The Effectuation Theory is relatively a new method thinking and decision making in the field of entrepreneurship developed by Saras Sarasvathy, a cognitive scientist and a University of Virginia Darden professor.
Traditionally, entrepreneurs have been assumed to be “causal t thinkers”. In other words, when starting a business, it is assumed that the future can be predicted and the entrepreneur would make plans to achieve the predetermined goal. This is causal t thinking because it is based on predetermined events. Entrepreneurship is not like that as the future is uncertain and unpredictable.
Professor Sarasvathy undertook a study of 27 expert entrepreneurs; founders of companies form $200 million to $6.5 billion in the US in 1997. Entrepreneurs are known for constantly making decisions and taking action, but how do they do it? The purpose of his study was to find out what makes “entrepreneurs entrepreneurial”. In other words, are there any methods that they use that could be identified? His study showed that entrepreneurs exhibit a peculiar rationality that makes them entrepreneurial. This rationality is what Professor Sarasvathy calls “effectual reasoning”.
Professor Sarasvathy defines effectuation as a form of thinking or problem – solving which assumes that the future is mainly unpredictable but can be controlled through human action. This unique logic of thinking serves entrepreneur well in starting a business and enables the future which by nature is unpredictable to be controlled.
What Is Effectuation
According to Professor Sarasvathy, effectuation is “a logic of thinking that uniquely serves entrepreneurs in starting businesses and provides a way to control a future that is inherently unpredictable”. It is what entrepreneur needs to start a business and after this they shift to causal reasoning, just like the First and Second Gears are needed to start a car before shifting to other gears.
Effectuation does the following:
- Ideas – It advances ideas towards a sellable product and services with proven customers.
- Stakeholder commitments – The entrepreneur uses effectuation to search, interact and select partners to co-create the venture with.
- Decisions – Experts entrepreneurs adopt a set of techniques that serve as the foundation for making decisions about what to do next.
| What effectuation is | What effectuaion is not |
| A thinking framework | A system to tell you what to do |
| A set of heuristics | An algorithm |
| Doing the do-able | “Not planning” |
| How to get the sellable products and services established | A way to launch an entire business |
According to Professor Sarasvathy, “effectual” is the reverse of causal. Casual or predictive reasoning or rationality involves having a pre-determined goal and using the resources available to find the most efficient way to achieve that goal. This is usually what managers do and what is taught in MBA around the world. For example, make or buy decision, hiring the best person in recruitment, choosing a target market with the highest potential.
A variation of causal think is where alternatives are developed in order to choose the best alternative.
Effectual reasoning is different as it does not start with a specific goal in mind. It begins with a set of means and goals only emerge over time through the of interactions of the founders with the stakeholders. For example, effectual thinkers are like explorers who set out on voyages to unknown places.
Professor Sarasvathy points out that the same person may use both effectual and causal thinking at different times depending on the circumstances and the best entrepreneurs are capable of using both modes well. However, entrepreneurs use effectual reasoning more, especially in the early stages of a start-up and most of the do not transition.
The Process Of Effectuation
According to Professor Sarasvathy, entrepreneur begin with the following categories of means:
- Who they are – their traits, tastes and abilities
- What they know – their education, training, expertise and experience
- Whom they know – their social and professional network.
Often, in most cases entrepreneurs would use these means to come up with ideas, begin to imagine and implement what could be created with them. Mostly, they often start very small with what that have got without elaborate planning.
In other words, effectuation principle holds the view that contrary to casual reasoning that takes that view that you have to make a plan first and the execution comes second, effectual reasoning depends on execution. As already stated above, the reason is that that most entrepreneurs use what they have got to start with. Plans are not static and many people with experience with start-ups will agree that business plans are changeable and sometimes do not reflect the realities of starting a business. I have heard many instances where business founders have said that they never used the business plan because the realities on ground was entirely different form predictions to the extent that the plan became irrelevant.
The Principles Of Effectuation
As already mentioned above, effectuation theory of entrepreneurship is based on what entrepreneurs actually do. They have learned that the world is unknown or unknowable and therefore cannot be predicted. Rather they use techniques that enables them to shape the future instead of using prediction. These techniques are the principles of effectuation
Bird in Hand – Start with Your Means
When expert entrepreneurs embark on a new venture, they start with what they have got (means) i.e. who I am, what I know and whom I know. The entrepreneur will then imagine possibilities that originate from the means. This can be contrasted with causal reason which we have been taught that first you set goals and then organise the means.
Affordable Loss Principle – Set affordable loss
Entrepreneurs usually pursue unknown markets where analysis cannot be made. They focus on analyzing the down-side of their actions to manage their risk, which can often be accurately calculated as they understand what they can afford to lose at each step. They chose goals where there is upside even though the downside ends up happening.
By contrast, causal thinking first focuses on the return and then tries to minimize risk.
Lemonade Principle – Leverage contingencies
The Lemonade principle takes the view that entrepreneurs should be flexible and see surprises or bad news as potential clues to exploit new markets. Basically what this principle says is that entrepreneurs have to be open to change and be prepared to go in a different direction.
Causal reasoning does the opposite by doing everything to minimize surprises or bad news.
Patchwork Quilt – Form partnerships
Expert entrepreneurs build partnerships with self-selecting stakeholders. By obtaining per-commitments from these key partners early on in the venture, they reduce uncertainty and co-create the new market with its interested participants.
By contrast the causal approach is to do a competitive analysis where competitors are regarded as rivals to contend with
Pilot-in-the-plane – Control v. Predict
By focusing on activities within their control, expert entrepreneurs know their actions will result in the desired outcomes. An effectual worldview is rooted in the belief that the future is neither found nor predicted, but rather made.
Causal reasoning accepts that established market forces will cause the future unfold.
The Cycle of Effectuation
Effectual thinking happens in the mind of an individual when thinking of making a decision without any predictive control. The cycle is a representation of a thinking process used in creating products, markets and ventures. It is not a prescriptive technique (e.g. do this or do that), but a heuristics that is uniquely and universally applicable to the types of challenges that entrepreneurs face.
The process starts with the evaluation of the entrepreneur’s means or resources and from there, the goal is determined. The goal chosen fall within the affordable loss. Then the entrepreneur would search and interact with stakeholders to enlist their commitment to become co-creators of the venture. In this way, the effectual entrepreneur grows closer to an idea of a defined, sell-able product complete with committed customers and stakeholders comprising the new market.
As can be seen from above, effectuation is a very pragmatic and relevant theory of entrepreneurship as it’s focus is how entrepreneurs think and what they do. It supports the lean startup methodology and further debunks the traditional method of starting a business where plans have to be gathered first even before having a customer.