenerate into hard work.”  Engaging in organizational innovation and investing in developing one’s entrepreneurial intelligence is very hard work.  Experimentation has a cost, and learning can be painful.  But, systematic experimentation and learning guided by entrepreneurial thinking and decision-making produces superior results.

¹The quotes in this essay are from Experimentation Matters by Stefan Thomke.

²See Teaching Smart People How to Learn by Chris Argyris.

³See Somebodies and Nobodies by Robert Fuller regarding how being a “somebody” can be a very constraining experience.

⁴For more regarding the circumstances that favored centralized control in the past, see Power to the Edge (PDF).