Dealing with the "Unk Unks" - Diagnosing and Managing Unforeseeable Uncertainty to Improve Venture Capital Returns

Any start-up company trying to enter a new market or adopt new technology will encounter what engineers call "unk unks" - the "unknown unknowns" that cannot possibly be foreseen at the outset. How can a company deal with the almost completely unforeseeable? Professor of Technology Management Christoph Loch and co-authors Michael Solt and Elaine Bailey examine the changes in the behaviour of venture capital firms regarding risk analysis in the wake of the dot.com crash, which has made it a vital skill for VCs to nurture portfolio companies through unforeseen crises.

by Christoph Loch, Elaine Bailey,Michael Solt
Last Updated: 23 Jul 2013

Any start-up company trying to enter a new market or adopt new technology will encounter what engineers call "unk unks" - the "unknown unknowns" that cannot possibly be foreseen at the outset, but inevitably emerge during a businesses' development. Unk unks obviously can't be included in a business plan or tackled with conventional risk management methods. How can a company deal with the almost completely unforeseeable?

Professor of Technology Management Christoph Loch and co-authors Michael Solt and Elaine Bailey examine the changes in the behaviour of venture capital (VC) firms regarding risk analysis in the wake of the dot.com crash, which has made it a vital skill for VCs to nurture portfolio companies through unforeseen crises. Traditionally a "high risk/high reward" industry, VCs suddenly preferred to invest in later-stage start-ups with more proven track records in more tested markets. Unfortunately, unk-unk-prone markets and technologies are often the best play for companies looking toward long-term competitive advantage in certain industries. The planning-oriented approach typically chosen by VCs is, in the authors' view, only really suited for medium-risk projects.

The authors demonstrate how, even though unk unks themselves can't be foreseen, their presence can be diagnosed at the point when a VC invests, allowing both the VC and the start-up's management to be sufficiently flexible. In criticising the current, largely reactive approaches of most VCs, they argue that certain procedures that are common in project management should be used.

Most critically, project management distinguishes between unk unks and foreseeable uncertainty. Since unk unks cannot be prepared for with contingency planning, they can best be dealt with, depending on the type of start-up, through either of two managerial approaches. Parallel trials of multiple approaches can be initiated by start-ups with regards to marketing messages or user interfaces, for example. It then becomes a matter of observing what works best. The second approach involves learning and adjusting as a firm progresses, while being constantly willing to adjust or even fundamentally change course if necessary - including keeping target expectations more flexible.

The paper includes the recent history of the software Escend Technologies, which developed pioneering collaboration software to help electronic component manufacturers and consumer electronics manufacturers to cooperate in spite of extreme industry fragmentation and outsourcing. Escend suffered from the fact that the nature of the market, the needs of the customers, and the locus of value appropriation were unclear to all parties. The Startup could not get its business model right and found itself foundering two years ago.

Escend CEO and co-author of this paper Elaine Bailey sought to distinguish parts of the business with foreseeable risks from parts that were affected by unk unks. She used time-proven project management principles in turning around the foreseeable risk problem areas. She "researched" the problems areas in which unk unks loomed as a "learning project", determining the best action as she went along. In the course of the turnaround, the business model was adapted twice. Due to learning and flexibility, Escend has achieved a reversal of fortune and is ready for a final financing round.

INSEAD 2004

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