The five key principles of Effectual Entrepreneurship.
Effectuation is a way to describe how successful entrepreneurs think. It turns out that successful entrepreneurs think differently about the world than others, and it is by studying these differences that we can learn what makes some entrepreneurs more likely to succeed.
In addition to being the co-founder & CEO of Borrowed & Blue, the wedding vendor marketplace, and a serial entrepreneur, I have the privilege of teaching Effectuation as an adjunct lecturer in Entrepreneurship at both the University of Virginia and the University of Colorado Boulder. I wrote this post to share some important research on entrepreneurial thinking and the key principles emerging from this research, which make up the foundation of Effectuation. My hope is that I can provide some valuable insights to help fellow entrepreneurs launch their businesses successfully.
I was first introduced to Effectuation in 2003 as an MBA student at Darden, the University of Virginia’s graduate business school. In our first year Strategy class, we were assigned a nine page reading note, titled What Makes Entrepreneurs Entrepreneurial? The author was Saras Sarasvathy, one of the leading thinkers of the Effectuation movement. It was the first work I had read that explored how entrepreneurs think differently, and it was a serious AHA! moment for me. In the note, Saras details how in her ground-breaking entrepreneurial research, she interviewed over 30 highly successful entrepreneurs that had built companies with revenues from $200 million to $6 billion, and had each entrepreneur go through a 17 page problem set over two hours that involved describing how they would bring the same specific product to market. She was observing how these expert entrepreneurs think about starting a venture, and if there were any common threads among them.
It turns out the answer is yes. After rigorous analysis, Saras was able to identify and distill an emerging Entrepreneurial Method — a way of thinking about the world that all these successful entrepreneurs shared — and thus was born a new entrepreneurial school of thought: Effectuation.
The following year, I was thrilled to learn that Saras had joined the teaching faculty at Darden, and I enrolled in her class. That was 14 years ago — we’ve been friends and collaborators ever since. I consider her one of my most important mentors, and I am grateful to her for sharing her time and her intellect with me.
As the newest discipline in business schools, Entrepreneurship has only recently come into its own as a teachable curriculum akin to Finance, Accounting, Management, Marketing & Communications, Operations, Quantitative Analysis, and Organizational Behavior. Many schools (and students) still struggle with the question, “Can entrepreneurship really be taught?” and its corollary, “Are entrepreneurs born or made?”
Until discovering Effectuation, I’ll admit that I wasn’t so sure myself. But now, I’m a big believer that there are core teachable tenets, an Entrepreneurial Method — and they are rooted in the principles of Effectuation. These principles are not meant to be prescriptive; rather, think of them as a lens through which to look at the world. They are particularly helpful for founders in the earliest stages of a startup venture — or as Peter Thiel likes to say, when you’re focused on getting from 0 to 1.
So what does ‘Effectuation’ mean anyway?
First, let’s start with what Effectuation is not. Causation, or causal reasoning, is what drives the vast majority of managerial thinking today — it’s the way we’re taught to think about most problems. We have a defined goal we’re trying to achieve, and we have to decide which of the various options at our disposal will allow us to best achieve that goal. What’s static in this approach are our given means and our given goal. We’re taught to ‘start with the end in mind,’ and figure out the best way to get there.
The expert entrepreneur thinks differently. They look around at the means they have at their disposal, whether these means are people, know-how, or resources, and determine what potential goals might be achieved with this unique collection of means. Additionally, the expert entrepreneur doesn’t look at their means as static — they are continuously looking to expand the means at their disposal. The expert entrepreneur reasons effectually — imagining all the possibilities they can create in a future controlled by them.
It is this fundamentally different way of looking at the world that brings us to the first of five key principles of Effectuation.
Principle #1: Worldview — Control vs. Prediction
The managerial thinker, the causal reasoner, believes, “To the extent we can predict the future, we can control it,” and gets busy focusing on prediction. The causal reasoner loves market research, financial models, and other tools that increase their perception of control by helping them predict an unknown future.
The expert entrepreneur, the effectual reasoner, thinks differently. They believe, “To the extent I can control the future, I don’t need to predict it.” The expert entrepreneur eschews market research and long-term financial forecasts, expending none of their valuable energy on predicting the future. Why would they? The effectual entrepreneur is rooted in the belief that the future is neither found nor predicted, but rather made — by them. The effectual entrepreneur knows that they alone are able to create their own future — that it is not something that happens to them as they stand idly by.
Many entrepreneurs choose their path because of this worldview, whether they realize it or not. They want to be their own boss and take personal control over their own destiny. This control allows them to work on what they want, when they want, where they want, how they want, and with whom they want. They are the pilot in the plane, steering their craft wherever they want to go.
Granted, as a venture progresses, there are times when effectual reasoning is the best method, and others when causal reasoning is more appropriate. The expert entrepreneur doesn’t rely exclusively on effectual reasoning, but is able to utilize both methods effectively given the needs of their venture at any given point in time.
So, the question then becomes, “how do we control a future we can’t predict?” This leads in nicely to our second principle of Effectuation — Bird in Hand.
Principle # 2: Means — Bird in Hand
The Bird in Hand principle of Effectuation posits that effectual entrepreneurs start by looking at the resources at their disposal to determine the various futures (ventures) they can create, instead of having a pre-determined end in mind. Specifically, they look at three things: who they are, what they know, and who they know. If an entrepreneur can leverage all three of these elements effectively, they maximize the likelihood of their venture succeeding.
I recently had Allen Lim come in and share his founding story with our Startup Execution class at CU Boulder. Allen is the founder of Skratch Labs, a nutrition company serving high performance athletes. Allen’s family migrated from the Philippines to the United States a generation after his grandparents fled Communist China with their lives in danger. At a very young age, Allen became obsessed with cycling, and spent most of his youth riding his bike around the streets of suburban Los Angeles. His family didn’t have much money, so he would make homemade snacks out of rice patties to sustain him on his rides, and started experimenting with various homemade recipes for hydrating sports drinks that didn’t taste gross. Allen would go on to get his PhD in sports physiology from the University of Colorado Boulder, and become a trainer for U.S. pro cyclists Floyd Landis and Lance Armstrong — before quitting after becoming completely disheartened by the illegal doping taking place in the cycling world.
Jobless, with little money and no real plans, he and two friends started a side hustle selling ‘secret drink mix’ they were formulating out of Allen’s kitchen to friends and colleagues in the cycling world. Allen cared deeply about helping athletes perform at the top of their game: cleanly, healthily, and legally (who we was). He also had a deep understanding of sports physiology and had been making homemade sports drinks for years (what he knew). And he had many friends and colleagues in the amateur and pro cycling worlds (who he knew). He was leveraging the Bird in Hand principle of Effectuation by leveraging the means at his disposal to launch a venture he was uniquely positioned to create.
Having completely bootstrapped their business and taken no outside funding, Skratch Labs is now a rapidly growing national brand, distributed by Whole Foods and REI, and generating millions of dollars in revenue each year.
How did Allen get from 0 to 1? Well, he started by leveraged his unique set of means. But to grow his business, he would need to utilize the third principle of Effectuation — Co-Creation — to find new stakeholders that could help take his business to the next level.
Principle #3: Co-Creation — Crazy Quilt
The third principle of Effectuation, Co-Creation (or the Crazy Quilt), addresses how the expert entrepreneur is continuously accumulating stakeholders to help them create the future while reducing uncertainty. Generally speaking, the effectual entrepreneur takes the shortest path to get their initial product or service in the hands of a potential customer. Allen started by selling his drink mix to his friends. His initial customers became part of the ‘crazy quilt’ he was weaving by self-selecting into co-creating his venture with him. Allen’s earliest customers shared their feedback about the product, provided resources in the form of cash, and offered emotional support with their words of encouragement and enthusiasm for the product.
The Co-Creation principle also works before a company even has a product or service to sell. Effectual entrepreneurs perform customer development by going out and securing ‘pre-commitments’, which might look something like this:
Allen: I’m thinking of developing a sports drink. What would make you interested in buying my new product?
Friend: Well, I think the current sports drinks on the market are too sugary, and leave a crappy aftertaste in my mouth.
Allen: OK, neat. So if I can create a sports drink that has low sugar content and tastes great, would you be a customer?
Allen: Cool. What would you be willing to pay for that drink?
Allen: Awesome. So can I come back to you in a week and share with you what I come up with?
The simple example above shows how the expert entrepreneur gets ‘out of the building’ and is able to secure pre-commitments for a product that doesn’t yet exist, while simultaneously learning about the features people are looking for and the price point they are willing to pay for a new product.
And the Co-Creation Principle doesn’t just relate to acquiring customers. Allen couldn’t grow Skratch Labs without co-founders, employees, distribution partners, and suppliers as well. The Co-Creation principle is the method by which Allen allows new stakeholders to opt into his business at the commitment level they feel most comfortable making, while simultaneously de-risking his venture and minimizing cash outlay.
One way this works in practice is for the entrepreneur to pose the simple question, “What would it take for you to become a part of my venture?” This allows stakeholders to basically tell the entrepreneur what their level of commitment will be to the venture, framed within the concept of their ‘affordable loss’, which brings us nicely to the next key principle of Effectuation.
Principle #4: Affordable Loss — Focus on Downside
The Affordable Loss Principle of Effectuation details how expert entrepreneurs focus on minimizing the downside of their decisions and actions, thereby mitigating risk and facilitating action.
A lot of times, an entrepreneur is faced with what is called the ‘Plunge Decision’. Am I really ready to go all-in on this new venture? Often times starting a new venture feels very daunting. The entrepreneur might be deciding whether or not to leave a high-paying job, while needing to support a family, make a mortgage payment, and more. Taking the plunge can feel like a highly risky proposition.
The expert entrepreneur focuses on minimizing the downside in the case their venture fails, or determining what Effectuation calls their Affordable Loss. Let’s look again at the early days of Skratch Labs. Allen found two friends who were interested in helping him get his business off the ground in the earliest days. All three co-founders had other jobs. They were using Allen’s kitchen to develop and refine their recipes, they were using a local hardware store to mix their product in bulk, and they were taking all the money they made from their initial product sales and plowing it back into the company, making sure to never spend more money than they had in the bank. They figured out that they couldn’t really afford to lose very much, and so they were tight with their time and their money. In retrospect, the origins of Skratch Labs were very humble — there was no really big ‘plunge’ because Allen kept the downside of failure to a bare minimum. What if no one had bought their first batch of product? No big deal — they wouldn’t have been out of pocket more than a few hundred bucks, and they all still had their day jobs to fall back on.
So if you’re an entrepreneur and you’re having a hard time making a ‘Plunge Decision’, how can you look at things differently? What would you be willing to invest to give your venture a shot, and what would you be willing to lose? How about spending 15 hours a week working on your venture for six months, investing $2,000 in the process? Now you’ve figured out your affordable loss, and you can say,
“OK, I’m going to give this 6 months of 15 hours a week, and put $2k to work, to see if I can get this thing off the ground.”
In thinking this way, you’ve now lowered the barrier to starting your venture to something you can afford to lose, so it doesn’t feel daunting at all. Plunge away!
Principle #5: Leverage Contingencies — Lemonade
The last of the five key principles of Effectuation is the Leverage Contingencies principle, which focuses on how expert entrepreneurs take advantage of the inevitable surprises that pop up in the venture creation process and turn them into opportunities.
A great example comes from the origin story of Stacy’s Pita Chips. Back in 1996, Stacy Madison became sick of her corporate job and decided to follow her passion for food by starting a food cart in her hometown of Boston. As her pita sandwich cart grew in popularity, it was common for long lines to form. So Stacy got creative, taking the left-over pita bread from the night before, chopping it up and baking it in the oven, and handing these baked pita chips out to the folks while they were waiting on line for their sandwiches.
Well, needless to say, Stacy’s pita chips were a big hit, and this ‘happy accident’ soon turned into the bigger opportunity — and Stacy’s Pita Chips was born. 7 years later, Stacy’s Chips was doing $65 million in revenue and employed 300 people. So much for her sandwich cart!
There are always going to be twists and turns along the road of your startup venture. Unlike the causal thinker that is laser-focused on a specific end in mind, the expert entrepreneur leverages these happy accidents and is comfortable reshaping the direction of their venture to leverage these surprises into opportunities.
Tying it All Together
OK — let’s bring all this together and summarize Effectuation in a nutshell.
The Effectual entrepreneur is not focused on predicting what is going to happen, because that’s out of their control. The Effectual entrepreneur instead focuses on the things that are within their control to create their own future.
The Effectual entrepreneur looks at who they are, what they know, and who they know, to determine the means at their disposal to start a new venture.
The Effectual entrepreneur gathers stakeholders along the way that opt into co-creating the future with them, adding new means to their venture and potentially new goals as well.
The Effectual entrepreneur minimizes the downside of taking the ‘plunge’, mitigating the risk of moving forward as much as possible so they can have an action-oriented bearing.
The Effectual entrepreneur embraces surprises and accidents, understanding that sometimes those surprises can become the biggest opportunities.
So there you have it — Happy Effectuating!
I hope you found this post valuable. For those of you interested in learning more about Effectuation, I encourage you to watch Saras’ TED Talk on the subject, buy the book she has co-authored: Effectual Entrepreneurship, and/or visit the web site she founded, Society for Effectual Action.
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