Effectuation: Elements of Entrepreneurial Expertise IIMB ... - Idea

Effectuation: Elements of Entrepreneurial ExpertiseIIMB Research Seminar, Jan 2010Saras SarasvathyWith inputs from:Nicholas DewEdward FreemanBrent GoldfarbGraciela KuechleJeanne LiedtkaAnil MenonStuart ReadHerbert SimonS. VenkataramanRobert Wiltbank

The First Empirical JourneyQuestion:What are the teachable and learnable elements ofentrepreneurial expertise?Subjects:Method:27 expert entrepreneurs(Founders of companies from $200M to $6.5B)Protocol analysis(80 hours of tape; 1500 pages of data)Theory: Sarasvathy, 2008(Effectuation: Elements of Entrepreneurial Expertise)Results:Over 63% of the subjects used an EFFECTUALlogic more than 75% of the time

Empirical Journey Continued• Comparisons with novices– 89% of experts used effectual more frequently than causal logic,while novices demonstrated a noticeably opposing preference, with81% using causal more than effectual. (JBV 2009; JM 2009)– Experts used 11 types of transformation techniques – not merely newcombinations (JEE 2009)• Comparisons with experienced corporate managers (ASQ WP)• Development of a survey instrument• Comparing angels and venture capitalists– emphasizing prediction has no impact on investor success or failure,while an emphasis on control reduces investment failure withoutreducing success rates. (JBV 2009)• Comparisons across countries, doctoral dissertations, teaching

Cognitive Distribution ofManagerial and Entrepreneurial ThinkingEffectualHighExpertEntrepreneursAngelsExperiencedVCsOrganicGrowthLeadersEntrepreneurialLarge FirmsNoviceVCsCorporateManagersLowLowHighCausal

Conventional Wisdom: Causal LogicCausal Logic is predictiveTo the extent you can predict the future, you can control itControl of outcomes achieved throughaccurate predictions,clear goals,and avoiding or protecting oneself against the unexpected

What is effectual logic?(SMJ 2006)PREDICTIONHighCausalLogicVisionaryLogicLowAdaptiveLogicEffectualLogic= Non-predictivecontrolLowHighCONTROLHow do you control a future you cannot predict?

5 Principles of Effectuation(AMR 2001)• Bird-in-hand principle:Start with Who you are, What you know, & Whom you know(Not with pre-set goals)

Examples of Effectual LogicFrom cooking a meal . . .. . . To building a restaurantOr something else . . .

Marketing Process InversionClassic Causation Model from Marketing TextbooksMarket DefinitionSegmentationTargetingPositioningSINGLE CUSTOMERUnderstandCustomerSegment DefinitionAdding Segments/PartnersDef of one of many possible marketsProcess of Effectuation Used by Expert Entrepreneurs

Principles of Effectuation(AMR 2001)• Bird-in-hand principle:Start with Who you are, What you know, & Whom you know(Not with pre-set goals)• Affordable loss principle:Invest what you can afford to lose – extreme case $0(Not expected return)• Crazy Quilt principle:Build a network of self-selected stakeholders(Not competitive analysis)• Lemonade principle:Embrace and Leverage surprises(Not avoid them)• Pilot-in-the-plane principle:The future comes from what people do(Not inevitable trends)

Dynamics of the effectual network(JEE 2005)Who I amWhat I knowWhom I knowWhat canI do?(Affordable loss)Interactionswith otherpeopleEffectualstakeholdercommitments

What is effectual logic?(SMJ 2006)PREDICTIONHighCausalLogicPlanVisionaryLogicPersistLowAdaptiveLogicAdaptEffectualLogicCo-create= Non-predictivecontrolLowHighCONTROLHow do you control a future you cannot predict?Through EFFECTUAL Co-creation

Dynamics of the effectual network(JEE 2005)Expanding cycle of resourcesActual courses ofAction possibleNewmeansWho We I amareWhat I We know knowWhom I We know knowActual MeansWhat canWe I do? do?(Affordable loss)Interactionswith otherpeopleEffectualstakeholdercommitmentsNewgoalsConverging cycle of constraintsNEW MARKETSAND NEW FIRMSClaus Meyer clip

Claus Meyer, Meyer Group – at CBS, Denmark

Pierre Omidyar on eBay• Almost every industry analyst and business reporter I talk toobserves that eBay's strength is that its system is selfsustaining-- able to adapt to user needs, without any heavyintervention from a central authority of some sort. So peopleoften say to me - "when you built the system, you must haveknown that making it self-sustainable was the only way eBaycould grow to serve 40 million users a day."• Well… nope. I made the system self-sustaining for one reason:Back when I launched eBay on Labor Day 1995, eBay wasn't mybusiness - it was my hobby. I had to build a system that wasself-sustaining… …Because I had a real job to go to everymorning. I was working as a software engineer from 10 to 7, andI wanted to have a life on the weekends. So I built a systemthat could keep working - catching complaints and capturingfeedback -- even when Pam and I were out mountain-biking, andthe only one home was our cat.

• If I had had a blank check from a big VC, and a big staff running around- things might have gone much worse. I would have probably puttogether a very complex, elaborate system - something that justifiedall the investment. But because I had to operate on a tight budget -tight in terms of money and tight in terms of time - necessity focusedme on simplicity: So I built a system simple enough to sustain itself.• By building a simple system, with just a few guiding principles, eBay wasopen to organic growth - it could achieve a certain degree of selforganization.So I guess what I'm trying to tell you is: Whatever futureyou're building… Don't try to program everything. 5 Year Plans neverworked for the Soviet Union - in fact, if anything, central planningcontributed to its fall. Chances are, central planning won't work anybetter for any of us.• Build a platform - prepare for the unexpected... …And you'll knowyou're successful when the platform you've built serves you inunexpected ways. That's certainly true of the lessons I've learned inthe process of building eBay. Because in the deepest sense, eBay wasn'ta hobby. And it wasn't a business. It was - and is - a community: Anorganic, evolving, self-organizing web of individual relationships, formedaround shared interests. (Omidyar, 2002)

Effectuation: A summaryNot just a jigsaw puzzleEFFECTUATIONE l e m e n t s o fE n t r e p r e n e u r i a l E x p e r t i s eSARAS D. SARASVATHYAnd an invitation…www.effectuation.org/N e w H o r i z o n s i n E n t r e p r e n e u r s h i pMore like a crazy quilt

ImplicationsWhat are the implications for performance?

Novice EntrepreneurFirm Life-Cycle and Entrepreneur’s CareerCausalTethered to goalsand predictiveHighLargeFirmResourcesExpertentrepreneursdo not alwaysmanage tobridge this gapLowEffectualTethered to meansand non-predictiveStartupFirmExpertEntrepreneurTime

Probability of Success vs Cost of FailureInvestment Levels / Failure CostsHighExternal ShockPrediction Gap:Investmentsin accuracyControl Gap:Use ofEffectual logicInvestment based onExpected ReturnActual investmentrequired (Ex-post)Investment based onExpected ReturnInvestment based onAffordable LossLowTimeline

Some thoughts on probability of success/failureAssuming small successes are expertise-dependent,but large homeruns are drawn from a random distribution:You get to explore more opportunities:• Effectuation gives you more shots at the jackpot –a larger temporal portfolio• You survive longer so you can win the marathons(you may lose some sprints along the way)You get to explore better opportunities for you:• You fully reap the benefits of cumulative learning effects

A Historical Analogy: The Scientific Method• The notion that the world can be systematically studied andunderstood in terms that do not include divine revelation orintervention (Carl Sagan)• The idea that the work of navigators, inventors and craftsmencan be a model for scholars (Francis Bacon of Verulam, 1521-1626)• The belief that Nature’s potential can be harnessed for theachievement of human purposes• Not the details of what exactly constitutes the method but therealization that such methods can and do exist

The Market for CoffeeBy the 1980s, per capita coffee consumption in the United Stateshad been declining for 20 years.What is the elevator pitch for Starbucks?

The Market for EngineeringKBL produced 6 iron ploughs in 1904They remained unsold for two years

The Market for Electric BulbsYear Cost Price Sales Price Quantity1 1.25 0.40 20-30,0002 0.70 0.40 50-80,0003 0.50 0.40 100-300,0004 0.37 0.40 > 1 Million

The Market for MoneyThe moment of “change”

“We have come to think of theactual as one among manypossible worlds. We need torepaint that picture. Allpossible worlds lie within theactual one.”Nelson Goodman,in Fact, Fiction, and Forecast: