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Leveraging Uncertainty. Effectuation for managers
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Leveraging Uncertainty. Effectuation for managers

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The unexpected emergence of the COVID-19 and its uncertain consequences is making managers to turn their attention to entrepreneurial tools….those where linearity and prediction are not the protagonist any longer. Leaders equipped with an entrepreneurial mindset are not just more prepared to deal with uncertainty and to increase the likelihood of their organisations to survive. They can also step up to help others in need. When it comes to face uncertainty, Effectuation is the tool par excellence. So, What’s effectuation?

Effectuation is a logic of thinking for decision making. Originally researched by Dr. Saras Sarasvathy to explain entrepreneurial behaviour, it has also been developed into a set of tools used in companies when coping with unpredictable situations.

Effectuation underlines the idea of leveraging uncertainty. Uncertainty can be a resource rather than an avoidable state. On this basis, the central point of Effectuation is that action begins with the available resources, and those resources are the most important input to gradually establish objectives (broad and varied, not specific). This is a type of reasoning inverse to causal reasoning, the standard approach in business (and in most business schools), where entrepreneurs and managers start with clear goals and then look for the resources to achieve them.

More in detail, Effectuation develops four principles:

Bird-in hand. Start with your means (instead of pre-set specific goals). In other words: what can you do with what you have? Take action based on what you have readily available. That is: Who you are? (Your skills, interests, passions), What do you know? (What you know to do, your education, expertise, training); and Whom you know? (Your networks)

Let’s take a look at an example under the current COVID-19 conditions. Glasgow Distillery, a spirits company, is now producing hand sanitiser for a number of health organisations and charities across Scotland. They have a key mean: they know how to make alcohol. In a rapidly changing situation they are using this mean to mitigate the harsh impact of the pandemic on their business. Along with protecting their workforce, they are helping to contain the virus.

Affordable Loss (instead of expected return). Make decisions firstly examining what you are willing to lose, before calculating all the return you are expecting to get. The loss is established on what you have, then it is known in advance and it responds to a controllable reality. The expected return is established on prediction

Lemonade (instead of avoiding contingency). Traditional strategic planning is built upon the idea of avoiding surprises at any expense. That is why generating alternative scenarios is a common practice in organisations that use a sequential model when developing their strategy. While this may be useful in slow-change and full-of-information situations, in entrepreneurial situations surprises are every day nature, and entrepreneurs take advantage of them. Entrepreneurially-minded leaders can develop the ability to turn the unexpected into the profitable. If you come across lemons, make lemonade!

Co-creation partnership (instead of focus on competitors). Once an entrepreneur stocks her means and identifies an affordable loss, she needs external input. The focus is on building partnerships instead of beating competitors. The goal is developing the so-called stakeholder commitment: building a network of self-selected stakeholders who have similar interests, are willing to commit themselves and leverage what they can afford to lose together.

The interaction with stakeholders brings new means and more specific goals into the venture. Among others, stakeholders may be suppliers, customers, or early adopters. For an organisational manager key stakeholders are also employees.

Managing effectually

All in all, effectuation may empower managers when encouraging and supporting action in critical situations. Direct your action examining the following:

What can you do now with what you have…now? Use a combination of your strengths and whatever means you have. Stock not just your company’s know-how, expertise and market information. Search for the collective knowledge of your people. Then, set goals on the fly.

When doing this, what are you willing to lose? Think not only about money, but also opportunity cost, time, emotions, reputation, leadership or control of the organisation. Under uncertainty, you better don’t make decisions based on linear predictions of expected returns, but on what you have at hand. This is your managerial way to control risk.

Whom can you do this with? Reaching out other people looking for co-creation will likely generate new opportunities. It is not only for whom you create a solution. It is also with whom you co-create it? For this purpose, customers facing problems because of a critical situation can also be insightful stakeholders in the process. Stakeholder participation leads to the development of new outcomes.

Use this mental artillery when thinking ahead and when making decisions. Effectuation challenges the tenets of strategic planning exactly in the same way that (an uncertain) reality does.

There are some topics about Effectuation that raise similar curiosity among entrepreneurs and corporate people alike. In this article I address the 5 most repeated questions I have being asked in diverse Effectuation trainings, lectures and workshops I have delivered over the past three years.

 

Photo: Robert Sölle by Sven Adrian

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If you want to know more about Effectuation, you might want to take a look at this book:

Read, S.; Sarasvathy, S.; Dew, N.; Wiltbank, R. (2017) Effectual Entrepreneurship. 2nd. Edition. Routledge. NY.

Five questions about Effectuation
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Five questions about Effectuation

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There are some topics about Effectuation that raise similar curiosity among entrepreneurs and corporate people alike. In this article I address the 5 most repeated questions I have being asked in effectuation trainings, webinars and lectures I have delivered over the past three years.

For newbies: Effectuation is a logic of thinking for making decisions under uncertainty. It has been discovered through research and it is known that expert entrepreneurs used it. Effectuation is based on four principles, which I go through in this other article.

The top five questions:

1. Can effectuation also be used in companies? Or is it useful only for entrepreneurship?

  Yes, effectuation can be – and is actually used in companies.

While rooted in entrepreneurship, effectuation may also be useful for medium sized and big companies. And this is for a good reason: Effectuation is a method for making decisions in situations with high levels of uncertainty. You may be wondering what is a highly uncertain situation? Those when there is no way to calculate probabilities of future scenarios. The logic of predictive rationality does not work any longer, and then the future is not only unknown, but unknowable.  

High uncertainty is the scenery’s flora and fauna for most entrepreneurs. However, venturing in unknown markets is not exclusively a “privilege” of entrepreneurs. Companies also face situations when there is no previous information to frame upcoming decisions. Radical innovation is a clear example. When large companies want to commercialize a new technology, there is no way to rely on predictions about the potential demand, simply because the market does not yet exist. It is a bit difficult trying to predict the reaction of a market…in the absence of this market.

Among other examples, there is sound evidence showing that effectuation is significantly related to success in highly innovative corporate contexts and in domains such as strategy and marketing.

2. What is the key difference between effectuation and other approaches in entrepreneurship?

  “How you think about goals and means”

In words of Dr. Saras Sarasvathy, creator of the framework, the key difference between other approaches and the effectual one is “how you think about goals and means”. Effectual entrepreneurs work with means (effects), as opposed to causal entrepreneurs who start out with clear goals (causes) and then search for means to reach this goal. The message is clear: Act now with what you have now.

Working with means allows the entrepreneur to leverage uncertainty. Surprises create new opportunities.

Causal approaches, on the other hand, are the standard framework in most business schools and entrepreneurship training programmes.

3. Are the effectual approach and the traditional (causal) approach mutually exclusive?

  No, they may co-exist.

Effectuation is not a replacement for the causal-predictive model. Certain situations call for an effectual approach while others for a causal approach. This is because decision-making is situational. What  distinguishes one from the other? The simplest answer is the amount of pre-existing information we can rely upon. With substantive previous information we can identify patterns, then we can predict…with more or less accuracy, but we can give it a try.

Take the company’s stage of development as an example. Once the initial process ends up and the company grows in size, it is useful (and possible) to use a more predictive approach to sustain the value created. That is possible because the market is already known.  

Another example: when it comes to explain the effects of causal and effectual behaviour on business innovation model, recent research has revealed that effectuation is more effective in high industry growth contexts and causation in low industry growth contexts.

All in all, the key question when comparing causation and effectuation is not which one is better, but which one is more effective under which circumstances.

4. Does effectuation mean: “not planning”?

  It depends on what you mean by “planning”

Planning requires specific goals and effectuation’s starting point is different than a specific goal. For the effectual approach action begins with the available means the entrepreneur has, and those resources are the key input for gradually setting goals. In the absence of previous information, setting specific objectives (particularly log-term ones) may be a useless exercise. So, yes, planning is not worthless as long as goal setting is a loose and incremental process that uses new/contingent information as resources for developing goals. In other words, when initial objectives are not specific, and the entrepreneur is flexible-enough to resetting them when required.

For example, when an opportunity is identified it starts an idea-development process. Along the way, this idea will undergo a number of transformations, likely ending up in a different product and/or in a not foreseen market. This process is impossible to predict, therefore cannot be planned.

5. Are Effectuation and Lean Startup compatible?

  Short answer: Indeed.

Lean Startup and Effectuation share two key assumptions:

  • Uncertainty is not faced with more planning. Traditional models promote exactly the opposite: uncertainty is faced elaborating (even) more detailed plans and alternative-scenarios.
  • Development is always incremental. Both frameworks do not expect you to come up with the finest, ready, final version of a business model from the beginning. Lean and Effectuation promote iterative design over “big design upfront” development.

Despite the common assumptions there are a number of differences between both approaches. The most apparent divergence is their starting points: for lean, is an idea, for effectuation is the entrepreneur. This however, is what enables compatibility. They can create value together precisely because they are different.

The lean entrepreneur goes through the feedback-loop, which consists of building a product (starting with a MVP), measuring (testing propositions about the initial business models) and learning (developing insight to be incorporated into the next version of the product). This cycle can be made more precise and less expensive if the effectual dimension is introduced by generating combinations of existing means until they converge into a viable concept. Missing means can come from stakeholders, such as supportive early adopters, in a co-creation process in successive iterations.

So, the iteration gives the entrepreneur a key resource not just to permanently set new goals, but also to increase the amount of useful means, thus developing the business model. Moreover, linking this effectual idea of increasing the amount of means with the lean concept of minimising waste when shorten product development cycles, may create additional compatibility.

All in all, even though the lean and the effectual cycles are not the same, both search for producing a type of learning that is validated by a previous interactive experience. This experience necessarily requires different stakeholders’ feedback.

Effectuation is an evolving idea, as Sarasvathy likes to say. Today, more than ever, an effectual mindset is indispensable in organisations ready to re-built (or build differently) the value they create for society.

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If you want to know more about Effectuation, you might want to take a look at this book:

Read, S.; Sarasvathy, S.; Dew, N.; Wiltbank, R. (2017) Effectual Entrepreneurship. 2nd. Edition. Routledge. NY.

Entrepreneurship: It’s not only about who you are…but also where you are.
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Entrepreneurship: It’s not only about who you are…but also where you are.

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What do you need to promote entrepreneurship? Entrepreneurially motivated people or an entrepreneurial culture? Both? …not really, one might just be enough.

The question why some societies are more entrepreneurial than others has been asked for about a century in the social sciences. The question why some individuals are more entrepreneurial than others is even older. To answer both questions separately there is a substantial amount of good information we can rely upon today.

Entrepreneurship, however, is a multilevel phenomenon. In order to properly grasp it, individual and social level analysis should be performed at the same time. Hence, questions addressing how these two levels of analysis interact become particularly relevant when trying to draw an accurate picture. And – comparatively speaking – this type of questions is far newer. The key reason to use this multilevel analysis is that entrepreneurial behaviour can only be understood if the context of the individual is taken into account. That means, we need to acknowledge that situational contingencies can change the relevance of individual characteristics.

Research in the field has traditionally focused on either the nature of the entrepreneur or the types of contexts that promote entrepreneurship. At the individual level, a huge body of literature has looked into the personal characteristics of entrepreneurs. Above all, topics such as personality traits, entrepreneurial skills, cognition, risk tolerance and the need for achievement, have received a great deal of attention. Something similar happens with studies that compare countries. Country-level researchers have mainly looked at economic, market and cultural-institutional conditions that hinder or facilitate entrepreneurial activity.

We published a research article showing evidence on how entrepreneurial motivations and national culture interplay. In that article we answer the question: Where are individual motivations more important to explain entrepreneurial behaviour, in more or less entrepreneurial societies?

Intuitively, a conjoint effect could be expected: both, cultural values and individual motivations reinforce each other when it comes to explaining the individual’s decision to be an entrepreneur. In other words, the more entrepreneurial a society is, the more relevant individual motivations might be to explain entrepreneurial behaviour.

Well…not that fast! Our study proves that the contrary is the case. Individual motivations are more important in cultures that are not supportive of entrepreneurship. Moreover, individual motivations and cultural values compensate for each other in explaining entrepreneurship. That is: an entrepreneurial culture does not necessarily increase the probability to be an entrepreneur for somebody who is already driven by personal entrepreneurial motivations. Instead, culture may play an instrumental role in compensating for the lack of these individual motivations, increasing the likelihood of being an entrepreneur.

We frame the findings within the situational strength theory, according to which contexts may restrict the effects of individual drivers, if they provide strong incentives for the desirability of a specific behaviour. Applied to entrepreneurship, this means that individual motivations may determine behaviour particularly in weak situations, meaning those situations in which few external rewards reinforce entrepreneurial behaviour. In strong situations, where there are large situational incentives in favour of this behavioural outcome, individual characteristics (motivational values, in this case) become less important because they are overruled by situational cues. They are just not as relevant any more.

Thus, we can conclude that individual motivations are a more important driver of entrepreneurship in less entrepreneurial cultures. In such cultures a person has to rely more on his/her motivational values. So, it is in non-entrepreneurial societies that (potential) entrepreneurs need to overcome the lack of societal resources, incentives and social legitimation. We got these insights developing advanced statistical models using data from the European Social Survey, which includes more than 35.000 individuals living in 28 countries.

The effects of entrepreneurship on economic development and social innovation are widely acknowledged and have triggered a massive interest in identifying its determinants. Studies such as this one contributes to understand what explains entrepreneurship and how these explanatory variables interact. The article presents fine-grained analysis integrating different-levels of entrepreneurship determinants and providing key evidence-based insights: individual motivations are essential in the decision to be an entrepreneur, but they are even more important in societies that do not highly promote entrepreneurship. Culture matters, but it matters differently depending on a person’s motivational values.

A number of implications can be drawn from these insights. Particularly for entrepreneurial education and policy-making in targeting (would-be) entrepreneurs who are most likely to benefit from societal support.

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If you want to know more about the topics discussed here, you might want to take a look at the following articles:

Autio E, Pathak S and Wennberg K (2013) Consequences of cultural practices for entrepreneurial behaviors. Journal of International Business Studies, 44(4): 334‒362. DOI: 10.1057/jibs.2013.15.

Cooper W and Withey M (2009) The strong situation hypothesis. Personality and Social Psychology Review 13(1): 62‒72. DOI: 10.1177/1088868308329378.

De Clercq D, Lim D and Hoon Oh C (2013) Individual-level resources and new business activity: the contingent role of institutional context. Entrepreneurship Theory and Practice 37(2): 303‒330. DOI: 10.1111/j.1540-6520.2011.00470.x.

Fayolle A, Liñán F and Moriano J (2014) Beyond entrepreneurial intentions: values and motivations in entrepreneurship. International Entrepreneurship and Management Journal 10(4): 679‒689. DOI: 10.1007/s11365-014-0306-7.

Fuentelsaz L, Maicas J, and Montero J (2018) Entrepreneurs and innovation: The contingent role of institutional factors. International Small Business Journal 1-26

Hayton J and Cacciotti G (2013) Is there an entrepreneurial culture? A review of empirical research. Entrepreneurship & Regional Development 25(9-10): 708‒731. DOI: 10.1080/08985626.2013.862962.

Licht A (2010) Entrepreneurial motivations, culture, and the law. In: Freytag A and Thurik R (eds) Entrepreneurship and Culture. Berlin: Springer-Verlag, pp. 11‒40.

Liñán F, Moriano JA and Jaén I (2016) Individualism and entrepreneurship: does the pattern depend on the social context? International Small Business Journal 34(6): 760‒776. DOI: 10.1177/0266242615584646.

Schwartz SH (2011) Values: cultural and individual. In: Van de Vijver FJR, Chasiotis A and Breugelmans SM (eds) Fundamental Questions in Cross-Cultural Psychology. New York: Cambridge University Press, pp. 463‒493.

Shepherd DA (2011) Multilevel entrepreneurship research: opportunities for studying entrepreneurial decision making. Journal of Management 37(2): 412‒420. DOI: 10.1177/0149206310369940.

Shepherd DA and Patzelt H (2018) Entrepreneurial Cognition, Motivation and Entrepreneurial Cognition. In: Shepherd DA and Patzelt H (eds) Motivation and Entrepreneurial Cognition. Exploring the mindset of entrepreneurs. Cham: Palgrave Macmillan.

Stephan U, Uhlaner L and Stride C (2015) Institutions and social entrepreneurship: the role of institutional voids, institutional support, and institutional configurations. Journal of International Business Studies 46(3): 308‒331. DOI: 10.1057/jibs.2014.38.

Wennberg K, Pathak S and Autio E (2013) How culture molds the effects of self-efficacy and fear of failure on entrepreneurship. Entrepreneurship and Regional Development. An International Journal 25(9-10): 756‒780.

Business Plan or Business Wish List?
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Business Plan or Business Wish List?

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Contrary to conventional wisdom, it is not possible to develop a business plan for every business idea. If you are in the disruptive-innovation arena playing the new product–unknown market game, for example, developing a business plan may be just time wasted. People like Richard Branson, Steve Blank, Pierre Omidyar o Saras Sarasvathy, among others, have expressed their not so encouraging opinion about writing a business plan.

Nevertheless, there are  situations when you certainly need a business plan. And – let’s face it – regardless of how realistic it is to properly plan something, there are many situations where a business plan is required for those who will potentially fund your venture.

So, if you have to do a business plan, you need to be sure that it is a plan, not just a detailed list of wishes. Take the following five points as basic double-checking criteria to ensure you are on the right planning track.

1. Problem instead of product. Focus your efforts, particularly your initial efforts, on identifying a problem or a need. Most business plans are product-driven and too much ink is spent on describing how wonderful, innovative, faster…whatever the product is. By making the problem/need the centre of your approach, you make your business plan market-driven. It’s not only a different starting point; it’s a whole different perspective. Analysing a problem/need leaves clearer room for introducing a solution: your product. A product is successful when there is a market willing to pay for it, and people pay for solved problems, not necessarily for wonderful products.

Use a Lean Startup approach here. Once you have identified a problem, validate its existence and key features.

2. Quantify the consequences of this problem. This is a valuable step ahead of merely identifying a problem. And very few entrepreneurs do it. This will give you early insight on how much your customer may be willing to pay for the solution you offer.

Quantify not only the economic consequences, but also the non-economic consequences of the problem. And do it both at the individual and at the aggregate level. Then you will be able to distinguish between personal and social consequences. Very likely, this will lead you into a path of discovering new opportunities.

How many resources your product can prevent to lose is also a powerful argument in front of investors.

3. Suspect if everything is going well. Think it over (and over again) if you are proving everything you wanted to prove or your calculations are going the way you expected. Entrepreneurs are masters of the confirmation bias. That is: searching and interpreting information in a way that confirms their assumptions. This bias is extensively used when collecting market information. For example, designing an experiment, survey, interview, MVP test (or whatever is used to collect information) to hear what they want to hear. It typically happens when doing lean iterations or when trying to test Business Model Canvas’ hypotheses.

Entrepreneurs’ cognitive biases are well studied. There is consistent evidence pointing that over-optimism and over-confidence influence early decisions frequently with not positive results. Two other well-known cognitive shortcuts when planning are: the planning fallacy (underestimating how much time will be needed to complete a task while overestimating its relevance), and the self-serving bias (attributing success to personal factors, but failures to external ones).

Cognitive biases are used to acquire external information. And they occur to everyone, really. Not everyone, however, has to make business decisions to compose a business plan. How realistic your business plan is, depends on the extent to which cognitive biases are overcome.

4. Use evidence-based information. This third point alone would require an entire post. Let’s summing it up this way: support your key decisions with data. It sounds familiar, doesn’t it? However, as intuitive as it is, research and data are mostly used in a spur-of-the-moment way in business plans.

Be aware of these three red flags…and avoid them (there are more, but these are the top three research flaws I have mostly seen).

  • Planning the research with no clear objectives. Ideally, all the research you conduct should be used to support your decisions.
  • Using anecdotal evidence. Basing your decisions on what has happened to you or to people you know (very likely, people similar to you), is not necessarily useful. Therefore avoid surveying your friends, for example.
  • Collecting primary data when more reliable (and cheaper) secondary data are available

5. Work with milestones. It’s not only because milestones make your goals concrete. It’s because milestones give you quick wins. And when you are launching a business you need them. Football’s match-to-match mindset works very well when venturing. It does not mean that you don’t care about your vision; it means that in order to walk towards it, you know that the most important step is today’s action. And action is what milestones condense.

Equip your milestones with the following: needed resources, a time window, and metrics. These are three key features to give you comparable information over time, track your progress, manage responsibilities, review your decisions and improve your plan. Without milestones, there may be strategic thinking, but there is no strategic action as part of the daily business.

In addition to these steps, keep in mind that customising your plan is an indispensable early task for any entrepreneur. Business plans have different audiences, for instance: potential employees, suppliers, partners, board members or investors. Even within investors, there is significant variety. Different kinds of funders use different criteria to make an investment decision. Depending on whether you are targeting banks, venture capitalists, business angels, or crowd funding as source of funds, you need to emphasise different aspects of your business plan.

A convincing business plan is not easy to create, largely because entrepreneurs tend to mix up the planning with the wishing. Take these five points to temper your entrepreneurial passion with the necessary market reality and I guarantee the planning will be easier, sounder and far more rewarding!