Effectuation Theory

Effectuation Theory is a framework developed by Saras Sarasvathy to understand the unique decision-making processes of entrepreneurs during the start-up phase of ventures. Unlike the conventional approach known as causation, which focuses on setting clear goals and forecasting outcomes, effectuation emphasizes a more flexible and resource-based mindset. Entrepreneurs operating under this model prioritize their available means—such as personal skills and networks—over specific objectives, allowing them to adapt to changing circumstances and unforeseen challenges.

Key principles of effectuation include setting an "affordable loss" to manage risk rather than aiming for maximum potential profit, leveraging unexpected events as opportunities for innovation, and forming partnerships that enhance project development. This approach fosters an entrepreneurial mindset that views the future as something that can be shaped by actions rather than merely predicted. Effectuation theory extends beyond the private sector, applicable to non-profits and social entrepreneurship, exemplified by figures like Muhammad Yunus, who utilized these principles to establish Grameen Bank. Overall, effectuation provides valuable insights into entrepreneurial thinking, emphasizing adaptability and collaboration in uncertain environments.

Published in: 2021

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Subject Terms

Effectuation Theory

Abstract

Effectuation theory is a theoretical framework used to understand the start-up process of entrepreneurial ventures. Effectuation can be applied to both the private and non-profit sectors; furthermore, it is a mode of thinking that can be learned. Effectuation studies focus on the decision-making process followed by entrepreneurial or "effectual" thinkers, as opposed to more conventional management types, known as "causal" thinking. Effectuation is best adapted to and better reflects real-life situations, according to supporters, but both types of thinking may be combined to make better choices across different arenas.

Overview

Effectuation theory refers to a system for entrepreneurial planning studied by researcher and professor Saras Sarasvathy, who later delineated its core tenets in a series of publications. Effectuation is based on much empirical research and seeks to illuminate in a clear manner the logic used by experienced entrepreneurs to "start up" firms and other enterprises. Entrepreneurship has been amply studied as a specific arena of the business world, yet it also has public sector and non-profit application. Some of the main phases of initial entrepreneurial planning are familiar to conventional private sector actors; that is, it includes a business plan, meant to show goals, a budget, and a market forecast or projection, which charts the target market—that is, the demographic and geographic areas expected to be covered—and an assessment of the competition and demand. With all of these steps taken care of, an entrepreneur seeks what is necessary to reach these goals, such as financing, equipment, knowledge and expertise and, of course, customers.

However, wide significant divergences exist between effectuation theory and conventional management and business theories taught at masters of business administration (MBA) programs, according to effectuation theory experts. In 1997, Sarasvathy realized a field study based on 45 successful entrepreneurs, with the purpose of understanding how successful entrepreneurs think and act. Of these she interviewed and observed 27 entrepreneurs in greater depth. Sarasvathy required that participating entrepreneurs have fifteen years or more of successful entrepreneurial experience; that they have started multiple companies and that these companies included both successes and failures; and that, of those, at least one had been made public, that is, publicly traded and owned, with stocks sold in the market. Finally, the companies had to have been managed by its founders the whole time. These companies could be dedicated to anything; some of them produced toys, one was a steel-based industry, and so on. Their revenues ranged from $200 million to over $6 billion. Sarasvathy published her final findings in 2001, in a seminal academic journal article titled "Causation and Effectuation: Towards a Theoretical Shift from Economic Inevitability to Entrepreneurial Contingency."

Sarasvathy had built her theoretical model upon the work of her thesis advisor, Nobel Laureate economist Herbert Simon (1916–2001), who did much research on his theory of "bounded rationality," which served as a base for development of his thought on "naturalistic decision-making." Naturalistic decision-making is a system to study how people make decisions in "demanding and real-life scenarios." Simon proposed that decision-makers always work under limitations or bounds: In a demanding real-life scenario, only a limited amount of information is available about alternatives and consequences and, furthermore, this information is usually unreliable; under demanding conditions, the human mind is limited—or bounded—by its capacity to assess and process the information available at a given moment; and, finally, individuals have only a limited amount of time to make these decisions.

These constraints, then, reduce people to making decisions, in complex and demanding situations, aimed at reaching merely satisfying, immediate and familiar results rather than those which are best or optimal. These limitations also make it impossible for managers to draw contracts that foresee every possible contingency, so that people tend to rely on broad principles and past experiences, what is known commonly as "rules of thumb."

The results in Sarasvaty's studies show that entrepreneurs tend to think very differently than corporate executives. An expert entrepreneur is somebody capable not only of creating a company, but also of "inventing" a market. There is a huge difference between one project and the other. In fact, contrary to a traditional marketing and product launch project, entrepreneurs do not start out with specific goals. The main job of an entrepreneur is innovative by nature: to ensure that there are customers for his or her product or service, not in the sense of "establishing that there are customers" as much as "locating a need and those who may become customers, attracting their attention, and making them take that first step." In other words, an entrepreneur often tries to identify gaps in the market and use that gap to reach customers and create a market.

To survive and thrive, entrepreneurs focus all their decisions on finding and reaching that market, and adapting products or services to that market. This, in turn, alters the conventional business-model decision-making process. Entrepreneurs have a different vision, one more focused toward a clientele base and less towards managing people in a firm. Making this work requires a logic—a reasoning process—drastically different from what is taught in conventional business schools. Savasty calls this way of thinking effectual reasoning or effectuation. Effectuation refers to the belief sustained by most experienced entrepreneurs that the future is not predictable, but it may be controlled.

Sarasvathy explains that entrepreneurs usually do not have, at the beginning of their start-up process, a very clear image of the path they want to follow. However, under the effectuation model, such an entrepreneur would first make a solid assessment of the resources he or she has at hand or has access to. This is followed by engaging in a brainstorm to figure out ideas based on the said resources. This includes taking into consideration the opinions of experts, friends, and professionals, among others. This leads to diffuse ideas gradually taking shape and a sort of road map being defined. Making alliances, partnerships, or pre-commitments with others follows; these alliances contribute to delineating better objectives, providing more resources, accruing greater value, and moving toward launching the project.

Effectuation, in full development, is a complex model with several components, among which it is important to highlight the concepts of "affordable loss"—an entrepreneur decides how much he or she can afford to lose. In this way, the entrepreneur engages in minimizing risk rather than investing in expected returns. The latter is considered a "causation" behavior. Also useful is the concept of "leverage surprises," which refers to the fact that organizations must face sudden changes and unexpected events on a daily basis. Therefore, an entrepreneur needs to be able to turn problems into opportunities and maintain flexibility, so that he or she can redefine objectives as needed.

Another important concept is the idea of dealing with the future. For example, it is possible to exert some control over future events and development by conducting market research, remaining up-to-date on innovations and new criteria, hiring the appropriate staff, and so on. If one does this, being able to forecast or predict the future is not as necessary. In fact, the motto of effectuation is: "If I can control the future, I need not predict it." According to effectuation studies, experienced entrepreneurs deeply mistrust the quantitative forecasting methods so popular in traditional business programs or MBAs. The future is controllable only up to a certain point, then, because it is the result of the actions of many variables and factors.

Further Insights

Saras Sarasvathy focused on studying professional entrepreneurs and what makes them different from conventional business managers. However, rather than focusing on the reasons they provided for their failure or success, as most researchers did at the time, she concentrated on observing their actions and how they coped with challenges. She asked the studied group of entrepreneurs to solve complex entrepreneurial problems based on trial-and-error solutions, to identify what she eventually called effectual thinking or effectuation. Sarasvathy distinguished this mode of thinking from causal mode or causation, the preponderant mode in corporate workplaces, or in organizations with more structure and restrictions. From these studies, Sarasvathy gleaned five tenets.

First, start with your means. Before beginning an entrepreneurial project, an effectual thinker considers about what he or she counts with, that is, the resources they have, what they know, and who they know. Causal thinkers, on the other hand, first determine the goal they want to reach and then look for and organize the resources needed to reach that goal. The advantage of the effectual mode is that the starting point is always under the control of the entrepreneur; that is, it does not depend on what investors want, or studies or trends forecast, or for enough knowledge to be gathered and so on.

Second, set affordable loss. The effectual thinker focuses more on the maximum he or she is willing to lose before deciding to start an enterprise. For the effectual thinker, it is difficult to live with the uncertainty of what would have happened had they dared to launch a business. However, effectual thinkers make the decision of launching taking into consideration the maximum loss he or she is willing to take on, before venturing ahead. Causal thinkers, on the other hand, focus on the maximum he or she can gain or profit, before deciding on the convenience of proceeding with a project.

Third, leverage contingencies. The effectual thinker considers potential contingencies or unexpected events as a natural and inevitable part of the entrepreneurial project. There is a great deal of flexibility in effectuation, which allows it to adapt the enterprise to whatever may happen on the everydayness of life. This works by generating less resistance to daily contingencies. The causal thinker, however, considers contingencies as chaotic events that must be eliminated and avoided at all costs. Therefore, the causal thinker uses conventional planning and control management methods to reach a goal, while the effectual thinker copes by embracing methods of learning and discovery to navigate the unknown waters of the future.

Fourth, form partnerships and alliances. The project of entrepreneurship is co-created, that is, formed in collaboration with others. The effectual thinker incorporates allies and a fresh vision by bringing in new resources—which also implies bringing in new restrictions, as he or she must now take into consideration the opinions of others. The effectual thinker recruits people he or she believes essential to the implementation of the project. In general, it is of particular importance for large and established corporations to recruit people who bring a similar ideology; this is key to the implementation of a vision pre-designed by the firm's executive plans. This is not the case for emerging or more flexible and dynamic businesses—such as entrepreneurial projects—that can constantly adjust the project to the new visions of the collaborators and eventual contingencies faced.

Fifth, create opportunities. Effectual thinkers believe that the future is built, not predicted. Key to the thinking of effectual entrepreneurs is the idea that the future is shaped by the actions of entrepreneurs. The entrepreneur is an actor who impacts and transforms reality; it makes no sense to try to predict the future, full of inevitable surprises, yet to some extent under the control of human response. Effectual thinkers, therefore, do not entirely trust the results of market studies as the sole resource for business plans. However, these may be considered useful as departure points and as supplemental tools for better strategies. The causal mode, for instance, seeks to identify future market trends to take advantage of them; that is why causal thinkers create expert-based market studies. The causal vision, in general, holds to the belief that the future has a relatively defined or fixed course that must be predicted as closely as possible. In the end, Sarasvathy's work repeatedly compounds the idea that the aversion entrepreneurs feel for market prediction may be characteristic of entrepreneurial personality traits but it bears repeating, as well, that it is the result of experience.

Issues

Sarasvathy's broad work showcases company founders whose thinking runs the gamut from the effectual to the causal. There seems to be indications that effectual thinking is learned through experience. For example, business people raised in a family business are likelier to be effectual thinkers, while those who came to the private sector through a traditional MBA and corporate experience, are more prone to think causally. It also seems to play a role in financing preferences. Experienced angel investors and venture capitalists, for example, tend to think more effectually. Some people may, in fact, think along the continuum from effectual to causal, depending upon the situation. In the end, both kinds of thinking modes are complementary and both are useful for entrepreneurs, which means that relying on one or the other mode depends on the circumstances, phases, and abilities of the entrepreneurs and their projects. Moreover, entrepreneurial thinking is applicable to a wide range of projects that go beyond the private sector.

One of the most famous cases, presented by Saras Sarasvathy in a world famous 2010 TED talk, is the case of banker and economist Muhammad Yunus. Yunus used Sarasvathy's principles in the creation of Grameen Bank for the Poor. Yunus identified the need that poor and unskilled women have in poor countries to provide for their families, and harnessed their entrepreneurial spirit to provide solutions that may help them work their way into a better quality of life for themselves and their families. This was achieved through a program of microloans and training, so that women, using their connections, new tools, and their knowledge, began saving and investing in small businesses. Their success is largely based on innovation and community and partner collaboration, all of which are anchors of the effectuation model.

In 2015, Sarasvathy explained that contemporary experts are gradually understanding that entrepreneurial systems can be taught and learned in business schools. These methods not only are useful for private sector companies but also serve to free human potential and build a better world. Starting a new enterprise, after all, profitable or non-profit, aims at expanding horizons and providing new economic opportunities. Based on Sarasvathy's work and non-profit models such as Yunus' work, there are already important educational projects in several countries worldwide to teach entrepreneurial skills to children beginning in elementary school. According to Sarasvathy, the world is gradually becoming a more "entrepreneurial society."

Terms & Concepts

Angel Investor: Angel investors are investors or lenders who invest in small or emerging businesses and entrepreneurs.

Causal: Following a cause or event. Usually used to describe an event in which one thing is contingent upon another that happens previously.

Effectuation: A method used by entrepreneurs to cope successfully with uncertainty. It is meant to face flexibly the effects of a contingency.

Entrepreneurship: The tendency and ability to start new businesses.

Leverage: To take advantage of a situation or use something advantageously.

Naturalistic Decision-making: A system to study how people make decisions in demanding and real-life scenarios.

Bibliography

Arend, R. J., Sarooghi, H., & Burkemper, A. (2015). Effectuation as ineffectual? Applying the 3e theory-assessment framework to a proposed new theory of entrepreneurship. Academy of Management Review, 40(4), 630–651. Retrieved December 26, 2017 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=110083938&site=ehost-live

Arend, R. J., Sarooghi, H., & Burkemper, A. C. (2016). Effectuation, not being pragmatic or process theorizing, remains ineffectual: Responding to the commentaries. Academy of Management Review, 41(3), 549–556. Retrieved December 26, 2017 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=116358580&site=ehost-

Bonk Sarmento, C. F., de Carvalho, C. S., & da Rocha Dib, L. A. (2016). Effectuation and the influence of social networks on the internationalization of accelerated startups. Internext: Revista Electrônica De Negócios Internacionais Da ESPM, 11(1), 63–73. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=asn&AN=119119247&site=ehost-live

Günzel-Jensen, F., & Robinson, S. (2017). Effectuation in the undergraduate classroom: three barriers to entrepreneurial learning. Education + Training, 59(7), 780–796.

Long, D., Xia, Z., & Hu, W. (2017). How does entrepreneurial opportunity affect the decision-making process of effectuation? Kybernetes, 46(6), 980–999.

Read, S., Sarasvathy, S. D., Dew, N., & Wiltbank, R. (2016). Response to Arend, Sarooghi, and Burkemper (2015): Cocreating effectual entrepreneurship research. Academy of Management Review, 41(3), 528–536. Retrieved December 26, 2017 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=116358575&site=ehost-live

Reuber, A. R., Fischer, E., & Coviello, N. (2016). Deepening the dialogue: New directions for the evolution of effectuation theory. Academy of Management Review, 41(3), 536–540. Retrieved December 26, 2017 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=116358576&site=ehost-live

Rieken, B., Schar, M., Shapiro, S., Gilmartin, S. K., & Sheppard, S. (2017). Exploring the relationship between mindfulness and innovation in engineering students. Proceedings of the ASEE Annual Conference & Exposition, 11882–11901.

Urban, B., & Heydenrych, J. (2015). Technology orientation and effectuation—links to firm performance in the renewable energy sector of South Africa. South African Journal of Industrial Engineering, 26(3), 125–136.

Effectuation Theory

On this Page

Subject Terms

Effectuation Theory

Abstract

Overview

Further Insights

Issues

Terms & Concepts

Bibliography

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