Effectuation Theory of Entrepreneurship

What is the effectuation theory of entrepreneurship?

Dr. Saras Sarasvathy is an Indian born business school professor researching strategy, entrepreneurship and business ethics, currently appointed at the University of Virginia.

Sarasvathy proposed the theory of effectuation in the early 2000s after studying a sample of expert entrepreneurs with diverse backgrounds. Effectuation theory is often considered a process theory because it explains the process that entrepreneurs use to create new ventures. Effectuation theory stems from the way that expert entrepreneurs think about problems and how they go about solving them.

Effectuation logic contrasts with what Sarasvathy calls "causation theories" of entrepreneurship, where it is proposed that entrepreneurs start with a goal and then acquire the resources needed to achieve the goal, in a linear fashion. Each resource acquisition is a step toward the goal.

In stark contrast, effectuation logic involves evaluating resources that are available to use today and then deriving goals out of what can be made from the recombination of those resources. Thus, entrepreneurs don't just recombine resources to meet goals, they accept floating goals within a set of limits and allow the resources that are available now to guide the evolution of their strategies. By forgoing the need for expensive resource like large sums of startup capital, effectuators do in kind deals that achieve their desired effects.

Elaborating on the theory, Sarasvathy suggested that effectuation involves five core principles.

1) The bird in the hand principle: A bird in the hand beats two in the bush—This refers to maximizing the use of what an entrepreneur knows (i.e., their background and experience), who they know (e.g., friends, family and others around them), and aligning options based on who they are (i.e., what are the entrepreneur’s abilities).

2) The affordable loss principle: Only take on affordable losses—Don't obsess about windfall profits, but do try to minimize potential losses. This involves taking low probability bets, but only with a small investment of resources lost with each failure.

3) The crazy quilts principle: Make crazy quilts—Weave potential deals with potential partners until something sticks. Many iterations are often required. 

4) The lemonade principle: Make lemonade means to see potential in depressed or under-utilized resources. This is similar to the alertness principle.

5) The pilot in the plane principle—Focus on today, not next year.

Effectuation theory continues to gain research attention from entrepreneurship scholars and has made its way into entrepreneurship textbooks. There is some evidence that expert entrepreneurs use effectuation logic more often than causal logic, providing some support for the theory. One meta-analysis suggests that most of the core effectuation behaviors are positively related to venture performance (Read, Song and Smit, 2009).

As an example, a chef using causal logic decides to cook a particular meal recipe and then gathers the requisite ingredients to do so. A chef using effectuation logic looks in the fridge to see what ingredients are available, then improvises a meal using what is there. Causation logic is rational and may be best employed in situations that do not involve too much uncertainty. By contrast, effectuation logic is useful when there is uncertainty about the goals of the entrepreneur, and therefore, no definable selection environment to analyze (Chandler, DeTienne, McKelvie, and Mumford, 2011).

Effectuation theory is rising fast in academic teaching because it offers a theory-rich complement to experiential courses such as Lean Launch Pad.

 

Sources:

Sarasvathy, S. D. (2001). Causation and effectuation: Toward a theoretical shift from economic inevitability to entrepreneurial contingency. Academy of management Review, 26(2), 243-263.

Chandler, G. N., DeTienne, D. R., McKelvie, A., and Mumford, T. V. (2011). Causation and effectuation processes: A validation study. Journal of business venturing, 26(3), 375-390.

Read, S., Song, M., and Smit, W. (2009). A meta-analytic review of effectuation and venture performance. Journal of Business Venturing, 24(6), 573-587.