Thursday, April 19, 2012

Everything you know about entrepreneurship is wrong

How do you achieve anything when the world seems uncertain and unpredictable? How does any new venture succeed? And are entrepreneurs nuts to run the kind of risks they do?
Here's an intriguingly different way to look not just at these questions, but also how people think more generally: Effectuation: Elements of Entrepreneurial Expertise by Saras Saravathy, a professor at Darden Business School at U Va.

It is a brilliant take on how much of the traditional understanding of entrepreneurship is wrong. Published in 2008, it has reportedly been shaking up the business school world.

She systematically interviewed 27 leading entrepreneurs and found most of them had a distinctive way of looking at things. And it was not consistent with the traditional view of the entrepreneur as a crazy, risk-taking visionary (although they often like to see themselves this way when they have succeeded.)
Entrepreneurship is not a personality trait or an extra willingness to take risks, she says.

It is not even a special skill in recognizing new demand or new opportunities. New markets are seldom created by new demand, as consumers often have no idea they would want a new product.
But successful entrepreneurship is a form of expertise, however. It is a way of thinking, a method of dealing with uncertainty. There is a logic of "effectuation", as opposed to causation or prediction.
So what is effectuation?
Effectual logic provides useful design principles for transforming extant environments into new futures in the face of ambiguous goals.
That definition is brainy but a bit indigestible (and the book as a whole is quite academic). But she does boil down what this means in practice.
She says (and I quote):
    • Expert entrepreneurs begin with who they are, what they know and whom they know, and immediately start taking action.
    • They focus on what they can do and do it, without worrying much about what they ought to do.
    • Some of the people they interact with self-select into the process by making commitments to the venture.
Expert entrepreneurs use a bird-in-hand principle, she says, creating something new with existing means rather than aiming to discover new ways to achieve given goals. They think in terms of affordable loss, rather than calculating expected returns. And they will negotiate with all stakeholders who will make actual commitments to the project.
They almost uniformly prefer one initial customer/partner to help develop a product rather than market research or elaborate prediction of market segments and size. They see human agency as the primary driver of opportunity, rather than technology or economic trends.

In other words, markets are made, especially through partnerships, not found by segmentation or prediction.
Effectual models begin with given means and seek to create new ends using non-predictive strategies... It makes these relationships a matter of design rather than decision.

So entrepreneurship is more like stitching together a patchwork quilt rather than solving a prefabricated rational jigsaw puzzle, she argues. Standard economics is fine for understanding established markets. But effectuation generalizes this. Established markets are a subset of markets that can be fabricated.
Effectuation is also a means of dealing with deep uncertainty. Its "problem space" includes Knightian uncertainty, where it is impossible to calculate probabilities for future consequences, goal ambiguity, when preferences are not given, stable or well-ordered, and isotropy.
Isotropy refers to the fact that in decisions and actions involving uncertain future consequences it is not always clear ex ante which pieces of information are worth paying attention to and which are not.
Incidentally, the word isotropy is new to me, but I think it is the key to many of the challenges we face. Most major economic and social problems are a matter of attention and perception, not simply analysis and parsimonious prediction.
Effectuators do not start off with a goal in mind, she says. Instead, they begin with a set of means and ask what they can do with them, and allow goals to emerge. And much of the goals and nature of the entreprise are set by the kind of partnerships that emerge.
Effectuation emphasises alliances and precommitments from stakeholders as a way to reduce and/or eliminate uncertainty and erect entry barriers.
Effectuators do not think about competitors, so much as partnerships right from the start. And they see unexpected events as opportunities to leverage and/or exercise control of the situation, as potential serendipity.
Effectual logic turns standard causal logic on its head, she claims.
Causal and effectual logics both seek control over the future. But causation focuses on the predictable aspects of an uncertain future. The logical premise goes something like this: To the extent we can predict the future, we can contol it. Effectuation, on the other hand, focuses on the controllable aspects of an unpredictable future. The logic here is: To the extent that we can control the future, we do not need to predict it.
And entrepreneurs do not necessarily seek risk.
effectuators see themselves not as risk rakers defying long odds but as active agents capable of causal intervention in changing those odds.
And over time the failure rate for entrepreneurs is better than for new firms they start. They take limited risks and kill off unsuccessful ventures quickly, she says.

I find all of this persuasive. She does not mention it, but there are also many echoes from another famous research paper which dates back to 1959, The Science of "Mudding Through" by Charles Lindblom. He argued that administrators and policymakers proceed not by the "root" method of rational means-end analysis, but by the "branch" method of starting with where they are and doing successive limited comparisons. They "muddle through" instead of deducing the most rational way forward - and indeed, this is the only realistic way to do policymaking.

Other studies find corporate managers and decision-makers have a similar perspective. They think of risk not as volatility, as financial economics has it, but as the extent to which they can control the situation in the event of contingencies.

And both can be seen as examples of the "adjacent possible" which evolutionary theorist Stuart Kauffman says is one of the building blocks of how evolution works. Evolution is an algorithm which efficiently explores nearby possibilities.

But entrepreneurs do not see the process as a standard "monkey with a dartboard" variation and selection. They feel they can exercise some control.

She does not explore the policy implications of her stance. But they could be considerable, given the amount of government money that is shovelled into promoting new business and influencing location every year. And it is a practical and fascinating account of how the economy evolves in practice.

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