What makes entrepreneurs entrepreneurial


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What makes entrepreneurs entrepreneurial

  1. 1. What makes entrepreneurs entrepreneurial? Saras D. Sarasvathy Associate Professor The Darden Graduate School of Business Administration University of Virginia sarasvathys@darden.virginia.edu
  2. 2. What makes entrepreneurs entrepreneurial? Professionals who work closely with them clear in the next section, I have termed this typeand researchers who study them have often of rationality “effectual reasoning”.speculated about what makes entrepreneurs“entrepreneurial”. Of course, entrepreneurs also Effectual reasoning: The problemlove to hold forth on this topic. But while there The word “effectual” is the inverse ofare as many war stories and pet theories as there “causal”. In general, in MBA programs acrossare entrepreneurs and researchers, gathering the world, students are taught causal ortogether a coherent theory of entrepreneurial predictive reasoning – in every functional areaexpertise has thus far eluded academics and of business. Causal rationality begins with apractitioners alike. pre-determined goal and a given set of means, What are the characteristics, habits, and and seeks to identify the optimal – fastest,behaviors of the species entrepreneur? Is there cheapest, most efficient, etc. – alternative toa learnable and teachable “core” to achieve the given goal. The make-vs.-buyentrepreneurship? In other words, what can decision in production, or choosing the targettoday’s entrepreneurs such as Rob Glaser and market with the highest potential return inJeff Bezos learn from old stalwarts such as marketing, or picking a portfolio with the lowestJosiah Wedgwood and Leonard Shoen? Or even risk in finance, or even hiring the best person forwithin the same period in history, what are the the job in human resources management, are allcommon elements that entrepreneurs across a examples of problems of causal reasoning. Awide variety of industries share with each other? more interesting variation of causal reasoningIn sum, is there such a thing as “entrepreneurial involves the creation of additional alternatives tothinking” that can be applied across space, time achieve the given goal. This form of creativeand technology? causal reasoning is often used in strategic In 1997, I set out on a rather perilous but thinking.exhilarating journey to investigate this question. Effectual reasoning, however, does notTraveling across 17 states in the US over several begin with a specific goal. Instead, it begins withmonths, I met with 30 founders of companies a given set of means and allows goals to emergeranging in size from $200 M to $6.5 B and contingently over time from the variedspanning a variety of industries from steel and imagination and diverse aspirations of therailroad to teddy bears and semiconductors and founders and the people they interact with.bio-tech. The idea behind the study was not While causal thinkers are like great generalsmerely to interview these founders, but to get seeking to conquer fertile lands (Genghis Khanbehind their stories and understand how they conquering two thirds of the known world),reason about specific problems in transforming effectual thinkers are like explorers setting outan idea into an enduring firm. The entrepreneurs on voyages into uncharted waters (Columbusworked their way through a 17-page problem set discovering the new world). It is important toover two hours, talking aloud continuously as point out though that the same person can usethey each solved exactly the same ten decision both causal and effectual reasoning at differentproblems to build a company starting with times depending on what the circumstances callexactly the same product idea. Rigorous for. In fact, the best entrepreneurs are capable ofanalyses of the transcribed tapes led to rather both and do use both modes well. But theysurprising but eminently teachable principles. prefer effectual reasoning over causal reasoningThis set of principles, when put together, rested in the early stages of a new venture, andon a coherent logic that clearly established the arguably, most entrepreneurs do not transitionexistence of a distinct form of rationality that we well into latter stages requiring more causalhave all long recognized intuitively as reasoning. Figure 1 graphically depicts the“entrepreneurial”. For reasons that will become different forms of reasoning discussed above. 2
  3. 3. Figure 1 unspecified ingredients and cook a meal with them. While both causal and effectual reasoning Managerial Thinking -- Causal Reasoning call for domain-specific skills and training, Distinguishing Characteristic: Selecting between given means to achieve a pre-determined goal effectual reasoning demands something more – imagination, spontaneity, risk-taking, and M1 salesmanship. M2 Given Effectual reasoning: The process M3 Goal All entrepreneurs begin with three M4 categories of means: (1) Who they are – their traits, tastes and abilities; (2) What they know – M5 Given Means their education, training, expertise, and experience; and, (3) Whom they know – their social and professional networks. Using these Strategic Thinking -- Creative Causal Reasoning means, the entrepreneurs begin to imagine and Distinguishing Characteristic: Generating new means to achieve pre-determined goals implement possible effects that can be created M1 with them. Most often, they start very small with the means that are closest at hand, and M2 move almost directly into action without Given elaborate planning. Unlike causal reasoning that M3 Goals comes to life through careful planning and subsequent execution, effectual reasoning lives M4 and breathes execution. Plans are made and M5 New means unmade and revised and recast through action are generated and interaction with others on a daily basis. Yet at any given moment, there is always a Entrepreneurial Thinking -- Effectual Reasoning meaningful picture that keeps the team together, Distinguishing Characteristic: Imagining possible new ends using a given set of means a compelling story that brings in more Imagined stakeholders and a continuing journey that maps Ends out uncharted territories. Through their actions, Given Means E1 the effectual entrepreneurs’ set of means and consequently the set of possible effects change M1 E2 and get reconfigured. Eventually, certain of the M2 M3 emerging effects coalesce into clearly achievable M5 E3 M4 and desirable goals -- landmarks that point to a E... discernible path beginning to emerge in the En wilderness. Yet, in our classrooms, we teach potential While causal reasoning may or may not entrepreneurs an extremely causal process – theinvolve creative thinking, effectual reasoning is sequential progression from idea to marketinherently creative. The simple task of cooking research, to financial projections, to team, todinner may be used to contrast the two types of business plan, to financing, to prototype, toreasoning. A chef who is given a specific menu market, to exit, with the caveat, of course, thatand has only to pick out his or her favorite surprises will happen along the way. Seasonedrecipes for the items on the menu, shop for entrepreneurs, however, know that surprises areingredients and cook the meal in their own well- not deviations from the path. Instead they areequipped kitchens is an example of causal the norm, the flora and fauna of the landscape,reasoning. An example of effectual reasoning from which one learns to forge a path throughwould involve a chef who is not given a menu in the jungle. The unexpected is the stuff ofadvance, and is escorted to a strange kitchen entrepreneurial experience and transforming thewhere he or she has to explore the cupboards for 3
  4. 4. unpredictable into the utterly mundane is the bring her idea to market? When used as a classspecial domain of the expert entrepreneur. exercise, students usually suggest courses of Let us consider how the two processes action such as partnering with an existingoperate in the simple case of building a restaurant, participating in ethnic food fairs,restaurant. Imagine an entrepreneur who wants setting up a catering service and so on. Let usto start an Indian restaurant. In the causal say that the actual course of action she decidesprocess that we teach, she would start with some to pursue is to persuade friends who workmarket research into the restaurant industry in downtown to allow her to bring lunch for theirthe city of her choice; select a location very office colleagues to sample. Let us further saycarefully based upon the market research; that some customers then sign up for a lunchsegment the market in a meaningful way; select service and she begins preparing the food attarget segments based on estimates of potential home and delivering lunches personally.return; design a restaurant to appeal to her target Eventually, she could save up enough money tosegments; raise the required funding; bring her rent a location and start a restaurant.team together; and finally, implement specific But it could equally be plausible that themarket strategies and manage daily operations to lunch business does not take off beyond the firstmake her restaurant a success. few customers, but instead our entrepreneur discovers that the customers are actually Figure 2 interested in her ethnic philosophy and life experiences or Indian culture or other aspects of Classic Causation Model from Marketing Textbooks her personality or expertise or contacts or Market Definition interests. She could then decide to go into any Segmentation one of several different businesses contingent (using relevant variables such as age, income, etc.) upon the ensuing feedback. To cite but a few Targeting possibilities, her eventual successful enterprise (based on evaluation criteria such as expected return) could turn out to be in any one or all of the Positioning following industries -- education, entertainment, (through marketing strategies) travel, manufacturing and packaging, retail, To reach interior decoration, or even self-help and motivation! THE CUSTOMER Figure 2 graphically depicts and contrasts the causal marketing process with the effectual one.1 Real life examples of effectual processes Customer Identification in entrepreneurship abound. In fact, the stories (through Who am I? of effectuation permeate and saturate the history What do I know? Whom do I know?) of entrepreneurship since at least as far back as Customer Definition the eighteenth century: In the eighteenth (through strategic partnerships & “selling”) century, a potter named Josiah Wedgwood, Adding Segments/Strategic Partners realized that pots can carry people’s aspirations Definition of one of several possible markets for social mobility; in the twentieth, King Gillette began toying with the idea of creating Process of Effectuation Used by Expert Entrepreneurs something that customers would want to 1 In the effectual process, it would all depend It is easy to see that the inverted causal triangle aton who our entrepreneur is, what she knows, and the top can be moved to the bottom below the uprightwhom she knows. For the sake of understanding effectual triangle and that would capture thethe process here, let us say she is a good Indian marketing life cycle of most entrepreneurial firms. Once the market had been clearly identified andchef who is considering starting an independent defined, one can now apply the traditional causalbusiness. Assuming she has very little money of marketing process to capture market share and growher own, what are some of the ways she can the company. 4
  5. 5. repeatedly re-purchase and while shaving one -- get me and my buddies -- or I would go outmorning, hit upon disposable razors as a and start selling. I’d learn a lot you know..possibility; Tom Fatjo, a respectable which people.. what were the obstacles.. whatprofessional in Houston, practically got dared were the questions.. which prices work betterinto founding the garbage giant BFI during a and just DO it. Just try to take it out and sell it.suburban subdivision meeting to solve the Even before I have the machine. I’d just go trycommunity’s garbage disposal problems; and to sell it. Even before I started production. Socloser to the twenty-first century, while trying to my market research would actually be hands onbuild an interactive cable channel with actual selling. Hard work, but I think muchprogressive content, an ex-Microsoft executive better than trying to do market research”.named Rob Glaser fell in love with Mosaic, and In finding the first customer within theirset out to give voice to the mute Web in the form immediate vicinity, whether within theirof RealNetworks; and so it goes. geographic vicinity, within their social network, or within their area of professional expertise, Effectual reasoning: The principles entrepreneurs do not tie themselves to any Does all this mean, though, that we are once theorized or pre-conceived “market” or strategicagain resorting to tales by the campfire? It turns universe for their idea. Instead, they openout that all these stories have some common themselves to surprises as to which market orprinciples of reasoning that invert their markets they will eventually end up buildingcounterparts in causal reasoning. Moreover, their business in or even which new marketsthese principles tie together into a coherent logic they will end up creating. Starting with exactlythat demonstrates that this is indeed a the same product, the entrepreneurs in the studyconvincing alternative to causal rationality: ended up creating companies in 18 completely• While causal reasoning focuses on expected disparate industries! return, effectual reasoning emphasizes affordable loss; The strategic partnerships principle• While causal reasoning depends upon Another key principle of effectual reasoning competitive analyses, effectual reasoning is is the focus on building partnerships rather than built upon strategic partnerships; and, on doing a systematic competitive analysis.• While causal reasoning urges the Since entrepreneurs tend to start the process exploitation of pre-existing knowledge and without assuming the existence of a pre- prediction, effectual reasoning stresses the determined market for their idea, detailed leveraging of contingencies. competitive analyses do not seem to make any sense to them at the startup phase. As one of theThe affordable loss principle subjects explained, “At one time in our While managers are taught to analyze the company, I ordered people not to think aboutmarket and choose target segments with the competitors. Just do your job. Think only ofhighest potential return, entrepreneurs tend to your work.”2 Instead entrepreneurs focus onfind ways to reach the market with minimum building partnerships right from the start. Inexpenditure of resources such as time, effort, fact, the ideal beginning for a successful startupand money. In the extreme case, the affordable seemed to be the induction of customers intoloss principle translates into the zero resources strategic partnerships. Again, to hear it from theto market principle. Several of the expertentrepreneurs I studied insisted that they would 2not do any traditional market research, but He went on to add, “Now that isn’t entirely possible, we do a lot of competitive research now.”would take the product to the nearest possible At the time of the study, his company was a 3 Billionpotential customer even before it was built. To dollar company. The evidence shows that as anquote but one of them, “I think I’d start by just... entrepreneurial company grows beyond a criticalgoing... instead of asking all the questions I’d go size, effectual reasoning has to be supplemented withand say.. try and make some sale. I’d make and even replaced at times by causal modes ofsome… just judgments about where I was going thinking. 5
  6. 6. horse’s mouth, “Traditional market research IBM had written a different type of a contract orsays, you do very broad based information if Gary Kildahl had not been out flying hisgathering, possibly using mailings. I wouldn’t airplane the day IBM came calling. Yet, it is notdo that. I would literally, target, as I said the contingencies themselves that shaped theinitially, key companies who I would call companies in the foregoing examples. It is howflagship, do a frontal lobotomy on them…. The the entrepreneurs leveraged the contingencieschallenge then is really to pick your partners, that came upon them that has to form the core ofand package yourself early on before you have models of effectual reasoning. The realizationto put a lot of capital out” that not all surprises are bad and that surprises, In fact, the strategic partnerships principle whether good or bad, can be used as inputs intodovetails very well with the affordable loss the new venture creation process differentiatesprinciple to bring the entrepreneurs’ idea to effectual reasoning from causal reasoning whichmarket at really low levels of capital outlay. tends to focus on the avoidance of surprises asFurthermore, obtaining pre-commitments from far as possible.key stakeholders helps reduce uncertainty in theearly stages of creating an enterprise. Finally, Effectual reasoning: The logicsince the entrepreneur is not wedded to any Underlying all the principles of effectualparticular market for their idea, the expanding reasoning is a coherent logic that rests on anetwork of strategic partnerships determines to a fundamentally different assumption about thegreat extent which market or markets the future than causal reasoning. Causal reasoningcompany will eventually end up in. is based on the logic, To the extent that we can predict the future, we can control it. That isThe leveraging contingencies principle why both academics and practitioners in The third principle of effectual reasoning is business today spend enormous amounts ofthe heart of entrepreneurial expertise – the brainpower and resources on developingability to turn the unexpected into the profitable. predictive models. Effectual reasoning,As one of the subjects in the study put it, “I however, is based on the logic, To the extent thatalways live by the motto of Ready-fire-aim. I we can control the future, we do not need tothink if you spend too much time doing ready- predict it.aim-aim-aim-aim, you’re never gonna see all the How does one control an unpredictablegood things that would happen if you actually future? The answer to this question depends onstart doing it and then aim. And find out where our beliefs about where the future comes from.your target is.” Is the future largely a continuation of the past? Great entrepreneurial firms are products of To what extent can human action actuallycontingencies. Their structure, culture, core change its course? While the future is alwayscompetence, and endurance are all residuals of uncertain, not all uncertainties are the same. Inparticular human beings striving to forge and fact, the simplest way we can model thefulfil particular aspirations through interactions different types of uncertainties is through thewith the space, time and technologies they live classic statistical model of the future as an urnin. For example, we could speculate whether containing different colored balls wherein theWedgwood pottery would have been possible if drawing of (say) a red ball, results in a rewardthe potter Josiah Wedgwood had not met the (of say, $50). Assume the first urn contains 10gentleman philosopher Thomas Bentley and red balls and 10 green balls. In this case, thewooed him into a partnership that created a player can calculate the odds as an expectedbrand and a great company that has lasted over return of $25 on every draw since there is a 50-two centuries. The key to the Wedgwood 50 chance of winning $50. This is the model offortune was the realization that people put their a risky, but predictable, future. Entrepreneurs,money where their aspirations are and that pots as well as most human beings in the real world,and vases could become vehicles of social however, usually have to operate without suchmobility. Similarly, in our time, researchers predictability. The urn they have to deal withspeculate what Microsoft would have been if does not have a given number of balls of known 6
  7. 7. colors. Instead it contains an unknown number periods of time. Sturdy urns of the future areof balls of unknown colors, but the game filled with enduring human relationships thatremains the same. In this case, the best strategy outlive failures and create successes over time3.for the player is to draw balls randomly several Embodied in a network of such enduringtimes and to carefully note the result of each relationships, effectual logic is particularlydraw so that the distribution of balls in the urn useful and effective in domains such as thecan be discovered over time. This is a model of introduction of new products in new markets, anan uncertain, but learnable future that becomes area often referred to as the suicide quadrantpredictable over time. Using the causal logic -- (See Figure 3), exactly the area where traditionalto the extent we can predict the future, we can marketing techniques are ineffective.control it – makes sense in both these cases. But entrepreneurs choose to view the futurethrough effectual logic. Consciously, or Figure 3unconsciously, they act as if they believe that the Existing Newfuture is not “out there” to be discovered, but Market Marketthat it gets created through the very strategies ofthe players. In other words, the entrepreneur Existingusing effectual logic says: "Whatever the initial Productdistribution of balls in the urn, I will continue toacquire red balls and put them in the urn. I willlook for other people who own red balls and New Suicideinduce them to become partners and add to the product Quadrantred balls in the urn. As time goes by, there willbe so many red balls in the urn that almost everydraw will obtain one. On the other hand, if I andmy acquaintances have only green balls, we willput them in the urn, and when there are enough, That is because effectual logic is peoplewill create a new game where green balls win." dependent, unlike causal logic, which is effectOf course, such a view may express hopes rather dependent. In other words, when a particularthan realities, and many entrepreneurs in the real effect has already been chosen such as a targetworld do fail. But the fact remains that segment within an existing market, the peopleentrepreneurs use this logic to try and build new we hire and partner with will depend on theurns and devise new games all the time. In fact, effect we want to create or the market we wantseveral of the expert entrepreneurs I studied to penetrate. Effectual logic, however, does notexplicitly stated that being in a market that could assume pre-existent markets and builds on thebe predicted was not such a good idea, since idea that the markets we create will bethere would always be someone smarter and predicated on the people we are able to bringwith deeper pockets who would predict it better together. In fact, in effectual reasoning, marketsthan they could. But being in an unpredictable are in essence stable configurations of criticalmarket meant that the market could be shaped masses of stakeholders who come together tothrough their own decisions and actions working transform the outputs of human imagination intoin conjunction with pre-committed stakeholders the forging and fulfillment of human aspirationsand customer-partners. Together they could use through economic means.contingencies along the way as part of the rawmaterials that constitute the very urn they are 3constructing. This is again a topic that is largely ignored in our Expert entrepreneurs are not usually in the entrepreneurship curricula which tend to focus onball counting business or the gaming business. market research, business planning, new venture financing and legal issues. As far as I know noInstead they are actually in the business of entrepreneurship programs offer courses in creatingcreating the future, which entails having to work and managing lasting relationships or stabletogether with a wide variety of people over long stakeholder networks, nor on failure management. 7
  8. 8. Experienced professionals in the The creation of U-Haul:entrepreneurial arena, whether they are bankers, An exemplar of effectual logiclawyers, VCs or other investors have always In 1945, newly married, and with barelyagreed with successful entrepreneurs that finding $5,000, Leonard Shoen set out on his effectualand leading the right people is the key to journey that led to the creation of U-Haul. Bycreating an enduring venture. These the end of 1949, it was possible to rent a trailerentrepreneurs know that such “right” people are one-way from city to city throughout most of thenot on the job market waiting for the jobs and United States. When we examine his journey,incentives the entrepreneurs can offer them. we find that this feat could not have beenInstead the “right” people need emotional accomplished except through the use of effectualownership in the goals and objectives of the reasoning. When students today set out to writeendeavor and can only be incentivized by the a business plan for this venture (using causalbelief that the effects they create will embody processes), they conclude that the plan istheir deepest passions and aspirations while financially infeasible, or even psychologicallyenabling them to achieve their best potential. infeasible, since it requires a large and risky But great entrepreneurs realize something capital outlay, most of which gets locked up inmore about the central role of people in shaping relatively worthless assets such as trucks andthe urn. Using effectual logic, they understand location rental. Moreover, the logistics ofthat they too cannot wait around to find the starting the business at a much smaller scale and“right” people all the time. Besides continually growing it as fast as Shoen did overwhelms thestriving to attract the “right” people, they learn analytical prowess of the best of causal thinkers.also to nurture and grow them in their own The final nail in the coffin usually is thebackyards. As Josiah Wedgwood wrote, “We complete lack of any entry barriers to imitatorshave to make artists of mere men.” And more with deep pockets after the concept is proved onrecently, the founders of AES Corp., a multi- a smaller scale.billion dollar electric power company with Shoen, however, did not do elaborate marketoperations in dozens of countries around the research or detailed forecasting and fund-raisingworld say, “[AES] is fun because the people in the sense in which we use the terms today.who work here are fully engaged. They have Instead, using effectual means, (who he was,total responsibility for decisions. They are what he knew, and whom he knew), he plungedaccountable for results. What they do every day into action, creating the market as he grew thematters to the company, and it matters to the business. In his own words, “Since my fortunecommunities we operate in.” was just about enough to make the down There is, however, a dark corollary to the payment on a home and furnish it, and knowinguse of effectual logic in entrepreneurial activity. that if I did this we would be sunk, we startedSince they do not assume specific pre-existent the life of nomads by putting our belongings in agoals or effects and let these effects emerge trailer and living between in-laws and parentsthrough the process, in using effectual logic to for the next six months. I barbered part time andcreate products and markets, entrepreneurs and bought trailers of the kind I thought we neededtheir partners may also end up creating harmful to rent from anybody who happened to have oneand problematic effects for the society they live at the price I thought was right. By the fall ofin. The effects they create may reflect the 1945, I was in so deep into the trailer rental dealignorance and cupidity as well as the will and economically that it was either make it or loseaspirations of the people who participate in the the whole thing.”creation of new urns and games of the future. At that time he moved with his wife AnnaBut our awareness of the existence of effectual Mary Carty Shoen and their young child to thereasoning should alert us more sharply to the Carty ranch in Ridgefield, Washington. There,role of entrepreneurs and the market system in with the help of the Carty family, the Shoensshaping our future as a species, not merely as built the first trailers in the fall of 1945, paintedcontributors to GDP. in striking orange with the evocative name U- Haul on the sides, using the ranchs automobile 8
  9. 9. garage (and milk house) as the first entrepreneurial ventures. Effectual reasoningmanufacturing plant. Shoen then practically may not necessarily increase the probability ofgave away the initial trailers to renters so they success of new enterprises, but it reduces thecould establish dealerships in cities they moved costs of failure by enabling the failure to occurto. He would also purchase trailers and trucks earlier and at lower levels of investment.and sell them to employees, family members,friends, and investors who would then lease So, what makes entrepreneursthem back to AMERCO, the parent company of entrepreneurial?U-Haul. He contracted with national gas station Entrepreneurs are entrepreneurial, aschains to utilize their unused space for parking differentiated from managerial or strategic,and to manage the paperwork. Together, this because they think effectually; they believe in avast network of stakeholders formed a yet-to-be-made future that can substantially besubstantial entry barrier to any imitator who shaped by human action; and they realize that towould have to risk a large capital outlay to the extent that this human action can control thecompete. Advertising was entirely limited to future, they need not expend energies trying toYellow Pages and to the sudden and startling predict it. In fact, to the extent that the future issight of growing numbers of distinctively shaped by human action, it is not much usepainted vans being driven along the freeways of trying to predict it – it is much more useful tothe country. understand and work with the people who are At any given moment, U-Haul could have engaged in the decisions and actions that bring itfailed, but the resulting financial fall-out would into existence.not have been a disaster since the investmentswere spread across so many stakeholders. Thisbrings us to the key implication of effectualreasoning for the success or failure of 9