Saras Sarasvathy on Effectual Reasoning by Expert Entrepreneurs

Update Feb-24-2011: Since I first wrote this in 2010 the Effectuation.Org site has been considerably upgraded and contains a lot more information on research on entrepreneurship by Saras Sarasvathy.

Recapping ideas, papers, and books that had changed my life yesterday reminded me of Saras Sarasvathy’s Effectual Reasoning Model from her 2001 paper “What Makes Entrepreneurs Entrepreneurial” (There is a reference on the Khosla Ventures site at “What Make Entrepreneurs Entrepreneurial” with an annotated PDF version)

Entrepreneurs Rely on Effectual Reasoning

Effectual reasoning, however, does not begin with a specific goal. Instead, it begins with a given set of means and allows goals to emerge contingently over time from the varied imagination and diverse aspirations of the founders and the people they interact with.

Effectual thinkers are like explorers setting out on voyages into uncharted waters.

All entrepreneurs begin with three 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 networks.

Saras Sarasvathy in “What Makes Entrepreneurs Entrepreneurial.“

In our “Idea to Revenue” Workshop we talk about three kinds of capital that startups begin with: intellectual, social, and financial. We don’t call out what she refers to as “human capital” or “who they are–their traits, tastes, and abilities” as a resource but instead encourage teams to “begin in phase two.” That is, to build on prior accomplishments and long term interests so that early customers view the startup as a continuation of earlier efforts and focus.

But I like this model of bootstrapping entrepreneurs as foragers: living off the land as hunter-gatherers until they can find a market to homestead. Bootstrappers have to start from where they are and search for opportunities. Pasteur advised that “Chance only favors the prepared mind” so you have to open yourself up to possibilities and be prepared to be surprised (which is another way of saying you have learned something new). Some more quotes from her paper:

Using these means, the entrepreneurs being to imagine and implement possible effects that can be created with them. Most often they start very small with the means that are closest at hand and move almost directly into action without elaborate planning.

Plans are made and unmade and revised and recast through action and interaction with others on a daily basis. Yet at any given moment, there is always a meaningful picture that keeps the team together, a compelling story that brings in more stakeholders and a continuing journey that maps uncharted territories.

Eventually certain of the emerging effects coalesce into clearly achievable and desirable goals–landmarks that point to a discernible path beginning to emerge from the wilderness

Seasons entrepreneurs, however, know that surprises are not deviations from the path. Instead they are the norm, the flora and fauna of the landscape, from which one learns to forge a path through the jungle. The unexpected is the stuff of entrepreneurial experience and transforming the unpredictable into the utterly mundane is the special domain of the expert entrepreneur.

Saras Sarasvathy in “What Makes Entrepreneurs Entrepreneurial.“

One of the reasons that we run the Bootstrapper Breakfasts as 90 minute unconferences–where folks introduce themselves and put issues on the table they would like to discuss–is that it keeps everyone in an entrepreneurial frame of mind:

When you hear someone describe a challenge that they are facing, it gives you much better insight into their thinking and allows you to evaluate what they might be like to work with.
Often as not they are describing a common problem, or aspects of a common problem. Hearing their perspective just on the problem can give you new insights into how to solve it.
It’s good practice to learn how to ask for advice and insight. Entrepreneurs need to do a lot of that in the early market especially.
Explaining how you managed an issue or situation can deepen your understanding of you solution, it forces you to put it into terms others can use and understand. This is good practice for scaling up (e.g. adding your first employee).

Sarasvathy stresses the cooperative nature of entrepreneurship in the paper, a perspective that I share. Often an entrepreneur is attempting to obsolete an aspect of the status quo, but they have much less competition and much more opportunity for collaboration than is appreciated.

Markets are stable configurations of critical masses of stakeholders, who come together to transform the outputs of human imagination into the forging and fulfillment of human aspirations through economic means.

Effectual reasoning may not necessarily increase the probability of success of new enterprises, but it reduces the costs of failure by enabling the failure to occur earlier and at lower levels of investment.

Entrepreneurs are entrepreneurial, as differentiated from managerial or strategic, because they think effectually; they believe in a yet-to-be-made future that can be shaped substantially by human action; and they realize that to the extent that this human action can control the future, they need not expend energies trying to predict it. In fact, to the extent that the future is shaped by human action, it is not much use trying to predict it–it is much more useful to understand and work with the people who are engaged in the decisions and actions that bring it into existence.

Saras Sarasvathy in “What Makes Entrepreneurs Entrepreneurial.“

Saras Sarasvathy on 3 Key Differences In Effectual Reasoning

Saras Sarasvathy highlights three key differences between effectual reasoning and traditional startup management models:

Risk taking
- Traditional: expected return, work the plan to deliver results to your investors (“Ready Aim Fire” can become “Aim–not big enough–Aim–not big-enough–Aim…”).
- Effectual: affordable loss, make many small mistakes as early and cheaply as possible to speed learning (“Ready Fire Steer“)
Focus:
- Traditional: competition
- Effectual: strategic partnership (especially with early customers)
Value Creation
- Traditional: rely on pre-existing knowledge to aim for a known market you can dominate and exploit
- Effectual: leverage contingencies; create opportunities as you map a new market

She goes into some detail on the “affordable loss principle” and offers extracts from an interview with an expert entrepreneur’s approach to a new market:

While managers are taught to analyze the market and choose target segments with the highest potential return, entrepreneurs tend to find ways to reach the market with minimum expenditure of resources such as time, effort, and money. In the extreme case, the affordable loss principle translates into the zero resources to market principle. Several of the expert entrepreneurs I studied insisted that they would not do any traditional market research, but would take the product to the nearest possible potential customer even before it was built. To quote but one of them, “I think I’d start by just… going… instead of asking all the questions I’d go and say.. try and make some sale. I’d make some… just judgments about where I was going — get me and my buddies — or I would go out and start selling. I’d learn a lot you know..which people.. what were the obstacles.. what were the questions.. which prices work better and just DO it. Just try to take it out and sell it. Even before I have the machine. I’d just go try to sell it. Even before I started production. So my market research would actually be hands on actual selling. Hard work, but I think much better than trying to do market research”.

In finding the first customer within their immediate vicinity, whether within their geographic vicinity, within their social network, or within their area of professional expertise, entrepreneurs do not tie themselves to any theorized or pre-conceived “market” or strategic universe for their idea. Instead, they open themselves to surprises as to which market or markets they will eventually end up building their business in or even which new markets they will end up creating.

Saras Sarasvathy in “What Makes Entrepreneurs Entrepreneurial.“

This is also an approach that favors older entrepreneurs to the extent that they have larger social networks (based on more shared work experience with more people) and deeper professional expertise. The one caveat is that they have to be open to new possibilities and not be blinded by what they “know” to be true in the face of new information.

SKMurphy Perspective

This 2001 paper offers another perspective on bootstrapping entrepreneurship that is independently derived and predates “Four Steps to the Epiphany (2003)”, “Blue Ocean Strategy(2005)”, and the “Sales Learning Curve (2004).” While all four are clearly addressing different aspects of the same core paradigm that takes a scientific or hypothesis driven approach to new products and new markets, I find Sarasvathy’s offers the best perspective.

I will leave with two final quotes from the paper which highlights the value of establishing enduring relationships.

Expert entrepreneurs […] are actually in the business of creating the future, which entails having to work together with a wide variety of people over long periods of time. [They fill their future] with enduring human relationships that outlive failures and create successes over time

This is largely ignored in our entrepreneurship curricula which tend to focus on market research, business planning, new venture financing and legal issues. As far as I know no entrepreneurship programs offer courses in creating and managing lasting relationships or stable stakeholder networks, nor on failure management.

Saras Sarasvathy in “What Makes Entrepreneurs Entrepreneurial.“