Optimism and Realism: Why Entrepreneurs Need Both

Why entrepreneurs swing between confidence and caution

Whoever starts or takes over a business does something that, soberly considered, is risky. Some young companies give up in the first years, many owners work more than their employees, and their own wealth depends on success. Nevertheless, hundreds of thousands do it every year. Without the expectation that it will turn out well, this would hardly be explicable.

The same expectation can later become a danger. The article thinking errors of entrepreneurs describes how overconfidence leads to bad investments and how it combines with sunk costs into a dangerous pair. This essay therefore asks: How much optimism does an entrepreneur need, and how does he combine it with realism without losing his drive?

To answer it, I first clarify the terms, then look at what studies show about optimistic entrepreneurs, and weigh two readings. After that, I present mental contrasting, a thinking model that combines both in one exercise, and apply it to typical decisions in a business.

Optimism, realism, overconfidence: the terms

Psychology understands dispositional optimism as the stable tendency to expect good outcomes. Hmieleski and Baron (2009) emphasize the delicate part in their definition: the tendency to expect good things even when the expectation is not rationally justified. Optimism is thus an attitude toward the future, not an assessment of a specific situation.

Realism here means the willingness to see a situation as the available evidence shows it, even if the picture is unpleasant. Realism is not the same as pessimism. A pessimist expects the bad; a realist checks what is to be expected.

This is to be distinguished from overconfidence, which the article thinking errors of entrepreneurs describes: one's own abilities and chances are rated higher than those of others or than the numbers suggest. Optimism concerns the world, overconfidence one's own person. Both often occur together. A related form is the planning fallacy, described by Kahneman and Tversky (1979): people underestimate the duration of an undertaking even though similar undertakings took longer in the past.

What studies show about optimistic entrepreneurs

That entrepreneurs are more optimistic than others is well documented. Puri and Robinson (2007) measured optimism in an unusual way: in a large American household survey, they compared self-estimated life expectancy with the statistical one. By this measure, the self-employed were more optimistic than employees. More optimistic people worked more and planned to retire later. The most revealing finding concerns the degree: moderate optimists behaved sensibly in financial matters, while extreme optimists showed habits that are generally not considered prudent.

How far optimism reaches at founding is shown by the study of Cooper, Woo, and Dunkelberg (1988), which the article on thinking errors presents in detail. Of 2,994 entrepreneurs surveyed, 81 percent put their chance of success at seven out of ten or better, 33 percent at ten out of ten.

What this means for success is disputed. Hmieleski and Baron (2009) found a negative relationship between optimism and the growth of revenue and employment among American founders. The conditions are remarkable: the negative relationship was stronger for founders with prior founding experience and in industries that change quickly. Experience thus did not protect; it amplified the problem, presumably because experienced optimists are even surer of themselves.

Other studies reach other results. Chen, Liao, Redd, and colleagues (2013) surveyed 146 entrepreneurs in Laos and found a positive relationship between optimism and the success of their young businesses, depending on education and the motive for founding. A study of 142 Chinese entrepreneurs points to one pathway: optimists built larger networks, and these networks were related to success (Chen et al. 2017). Research is therefore not in agreement. That in itself is a finding.

Two readings: drive or risk?

The first reading sees optimism as a drive. Whoever expects good things gets started, sticks with it when it gets difficult, and makes contacts because he expects something from them. A business in crisis needs someone who believes it will go on. The article entrepreneurial resilience shows that businesses survive crises above all when they not only preserve but also try new things. That requires confidence.

The second reading sees optimism as a risk. Whoever expects good things plans too tightly, counts on too much revenue and too few costs, and holds on to undertakings for too long. The findings of Hmieleski and Baron and of Puri and Robinson show that a strong degree of optimism goes along with worse results and incautious decisions.

I consider both readings correct, because they speak about different tasks. Optimism helps in acting: getting started, persevering, approaching people. Realism helps in planning: money, time, capacity. It becomes dangerous when the optimism needed for acting migrates into planning. Then confidence turns into a cash flow plan without a buffer. The obvious solution, simply being less optimistic, does not hold, because attitudes can hardly be switched off. A method that uses both one after the other is more viable.

Confidence belongs in the decision, not in the cash flow plan.

The thinking model: mental contrasting according to Oettingen

The psychologist Gabriele Oettingen has studied how thoughts about the future affect action. She distinguishes two kinds: expectations, which rest on experience and estimate the probability of success, and fantasies, mere images of a desired future (Oettingen and Mayer 2002). In her studies, positive expectations went along with more effort and success, positive fantasies with less. Whoever merely pictures the goal already feels a little as if he has arrived and makes less effort.

From this, mental contrasting emerged: you first picture the desired outcome and then contrast it with the most important obstacle in the present. Supplemented by an if-then plan, a so-called implementation intention, it becomes a four-step exercise known in English by the acronym WOOP.

1. Wish

   What do you want to achieve within a manageable period? For example: open a second location next year.

2. Outcome

   What would be the best thing about it? The image may be concrete and pleasant. This is where optimism has its place.

3. Obstacle

   What in you or in your business is most likely to stand in the way? Not the market in general, but the one obstacle you can influence.

4. Plan

   If the obstacle occurs, then what do you do? One sentence with a trigger and an action.

The effect is well studied, though not among entrepreneurs. Wang, Wang, and Gai (2021) analyzed 21 studies with a total of 15,907 participants. The exercise helped in reaching goals, with a small to medium effect. It was stronger when the exercise was carried out in conversation with another person, and weaker when participants only filled in a form.

An everyday analogy shows the logic. Whoever plans a mountain hike needs the anticipation of the summit, or he will not set off. But he also needs to look at the weather forecast and ask when he will turn back. Mental contrasting is that look, after the decision to set off has been made.

Where in the business which attitude should lead

Applying the weighing to everyday work, one can say for typical tasks which attitude should lead. The overview is an assessment based on the findings, not a measurement.

For planning, the essay realistic growth targets recommends planning from the bottom up: from capacity, close rate, and pipeline instead of a wished-for revenue figure. For schedules, planning projects in small teams describes how comparison with earlier undertakings dampens the planning fallacy. Both tools are applied realism, and neither takes the owner's confidence away.

What you can do this week

The exercise needs no preparation. According to the findings of Wang and colleagues, it matters not to fill it in alone but to go through it with another person.

• Choose an undertaking that matters to you right now and write down the four steps: wish, outcome, obstacle, plan.
• Discuss the obstacle and plan with someone who is allowed to contradict you, such as an employee or another owner.
• Check your current planning: where is a wished-for value, where a value from past experience?
• Decide in advance for the undertaking how you will know that you should abandon it.

Whoever wants to make decisions under uncertainty better in general will find further tools in the essay deciding under uncertainty.

Conclusion: How much optimism does an entrepreneur need?

We set out to ask
much optimism an entrepreneur needs and how he combines it with realism. The findings speak for a moderate degree: the self-employed are more optimistic than employees, and moderate optimists decide sensibly, while strong optimism goes along with weaker growth and incautious decisions. Whether optimism helps or harms depends less on its strength than on where it takes effect.

Mental contrasting offers an answer that sacrifices neither attitude. Optimism may picture the goal, realism names the obstacle, and the plan connects the two. An entrepreneur needs both, but not at the same time: confidence for the decision and for hard times, sobriety for money and the calendar.