Book Summary
MAKING THE
ENTREPRENEUR:
EFFECTUATION
EXPLAINED
Learning from Expert Entrepreneurs
Entrepreneurs are the heroes of our
times: Jeff Bezos, Stelios Haji-Ioannou
and Richard Branson are the daring
visionaries of our common corporate
cultures - conquering new markets,
thriving on risk and uncertainty, changing
our worlds.
This portrait of the visionary
entrepreneur is very much in line with the
dominant belief in economics and
entrepreneurial research today - that new
opportunities are discovered through the
exploration of all existing markets and the
exploitation of the most promising
opportunity. All an entrepreneur does is
identify the opportunity and exploit it.
But there is one major flaw to the idea
that markets exist in some theoretical form
before they are explored and exploited – it
assumes that the decision to create a new
market is backed by perfect - or at least
useful - information and knowledge.
Imagine predicting the future value of
the Internet in 1990. Or guessing what
innovations stem cell research will yield
ten years from now. What information do
you have to make those decisions?
When we act in an environment that
is predictable, we can use the past to look
for recurrences, common patterns. When
the environment and its future are risky,
we use the past, probabilities, and in
some cases, we hedge our bets. When
the future is unknowable, what do we do?
The fact that we are surrounded by
uncertainty is not news to anyone. The
extent of uncertainty in business today,
however, might surprise you. Alternative
energy companies are uncertain.
Biotechnology start-ups are uncertain.
But what about the Fortune 500? Has
uncertainty permeated industries we see
as established and mature? Consider the
implications of the fact that 1 of every 4
firms on that list simply did not exist 30
years ago. Every 88 days, a new firm is
created that will replace one of the
existing Fortune 500.
What new
competitors, products, and business
models, that have yet to be imagined, will
burst into the landscape without any
advance notice? This is hardly a certain
environment.
So given that even the
largest and most established of
corporations can take little for granted, it is
clear that successfully operating in
uncertainty is a universal imperative.
We tried to understand how people
behaved in uncertainty.
Naturally we
turned to expert entrepreneurs, because
their success is closely tied to the way
they perceive and manage the uncertainty
of new venture, market or product
creation. Our first finding was that
entrepreneurs were generally not
visionaries who were better/faster/smarter
than others at seizing and exploiting
existing realities. Secondly, while
entrepreneurs did not try to predict the
future, they did more than toss a coin
when making strategic decisions. A
Read, et al, Making the Entrepreneur, 19.06.08
pattern of decision-making behavior
emerged, which we called effectuation.
This pattern can be grouped into four
distinctive principles which we will look at
next. These principles make up what we
call the effectuation logic. Underlying all
the principles of effectual reasoning is a
coherent logic that rests on a
fundamentally different assumption about
the future than predictive reasoning.
Causal reasoning is based on the logic;
To the extent that we can predict the
future, we can control it. That is why both
academics and practitioners in business
today spend enormous amounts of
brainpower and resources on developing
predictive models. Effectual reasoning,
however, is based on the logic, To the
extent that we can control the future, we
do not need to predict it.
Why study expert
entrepreneurs?
Experts develop unique heuristics for
pattern matching and problem solving
within their domains. Chess masters
are no smarter than the person on the
street - they have just developed
expertise in chess. It is the same with
expert entrepreneurs, who have
developed expertise in making
opportunities in uncertain
environments.
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First Principle: Start with your means
When an expert entrepreneur considers a new venture, s/he starts with available means. Means can be grouped into 3 categories:
• Who I am– my traits, tastes and abilities;
• What I know – my education, training, expertise, and experience;
• Whom I know – my social and professional networks.
Using these means, the entrepreneur begins to imagine and implement possible effects that are a combination of those means.
Most often, s/he starts very small with the means that are closest at hand, and moves almost directly into action without elaborate
planning. With each action, possible outcomes are reconfigured. The end result is a combination of the imagination and aspirations of
the entrepreneur and the people s/he has interacted with over the course of the process. Below is an example.
Curry in a Hurry
Imagine an entrepreneur who wants to start an Indian restaurant. In the opportunistic, search and select process that we teach in
business schools, she would start with some market research into the restaurant industry in the city of her choice;
select a location very carefully based upon the market research; segment the market in a meaningful way; select target
segments based on estimates of potential return; design a restaurant to appeal to her target segments; raise the
required funding; bring her team together; and finally, implement specific market strategies and manage daily
operations to make her restaurant a success.
In the effectual logic, what actually happens would all depend on who our entrepreneur is, what she knows, and whom
she knows. For example, let us say she is a good Indian chef who is considering starting an independent business.
Assuming she has very little money of her own, what are some of the ways she can bring her idea to market? She
might partner with an existing restaurant, participate in ethnic food fairs, set up a catering service and so on. Let’s say
she chooses to persuade friends who work downtown to allow her to bring lunch for their office colleagues to sample.
Let us further say that some customers then sign up for a lunch service and she begins preparing the food at home and
delivering lunches personally. Eventually, she could save up enough money to rent a location and start a restaurant.
But it could equally be plausible that the lunch business does not take off beyond the first few customers. Instead our entrepreneur
discovers that the customers are actually interested in her ethnic philosophy and life experiences or Indian culture or other aspects of
her personality or expertise or contacts or interests. She could then decide to go into any one of several different businesses contingent
upon the ensuing feedback. To cite but a few possibilities, her eventual successful enterprise could turn out to be in any one or all of the
following industries -- education, entertainment, travel, manufacturing and packaging, retail, interior decoration, or even self-help and
motivation!
Second Principle: Set Affordable Loss
In a predictive world, the manager in charge of launching a new
product analyses the market and chooses target segments with the
highest potential return. He has been taught to try and maximize
returns by selecting the optimal strategy for his/her target.
Entrepreneurs think in terms of affordable loss rather than
expected returns. They decide on what they are willing to lose rather
than on what they expect to make. Instead of calculating up front
how much money they will need to launch their project and investing
time, effort and energy in raising that money, the effectual
entrepreneur tries to estimate the downside and examines what s/he
is willing to lose. They then build the project to bring other
stakeholders on board and leverage what they can afford to lose too.
An estimate of affordable loss does not depend on the venture
but varies from person to person and even across his or her life
stages and circumstances. In the Silly Putty example, Hodgson had
time on his hands but no cash. His affordable loss was different from
that of GE, who had the cash but no time for the distraction. By
allowing estimates of affordable loss to drive their decisions about
which venture to start, the entrepreneur does not need to depend on
any predictions. Preference is clearly on fabricating options that
generate more options for the future rather than on maximizing
immediate returns.
Making a Market Out
of a Mistake:
In 1943, James Wright was
working in General Electric's
development labs to create
an inexpensive substitute for
synthetic rubber. By mistake,
Wright dropped boric acid into
silicone oil, and was surprised
to find the result both
stretchier and bouncier than
rubber.
General Electric
presented "nutty putty" to
scientists around the world but
was completely unable to find a commercial use for it. Until
in 1949, Peter Hodgson, an unemployed ad man,
encountered “nutty putty” at a party. Hodgson borrowed
$147 to buy the rights from GE, renamed it Silly Putty®,
packaged it inside a plastic egg, and the rest is, as they
say, history.
This does not mean entrepreneurs chose projects that have low potential - what it describes is how they develop projects with their
co-stakeholders, anticipating the possibility of failure and working to make sure that failure is a learning, not a terminating experience.
Read, et al, Making the Entrepreneur, 19.06.08
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Third Principle: Leverage
Contingencies
The Unknowable Market:
If you come across lemons, make
lemonade! The third principle of effectual
reasoning is at the heart of entrepreneurial
expertise – the ability to turn the unexpected into
the profitable.
Expert entrepreneurs learn to not only work
with the surprise factor, but also how to take
advantage of it. In most contingency plans,
surprises are bad – the “what if?” scenarios are
usually worse case scenarios.
Take the
Nespresso story. While Nespresso initially
targeted the wrong market (Boutique restaurants
and offices) the fact that they were able to react
and reposition the product for the young, urban,
hip professional making espresso at home,
saved the fledging company. In fact, it was such
a success that the company could not keep up.
The worse case scenario (that there was no
market) turned out to be rather the opposite
(there was a huge, unplanned market). In the Pet
Rock example, Gary Dahl turned a joke into an
unexpected business success.
The table below shows you the difference
between prediction, risk and uncertainty. As you
think about the different categories, notice how
surprises are perceived as a the result of a
“mistake” in both the predictive environments
and the risk environments. In both, we believe
that had we planned and hedged better, we
would have done better.
Gary Dahl, a California advertising man, was having
drinks with his friends one night in April 1975 when
the conversation turned to pets. As a lark, Mr. Dahl
informed his friends that he considered dogs, cats,
birds, and fish all a pain in the neck. They made a
mess; they misbehaved; they cost too much money.
He, on the other hand, had a pet rock, and it was an
ideal pet - easy and cheap, and it had a great
personality. The group laughed at the idea.
Dahl spent the next two weeks writing the Pet Rock
Training Manual - a step-by-step guide to having a
happy relationship with your geological pet, including instructions for how to make
it roll over and play dead and how to house train it. "Place it on some old
newspapers. The rock will never know what the paper is for and will require no
further instruction.' To accompany the book, Dahl decided to create a Pet Rock.
He went to a builder's supply store in San Jose and found the most expensive
rock in the place - a Rosarita Beach Stone, which was a uniform size, rounded
gray pebble that sold for a penny. He packed the stone in excelsior in a gift box
shaped like a pet carrying case, accompanied by the instruction book.
The Pet Rock was introduced at the August gift show in San Francisco (the gift
market is much easier to break into than the cutthroat toy market), then in New
York. Neiman-Marcus ordered five hundred. Gary Dahl sent out homemade news
releases of himself accompanied by a picture that showed him surrounded by
boxes of his Pet Rocks. Newsweek did a half-page story, and by the end of
October Gary Dahl was shipping ten thousand Pet Rocks every day.
He
appeared on "The Tonight Show," twice. By Christmas when, two and a half tons
of rocks had been sold, three-fourths of all the daily newspapers in America had
run Pet Rock stories, often including Gary Dahl's tongue-in-cheek revelations
about how each rock was individually tested for obedience at Rosarita Beach in
Baja, Mexico, before being selected and boxed. A million rocks sold for $3.95
apiece in just a few months, and Gary Dahl - who decided from the beginning to
make at least one dollar from every rock - had become an instant millionaire.”
http://www.virtualpet.com/vp/farm/petrock/petrock.htm
The difference
between prediction,
risk & uncertainty
Prediction
Risk
Uncertainty
(Known)
(Unknown)
(Unknowable)
What matters:
Data, the past
Variance & probability
Expertise, influence &
control
How you move ahead:
Refine prior efforts strive for perfect
business plan
Robustness,
preparedness scenarios
Co-creation & affordable
loss
Dealing with surprises:
Quality checking
(must have been my
mistake)
Weather the storm,
work to stay on track/
on plan
Embrace and rethink: it
provides new
opportunities
Measuring Success:
Actual vs plan,
execution
Actual vs plan,
closeness to the
vision, within margin
Valued novelty, are we
somewhere that has
potential.
Read, et al, Making the Entrepreneur, 19.06.08
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Fourth Principle: Form Partnerships
Another key principle of effectual reasoning is the focus
on building partnerships. They will almost always take the
product to the nearest possible potential customer. 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. As such, some
of the people the entrepreneur interacts with self-select into
the process by making commitment to the venture.
The strategic partnerships principle dovetails with the
affordable loss principle to bring the entrepreneurs’ idea to
market with very little cash expenditure (resources come
from partners, not from cash). Furthermore, obtaining precommitments from key stakeholders helps reduce
uncertainty in the early stages of creating an enterprise.
Finally, since the entrepreneur is not wedded to any
particular market for their idea, the expanding network of
strategic partnerships determines to a great extent which
market or markets the company will eventually end up in.
Effectual logic is highly people dependent, unlike causal
logic, which is effect dependent. In other words, when a
particular effect has been chosen ex ante (such as a target
segment within an existing market) the people we hire and
partner with will depend on the effect we want to create or
the market we want to penetrate. Effectual logic, however,
does not assume pre-existent markets and builds on the idea
that the markets we create will be predicated on the people
we are able to bring together.
Conclusion
The effectual principles bring us back to the question of
how one controls an unpredictable future. The answer to this
question depends on our beliefs about where the future
comes from. Is the future largely a continuation of the past?
To what extent can human action actually change its course?
Entrepreneurs choose to view the future through
effectual logic. Consciously, or unconsciously, they act as if
they believe that the future is not “out there” to be discovered,
but that it gets created through the very strategies of the
players. And they live by the fifth principles: If you control the
future, create it, and risk plays a much smaller role in the
overall adventure.
Breaking the Ice on Partnerships
After five
y e a r s
working
for
a
mining
company
in Kiruna,
Sweden,
Yngve
Bergqvist
decided
that he
no longer
wanted to be referred to only by his employee number.
He took up river rafting and soon enough he was taking clients up
and down the river. He resigned from his mining job, and expanded
the rafting business to 40 summer employees and 30 boats. But
summer in Sweden is short. Bergqvist needed to find a winter
business to supplement his summer earnings. He had heard of
Japanese tourists visiting Alaska in winter to see the northern lights.
In 1988, he travelled to Sapporo and Hokkaido in Japan for the
snow festivals, and there he met an ice sculptor from Asahikawa.
The two men planned a winter ice-sculpting workshop in Sweden.
The workshop received a lot of press, as numerous international
artists, spectators and local people flocked to Jukkasjärvi.
The day of the exhibition, it rained. Berggvist recalls “It was then
that I realised that we were trying to preserve something natural. So
I decided, 'let it be destroyed and we can make something new
when it is destroyed."
What they 'made new' was the ICEHOTEL, which would have a
lifespan in tune with the seasons. Employing the skills Bergqvist
learnes during his ice-sculpting projects, the hotel is constructed
each winter using ice from the Torne River. Bergqvist's friends at
the Swedish tourist board introduced him to Sakata, owner of a
Japanese travel agency called Northern Express. A natural
partnership ensued where Sakata generated interest in Japan for
travel to Jukkasjärvi and Bergqvist provided Sakata’s clients with a
unique experience in Swedish Lapland, including ice fishing, getting
married in an ice chapel or simply marvelling at the artwork that is
the ICEHOTELl itself. The business has grown well beyond the size
of the original rafting venture, and has further expanded in
collaboration with Absolut to create ICEBAR in big cities all over the
world. (Ice Man Cometh, Read & Sarasvathy, 2007)
Discussion questions:
1. How do you know uncertainty when you see it?
So what?
Resear ch show that ef fectuation
systematically results in more variety and
is strongly prefer red by exper t
entrepreneurs as a means of creating
new firms, products and markets.
2. What are examples of uncertain situations that members
of your group are currently facing (new product, new
market, competitive action, regulatory actions)?
3. Choose one of the uncertain situation “case studies” from
the group to discuss and see whether you can offer ideas
to the group member that owns the situation.
Read, et al, Making the Entrepreneur, 19.06.08
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