Navigating Uncertainty: Effectuation Principles as the Entrepreneur's Compass

Weekly Reflection / July 26, 2023 / 2 mins read

Successful companies like Sony, which transitioned from repairing war-damaged radios to producing an electric rice cooker, have incredible origin stories. Let’s explore how entrepreneurs make decisions when faced with uncertainty, drawing from Professor Sara Sarasvathy’s theory of Effectuation .

Entrepreneurship is crucial for economic growth. Classical economists defined the factors of production into three categories: land, labor, and capital. In an open, efficient market, a product or service should cost no more and no less than the prices paid for these factors. But economist Frank Knight argued that human capital, including entrepreneurship, should be considered a fourth factor of production.

Knight highlighted that entrepreneurs handle uncertainties, which he categorized into three types: known uncertainty, unknown uncertainty, and unknown unknown.

In her study, Dr. Sara Sarasvathy explored how entrepreneurs make decisions. She conducted a study on 27 expert entrepreneurs, listened to their thought processes, and derived the framework known as “Effectuation”. This framework is a process theory explaining how entrepreneurs create new ventures.

Two approaches exist in entrepreneurial thinking: causal thinking and effectual thinking. Causal thinking is setting a goal and acquiring the resources to achieve it. Effectuation, on the other hand, does not predict the future but builds sufficient conditions for success from what one has.

According to Effectuation, expert entrepreneurs shape the future rather than predict it. They apply the following five principles:

  • Start with your means: Take action based on what is readily available to you.

  • Set affordable losses: Limit risk by spending only what you can afford to lose.

  • Leverage contingencies: Use surprises and uncertain situations to create new opportunities.

  • Form partnerships: Collaborate with those willing to make a real commitment.

  • Control the controllable: Focus on activities within their control.

In essence, entrepreneurs play a vital role in economic development as they adopt effectual thinking. They work with people engaged in decisions and actions that bring the future into existence.

All possible worlds lie within the actual one. /- Nelson Godmann