Five Principles of Effectuation

Context

Effectuation is a concept that arises from a long-standing question: What drives entrepreneurs to be entrepreneurial? Though a number of academic researchers and practitioners of entrepreneurship have attempted to answer the topic question, there was still no practical use for the entrepreneurs who were starting their ventures.

By the late 1990s, Saras Sarasvathy, a professor at the University of Virginia’s Darden School of Business, discovered the term ‘effectuation’ in her interview among a sample of successful entrepreneurs. The research revealed that more than half of the respondents used effectual logic in solving entrepreneurial problems and creating new opportunities.

So, What is Effectuation?

Based on Dr Saras Sarasvathy’s findings, effectuation is born and defined as a way of thinking and decision-making framework used primarily by entrepreneurs, emphasising adaptability, flexibility and leveraging available resources rather than extensive planning and prediction.

During the unpredictable start-up phases, it is effectuation, a common logic, that helps entrepreneurs overcome entrepreneurial hardships, not by their genes, personality traits, risk-seeking behaviour, money or unique vision.

Effectuation vs Causation

In general, what makes the effectuation approach different from traditional casual reasoning lies in a focus on the means available to the entrepreneurs – who they are, what they know and whom they know – and allow goals to emerge over time as new circumstances arise. In contrast, the causation approach focuses on achieving a desired goal through a specific set of given means.

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The Principles of Effectuation

As the theorist behind the theory of effectuation, Dr Saras Sarasvathy introduced five key principles that she believes are common among successful businesspeople. Knowledge of how to function a business like financial management, inventory and so on is still necessary, but these principles can help entrepreneurs sidestep the common causes of business failures.

The Bird In Hand Principle

Borrowed from the phrase ‘ A bird in hand is worth two in the bush’, the message is that when entrepreneurs seek to build a new venture, they start with what they have, their means such as skills, knowledge, current professional and social networks instead of waiting for the perfect conditions and timing.

Most often, entrepreneurs will take small steps with implementation, configure possible outcomes that emerge and get closer to creating an enterprise.

The Affordable Losses Principle

Effectual entrepreneurs don’t think about starting a business with maximising returns by selecting the optimal strategy for the target. Instead, they will try to estimate the downside and examine what they are willing to lose. Entrepreneurs then use the process of building the project to bring other stakeholders on board and leverage what they can lose together.

An estimate of affordable loss varies from person to person across an individual’s life stages and circumstances. Some are willing to lose a property like their own house to have a venture a go, while others are limited to certain amounts in the savings account.

This also enables cheap failure as entrepreneurs will stop depending on prediction and focus on cultivating opportunities that have a lower chance of failure and generate more options for the future.

The Lemonade Principle

As opposed to conventional business thinking, any hiccup in the predetermined plan can potentially interrupt the entire venture, effectuation entrepreneurs frequently expect uncommon things to happen as their ideas do not stick to any preconceived market.

Therefore, at the heart of entrepreneurial enterprise, the lemonade principle highlights that entrepreneurs need to learn not only to work with surprises but also to take advantage of them and turn them into valuable opportunities.

The Crazy Quilt Principle

Since entrepreneurs tend to start the process without knowing who their competitors will be, so detailed competitive analyses have little value. As a result, the effectuation mindset is focused on building partnerships rather than beating unclassified rivals.

Instead, entrepreneurs aim to seek pre-commitments from key stakeholders, suppliers and customers who can contribute time, and/or money, and/or resources to bring their business ideas to the market with very little cash expenditure and reduced uncertainty in the early stages of creating an enterprise.

The Pilot in the Plane Principle

Many entrepreneurs choose the entrepreneurship path because they recognise the importance of personal control, they prefer personal freedom and value time spent working for themselves more than they ever could work for someone else. This desire for personal control inspires them to take the risk of starting a business.

Bottom Line

In conclusion, the five principles of effectuation empowers entrepreneurs in navigating the uncertain and unpredictable terrain of starting a business. By leveraging what they have, minimizing risks through affordable losses, embracing unexpected opportunities, building partnerships, and maintaining control over their ventures, entrepreneurs can adapt and innovate without relying on extensive forecasting. This mindset allows them to build resilient businesses that evolve with circumstances, making effectuation a vital tool for long-term entrepreneurial success.

References

Effectuation n.d., The Principles of Effectuation, Effectuation, available at <https://effectuation.org/the-five-principles-of-effectuation-detail>.

Read, S. & Sarasvathy, S.D 2005, Knowing what to do and doing what you know: Effectuation as a form of entrepreneurial expertise, Journal of Private Equity, 9, pp.45–62.

Sarasvathy, S.D 2001, Causation and effectuation: Toward a theoretical shift from economic inevitability to entrepreneurial contingency, Academy of Management Review, 26, pp.243–263.

Sarasvathy, S.D 2008, Effectuation: Elements of entrepreneurial expertise, Northhampton, MA: Edward Elgar.

Sarasvathy, S.D. & Venkataraman, S 2001, Strategy and entrepreneurship: Outlines of an untold story, Oxford, U.K.: Blackwell.

Sarasvathy, S.D. & Dew, N 2008, Effectuation and over-trust: Debating Goel and Karri, Entrepreneur-ship Theory and Practice,32, pp.727–737.

Sharon, M.W 2016, Social innovation, effectual reasoning, and developmental evaluation, Sharon M. Wasco, available at <https://www.sharonmwasco.com/home/2017/6/1/social-innovation-effectual-reasoning-and-developmental-evaluation>.