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  • Effectuation: How Entrepreneurship Really Works

    Are entrepreneurs born risk-takers? Is there something about their personalities that predisposes them to take risks that others can’t stomach? Can entrepreneurship be taught?

    According to entrepreneurship researcher Saras Sarasvathy, entrepreneurs aren’t different from anyone else; they simply adopt a different approach to problem solving.

    Dr. Sarasvathy suggests that entrepreneurs actually create their own odds of success by taking incremental steps that move them closer to their goals. After being an entrepreneur for over 25 years and studying the behavior of many others, I think she’s right. She calls this incremental approach “effectuation” because it takes advantage of the compounding effects that the entrepreneur causes by their own actions.

    Here are 6 key points to understand about Dr. Sarasvathy’s theory of effectuation:

    1. Entrepreneurs start with what they have and who they are. What do you know a lot about? What early or deeply personal experiences have affected you? What connections do you have? Leverage these assets to do something and then see what comes of it. This first step leads to additional opportunity, and sometimes these opportunities are very big and unpredictable. Action attracts others, and those others enhance opportunity and the odds of success.

    2. Entrepreneurs limit risk by understanding what they can afford to lose at each step. True entrepreneurs never take very much risk at once. Typically the calculation goes something like this, “I think it would be worth investing $50,000 in exploring this opportunity. If I lose it, I can survive. What’s the worst that can happen?” There are two likely outcomes of that reasoning: either the experiment is successful, in which case the investment is rewarded and leads to other follow-on opportunities, or the experiment is not successful, which most likely also will lead to other follow-on opportunities. Either way, new opportunities typically emerge because action attracts others.

    3. Entrepreneurs create their own market opportunity. When Burt Rutan set out to build Spaceship One, it was not because he perceived that there was a  big market for expensive one-off spacecraft that was going unmet. He started with what he knew how to do and an affordable risk. When Pierre Omidyar started Ebay, he didn’t anticipate it would become a multibillion dollar company. Google’s founders Sergey Brin and Larry Page tried to sell Google for $1M, but were instead forced to see it through and become multibillionaires. The market for a company is often not clear at the moment of founding. Entrepreneurs find their way to the market by the creative, iterative leverage of what and who they know.

    4. Entrepreneurs trust people. The best entrepreneurs internalize the African proverb, “If you want to go fast, go alone; if you want to go far, go together.” To uncover large opportunities, it’s often necessary to coordinate the interests of many. The best entrepreneurs involve more people in the effectuation process, because more people means more assets, which often has a non-linear impact on the eventual outcome. In fact, Sarasvathy argues that a degree of calculated “over-trust” and “intelligent altruism” is a rational strategy for uncovering large multiplayer opportunities that would otherwise be hidden or impossible to achieve.

    5. Effectual thinking can be taught. Because entrepreneurship is just an application of effectual logic and not the result of innate personality traits, it can be taught. We do not accept the notion that “scientists are born, not made,” and even while we might believe that some people are more disposed to scientific work than others, we do not accept the notion that people cannot be taught to think scientifically. It is similarly possible to teach people effectual thinking. Tellingly, in communities where effectual thinking is common (Silicon Valley, for one), people who had not previously displayed effectual tendencies are often motivated to adopt the pattern once they see it can be effective at problem solving or in generating wealth. Effectual thinking may not only be teachable; it may be contagious in the right circumstances.

    6. Failure increases the odds of individual success. While the success rate of a typical individual venture might be quite low, an entrepreneur that sustains a failure is more likely to succeed in later rounds. Failure teaches the entrepreneur about affordable risk, suggests boundaries for over-trust behaviors, and offers hints about how to maximize opportunity. We should never stigmatize failure, but instead understand that it is part of the effectual process.

    Pop Business Books

    It is fashionable to tell people stories about Purple Cows, Tipping Points, Outliers, Whuffie, Crushing It, and practicing a Four Hour Workweek. However, these books all have their roots in effectual thinking. Do something. Utilize what you really know to stand out and be different. Work with others to uncover the opportunity you want to find. If books like this can motivate people to act, they’re probably a good thing. But I find they can be crazy-making because they don’t offer the intellectual underpinnings to explain why (or how) these approaches might actually work. They’re most often shaming you into action, and in the end they’re giving you a fish, instead of teaching you how.

    Effectuation and Social Networks

    The internet (in general) and social networks (like Twitter and Facebook, in particular) are platforms for effectuation. They allow entrepreneurs to find the people who will, at each successive stage, help to contribute to the success of their enterprise. These could be customers, partners, or investors. Any platform that allows like-minded individuals to find each other is an accelerant to the effectuation process. In fact, the like-mindedness of these stakeholders is more important than the roles that they play. What is the difference between a company and a customer when both are stakeholders in the product? Who is paying whom for what and when is a detail that needs tended to, but without finding the people who will participate in the conversation that maximizes the utility of the product, maximizing revenue will never be a consideration.

    The Myth of the Visionary Entrepreneur

    We give a lot of credit to successful entrepreneurs. Warren Buffett, Bill Gates, Steve Jobs, and Richard Branson are some of the most admired people in the world. In some ways that credit is deserved (though one could argue that civil servants and humanitarians are worthy of even more praise). However, we assign them too much credit, or at the very least we assign them credit for the wrong insights.

    These people did not anticipate the circumstances of their success, and did not set out to attain the particular achievements for which they are most well known. Rather, these people are all master effectuators. They took action early. They involved others. They took many successive steps that moved them closer to their passions. They suffered failures. And perhaps most importantly, they are alive to tell about it.

    There are many unsung heroes and master effectuators who have had great success but whose stories have ended less well. And we don’t hear as much about them. The final outcome should not diminish their achievement.

    You do not need to be the next Bill Gates or Steve Jobs, or even have an idea right now, to be an effectual entrepreneur. Start now and take the journey. You will be glad you did.

    References

    • Gordon

      Effectual thinking. Many years ago, I interviewed at IBM. On the vp's desk, a sign in black and white: Think. Great post.

    • Brian Sierakowski

      Great post Dave.

      I think there is also some pretty significant cross pollination across the six points. For example, I do not have great personal experience in the domain that my startup lives, however, my personal experience has lead me to trust people more then most people do. The act of traveling around the country and being offered hospitality by complete strangers totally reinforced the concept that people are 99% good.

      If you can be taught the framework of effectual thinking, you're more likely to be able to take measured steps, placing appropriate bets along the way. So on and so forth.

      I think this goes a long way to encourage entrepreneurship, Gates and Jobs and Branson do not have some special magical DNA that allows them to do the things they've done. And even taking that thought a step further, the processes they used and still use are repeatable. Plus, Gates and Jobs and Branson did not have Gates and Jobs and Branson to learn from. The odds of us achieving more then they have may be greater since we can learn from their mistakes, accelerating our own personal growth.

      Thanks for the inspiration!

    • http://www.raywenderlich.com/ Ray Wenderlich

      Excellent post and very motivating – sometimes it can seem overwhelming when trying to start your own business, but you are right that the path to success seems to be all about following your passions, taking action one step at a time, and learning from your mistakes.

      I've seen so many stories about people who just went crazy about whatever it is they love – whether doing silly YouTube videos or raising a wolf and writing a blog about it – and opportunities just come to them that they never even thought were possible when they started. It's amazing how that happens!

    • http://www.twitter.com/aainslie Alexander Ainslie (@AAinslie)

      ~calculated “over-trust” & “intelligent altruism” is a rational strategy for uncovering large multiplayer opportunities that would otherwise be hidden or impossible to achieve. <- love this articulation

    • http://www.blakejennelle.com Blake Jennelle

      Awesome post Dave. You have some really powerful concepts and explain the often murky “entrepreneurial mindset” with a specificity that's hard to find.

      Do you have a good soundbite for what effectuation means? I'm having a hard time keeping a firm hold on it in my mind.

    • http://www.facebook.com/people/David-Troy/741590524 David Troy

      Blake – a decent definition of effectuation might be “an incremental process for problem solving and enterprise-building in which an entrepreneur iteratively leverages available assets to achieve a desired outcome, adjusting goals as circumstances and available assets change as a result of execution.”

      A little wordy, but I think it's accurate. Would welcome simplifications.

    • http://twitter.com/joeweaverjr joeweaverjr

      Dave, think your on to something here – the magic is in the unknown

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    • http://janechin.com/ Jane Chin

      Excellent post, David! I like how you demystified the mega celebrities' success – and make the potential for success accessible to everyone willing to notice and leverage their strengths. (I found you via David Patton via Google Buzz btw.)

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    • http://www.youngimpact.com/ Stephen Douglass

      Thank you for your “Pop Business Books” section–such a critical point!

    • Kerry Dobry

      Great Post! I am a fledgling entrepreneur at the beginning of taking a volunteer venture, a curriculum and class I designed to help student/family member teams to master the times tables, and turning it into a small business. It's a unique, very creative, fun, and a little loud class. It involves teaching plus some motivational coaching on my part and leadership chances on the part of families and students. It has really been EFFECTIVE and fun. I had read that most successful entrepreneurs are risk-takers, but I wouldn't have really labled myself this. More a calculated risk taker, but I think your post is a clearer definition than that. I saw a need, and have worked to make connections with families where they are in the spotlight. “Risk-taker” is too precarious a label. I can envision myself as an “effectual entrepreneur”! Thanks for the unique perspective on entrepreneurship, I think it will have an effect on my vision of myself as a leader.

    • katiemeyler

      thanks dave! i like the idea of trusting people, its gotten me further than I coulve ever imagined. im starting to get nervous though. i have a non profit and some of tour directors are very safe and traditional. i worry that when i go back overseas the org will warp into some unrecognizably boring non profit that loses our edge.-oh gosh. @ the same time, I love these people and we need different kinds of people.

    • katiemeyler

      thanks dave! i love trusting people! its gotten me further than i couldve ever imagined. its getting to the point of scariness now though. i founded a non profit, and i travel a lot. we have some pretty safe, traditional directors and i worry when i go back overseas for awhile the org is going to warp into something unrecognizably boring. ;) its probably a healthy tension but i still get nervous. no time to lose though. jump! :)

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    • Tim

      Hello DavenThank you for this fabulous insight. I am frantically pulling research sources together as part of an effort to link the why and how of what you call effectuation and what Roger Martin at the Rotman School of Business here in Canada calls Abductive reasoning. nQuestion: can you point me in the direction of articles, papers that establish Principals of Entrepreneurship that have been peer reviewed? nnThanks a ton for this exceptionally well written piecenCheersnTim Glover

    • http://www.melnic.com Jill

      These statements may be contradictory, “Because entrepreneurship is just an application of effectual logic and not the result of innate personality traits, it can be taught.” and “While the success rate of a typical individual venture might be quite low, an entrepreneur that sustains a failure is more likely to succeed in later rounds.” It may be that the ability to sustain failure or on the flip side to actually believe this statement, “If I lose it, I can survive. Whatu2019s the worst that can happen?u201d That makes someone and entrepreneur or not. You may not be able to teach that.nThere is another factor. It is the ability to manage success. When the business takes off, decisions need to be made, people need to be managed, systems need to be created, etc, and some people cannot cope with the demands and maintain confidence as decision makers. Innate personality traits may be the differentiator in the eventual success or failure of a business. n

    • Yusuf

      Thanks Dave, This has been very helpful. Im a student of entrepreneurship andI always thought there’s a better way to think and teach entrepreneurship than what is taught in many universities. Effectuation seems to be the missing link. I like the way you simplified it.
      Yusuf, Uganda 

    • Sadayantra

      Amazing! So in a way we all are entrepreneurs! 

    • Onions

      And yet, unfortunately, despite all this you and Sarasvathy make entrepreneurship out to be practical and instrumental practice enacted by rare, inimitable characters. Still the entrepreneur is central, creating things, with some miraculous inalienable control over the environment. The opportunity you talk of is still individualised, not embodied across the networks and spaces occupy. As a result, entrepreneurial practice still seems the reserve of a rare few.
      danielhartley.blogspot.com

    • Thomasblekman

      You could also check out Corporate Effectuation and soon also Orchestration of Effectuation at Amazon.