Decision-making under uncertainty: the business owner’s job

In this Italian-language video, shot in New York, I say that deciding under uncertainty is the job of the people who run a company, not a limitation. Here I explain why, using the distinction between risk and uncertainty that the economist Frank Knight proposed in 1921, and what it means for the confidence of the person who decides.

Video transcript (translated from Italian)

A talented young business owner I work with told me something I have been thinking about for days: “In my world, there is no room for mistakes.” He was not talking about perfectionism. He was talking about something deeper. Anyone who finds themselves running a company today, whether they inherited it or are building it from scratch, is working in a context that is not what it was 20 years ago. Markets move faster, competition is global, margins are tighter. The previous generation built important things, and it did so with tools and time frames that no longer exist. Those arriving now start on different ground. Not easier, not harder. Different.

What I observe, working with business owners young and not so young, is that the real difference is not between those who are afraid and those who are not. Everyone is afraid, at any age. The difference lies in the ability not to be paralyzed by that fear. And this is where something comes in that is not taught in business schools: the courage to decide knowing that you will never have all the information. Frank Knight, an economist I consider essential, distinguished between risk and uncertainty. Risk can be measured. Uncertainty cannot. And the business owner, by definition, lives in uncertainty. It is not a personal limitation. It is the very nature of what they do.

A serious business strategist does not sell certainties. They cannot. Nobody can. What they can offer is something different: staying inside the complexity together with the business owner.

Building a method, a reading of the context, a way of reasoning that holds even when the ground shifts. The work is not to eliminate uncertainty. It is to make sure that it is no longer an enemy, but becomes the ground you build on.

Someone looking for a business strategist is not looking for someone to decide for them. They are looking for someone to help them trust their own decisions. And perhaps this is the greatest contribution, the most important thing this profession can offer.

Deciding under uncertainty is the job of running a company

Nobody decides with all the information in hand. People who run a company know this without needing any theory: the customer who has not yet chosen, the competitor who has not yet moved, the regulation that has been announced but not yet drafted. In the video I say that everyone is afraid, at any age, and that what makes the difference between people is the ability not to be frozen by fear.

Risk can be measured, uncertainty cannot: deciding without having all the information is the job of the people who run a company, not a limitation.

Whoever comes to run a company today, inherited or built from scratch, starts on ground that differs from the previous generation’s, neither easier nor harder. The underlying condition is as old as business itself. In 1921 the American economist Frank H. Knight described it like this: “It is a world of change in which we live, and a world of uncertainty.” Life depends on knowing something about the future, he went on, and our problems come from knowing so little of it: whoever acts almost always does so with partial knowledge. Every business strategy is decided inside that condition.

Risk can be insured, uncertainty stays with the person who decides

When he published Risk, Uncertainty and Profit (in Italian, Rischio, incertezza e profitto, La Nuova Italia, 1960), Knight was teaching at the State University of Iowa. His question was an economist’s: why companies go on making profits and losses if competition tends to even out earnings.

Knight calls risk the uncertainty that can be measured. This happens when a situation belongs to a group of similar cases whose distribution of outcomes is known, by calculation or from statistics. Nobody knows whether a particular building will catch fire, but across many buildings the loss becomes predictable, and insurance turns it into a fixed cost. Uncertainty is everything else: situations that are “in a high degree unique,” for which that group of cases cannot be formed.

Knight’s example is a manufacturer weighing a large expansion of his plant. He does the sums on what can be measured and in the end arrives at an “estimate,” but there are not enough cases like his to say how likely it is that the estimate is wrong. Faced with a single decision, Knight admits, the distinction makes no difference to how one behaves, because the person who decides forms an idea of the probabilities anyway; the difference lies in what can be passed on to others.

In 1921 Frank Knight used risk for the uncertainty that can be measured, because it concerns many similar cases and can therefore be insured, and uncertainty for the kind found in unique situations, which nobody can insure and which stays with the person who decides.

For Knight, it is precisely the uncertainty that cannot be insured that gives economic life the form of the business firm and explains the income of the person who runs one: where it exists, “the primary problem or function is deciding what to do and how to do it.” And since men differ in their confidence in themselves, the more confident come to “insure” the more timid, guaranteeing them a fixed income and keeping the result for themselves, whatever it turns out to be.

Tools produce the estimate, the person accountable signs the decision

The courage to decide knowing that you will never have all the information, as I say in the video, “is not taught in business schools.” The tools for deciding, on the other hand, are taught, and have been for a long time: Howard Raiffa, who arrived at Harvard in 1957, presented almost every problem of choice to his students as a decision tree (Decision Analysis, 1968). They are serious tools, and like the sums of Knight’s manufacturer they end in an estimate. Signing it remains the task of the person who decides, and this is the part that takes courage.

The same goes for data. On the part that can be measured they reduce risk, sometimes by a great deal, and it is right for the work to start there, as I write in the piece on international expansion. On the uncertainty that remains they help you see the case more clearly, without making it similar to other cases.

Knight adds an observation that anyone in my line of work must keep in mind: bearing uncertainty and having responsible control of the business, he writes, are “inseparable.” That is why the strategist helps the owners and the board decide and does not decide for them, as I explain to those who ask what the difference is between a business strategist, a manager and a coach. What the strategist brings is a way of reasoning that holds when the ground shifts: a reading of the context, criteria written with the owners, a shared structure for choosing, what in the language of the trade is called a strategic framework.

The right kind of confidence concerns how you decide, not the outcome

Someone looking for a business strategist is looking for someone to help them trust their own decisions. Knight gives confidence of this kind more weight than one might think. What we do after forming an opinion, he writes, depends as much on our confidence in that opinion as on what the opinion promises. This means, for example, that two business owners with the same estimate can take opposite paths if one believes in it and the other does not.

Confidence can also be excessive. Knight was convinced that businesses, taken as a whole, end up losing money. He admitted that the statistics were inconclusive, but the psychology seemed clear to him: most men have an unreasonable confidence in their own good luck, and even more so when they are betting on themselves. And there is a subtler limit, which concerns judgment after the fact.

In a single case, Knight observed, there is no way to tell good judgment from good luck: confidence in your own decisions is built on how you decide, not on the outcome.

In practice, this means writing down beforehand, with the owners, the reasons for a choice and the criteria by which it is made. Once the result is known, you reread them and ask whether the decision was a good one given what was known at the time. This is part of the work on direction and priorities. It also helps you look at a mistake without treating it as a fault, and at a success without taking it as proof of skill.

Those who choose to face uncertainty with someone at their side, instead of waiting for a certainty that will not come, fully accept the hardest part of their job. I have great respect for those who make this choice, because they ask for support precisely at the point where the decision remains theirs.

What to do and what not to do

• Before an important decision, separate the part that can be measured from the part that remains uncertain.
• Write down the reasons and criteria for a choice before making it, and reread them once the result is known.
• Use data and tools to reduce risk, knowing that the final estimate is signed by the person who answers for it.
• Do not judge a decision by its outcome alone.
• Do not ask a strategist to decide in place of the owners.

Sources

• Frank H. Knight, Risk, Uncertainty and Profit, Houghton Mifflin, The Riverside Press, Boston and New York, 1921, Part III, chapters VII–XII; Italian edition: Rischio, incertezza e profitto, preface by Tullio Bagiotti, translated by M. Giorda, La Nuova Italia, Florence, 1960. English text in the Econlib edition (Liberty Fund): https://www.econlib.org/library/Knight/knRUP.html
• Howard Raiffa, Decision Analysis: Introductory Lectures on Choices under Uncertainty, Addison-Wesley, Reading, Massachusetts, 1968.
• INFORMS, “Howard Raiffa,” biographical profile. https://www.informs.org/Explore/History-of-O.R.-Excellence/Biographical-Profiles/Raiffa-Howard