Affordable Loss

In the early 70s, Hewlett-Packard engaged SRI International, the premier computing research group, to assess the market for an electronic scientific calculator. After a great deal of market research, SRI concluded that the product wouldn’t “sell” even though the primary alternative was a slide rule. As Peter Sims recounted the story in Little Bets, Bill Hewlett wasn’t so sure about the conclusion.

With $30 billion in sales at that time, HP’s organizational bias only considered opportunities that were going to be billion dollar businesses. Hewlett, however, had recently had a lengthy discussion about the calculators on a plane with a fellow passenger who was amazed by the product. After performing his own casual, informal research, Hewlett suggested that they build a thousand units and “see what happens”. Within five months, HP was selling one thousand units per day. Testing a thousand units was an affordable bet for HP.

Saras Sarasvathy, researcher at the Darden School of Business, University of Virginia, would characterize the approach as an “affordable loss”. She found affordable loss to be one of the operational principles used by expert entrepreneurs to launch a business in the face of the unknown. While a causal approach to a business or product launch would select optimal strategies to maximize returns, the entrepreneurial approach estimates the downside and examines what is an affordable loss to start the venture or launch the new product.

Sarasvathy calls the entrepreneurial approach the “effectual approach” since it begins with the known and moves to the unknown. The causal approach requires estimates of future sales and the risks that impact cost of capital while the effectual approach of the expert entrepreneur requires only that they know their current financial condition and a psychological assessment of their commitment in the face of a worst case scenario, i.e., their affordable loss. In the causal approach, all of the information is about things outside of the decision makers’ control while the effectual approach is about things within the decision makers’ control.

The effectual approach works for the entrepreneur or the new product manager if one is open to adapting the venture to the means-at-hand as opposed to an idea based on analysis of the future. One approach is about predicting the future and one approach is about designing the future. By choosing not to constrain themselves to a pre-conceived market, entrepreneurs and product marketers open themselves to the businesses or markets that will resonate with them, even if those markets do not exist today. Hewlett was able to test the non-existent electronic scientific calculator market by knowing and accepting his affordable loss.