Lecture 1

Effectuation and Affordable Loss Principles

Startup - Option 1 • • Do market research and competitive

analyses to figure out target market segments• • Develop marketing strategies, calculate

cost/price margins, and make financial projections

• • Make a business plan, raise resources, hire a team and build your venture.

Startup – Option 2• Begin with who you are, what you know and

who you know and begin DOING the doable with as little resources invested as possible

• • In particular, begin interacting with a wide variety of potential stakeholders and negotiating actual commitments

• • Let the actual commitments reshape the specific goals of the venture

• • Repeat the process until the chain of stakeholders and commitments converges to a viable new venture

Option 1 – Causal Logic• Analysis precedes action• Time and/or other resources are invested in upfront

information gathering• Accuracy of prediction and clarity of goals drive the

resource-acquisition process• Here the key is to bring the right people on board

who can deliver on the pre-selected targets• Control over outcomes is achieved by being one step

ahead of the trends and the competition• Risk management involves the careful avoidance of

failure at all costs

Option 2 – Effectual Logic• Action and interaction with others precede and drive the entire

process• Creative energies are focused on building the venture with virtually

no resources invested– each stakeholder invests only what he or she can afford to or is

willing to lose• Unpredictability itself is seen as a resource – hence the emphasis

on non-predictive strategies• Who comes on board determines the goals and shape of the new

venture and its market• Control is achieved by doing the doable and continually

transforming current realities into new and unforeseen possibilities• Risk management involves keeping failures small and having them

happen early, and then building upon them for future success.

Causal Reasoning

Strategic Thinking

Entrepreneurial Thinking

Two Chefs• Chef 1

– Plans menu Buys food Cooks dinner

• Chef 2 – Explores cupboards and fridge WHILE cooking

dinner

Entrepreneurial Means

1) Who they are – their traits, tastes and abilities;

2) What they know – their education, training, expertise, and experience; and,

3) Who they know – their social and professional networks.

AFFORDABLE LOSS

Venture Capital Thinking

Successful Entrepreneurs

• • Have a sound knowledge of their marketplace

• • Have a sound knowledge of their competition

• • Plan and execute their plans

Failures

• • Inadequate Pricing• • Insufficient start-up

capital• • Failure to look at industry

norms• • Lack of focus• • Inadequate market

research• • Failure to segment

market

Entrepreneurial Thinking• What You Learn From Company No. 1: When

and How to Leave• What You Learn From Owning More Than

One Company: Don't Fall in Love With the Product

• What You Learn by the Third Company: How to Leverage Your Resources Creatively

• What You Learn by the Fourth or Fifth Company: It's Okay to Fail

Plunge Decision –Basic Decision Tree

Plunge Decision –Real Options Staged Tree

Plunge Decision –Min Max Collapsed Tree

Plunge Decision – Effectuation

Effectual Reasoning• While causal reasoning focuses on

expected return, effectual reasoning emphasizes affordable loss;

• • While causal reasoning depends upon competitive analyses, effectual reasoning is built upon strategic partnerships;

• • While causal reasoning urges the exploitation of pre-existing knowledge and prediction, effectual reasoning stresses the leveraging of contingencies.

Affordable Loss Principle

• Entrepreneurs tend to find ways to reach the market with minimum expenditure of resources such as time, effort, and money

• In the extreme case, the affordable loss principle translates into the zero resources to market principle.

Affordable Loss Principle (cont.)

• Entrepreneurs do not tie themselves to any theorized or pre-conceived “market” or strategic universe for their idea.

• They open themselves to surprises as to which market or markets they will eventually end up building their business in or even which new markets they will end up creating.

Strategic Partnerships Principle

• Focus on building partnerships before doing a systematic competitive analysis

• Ideal beginning for a successful startup would be the induction of customers into strategic partnerships

Leveraging Contingencies Principle

• The ability to turn the unexpected into the profitable

• Ready Fire Aim

• Ctructure, culture, core competence, and endurance are all residuals of particular human beings striving to forge and fulfill particular aspirations through interactions with the space, time and technologies in which or with which they live

Causal vs. Effective Reasoning

• Causal reasoning is based on the logic To the extent that we can predict the future, we can control it.

• Effectual reasoning, is based on the logic To the extent that we can control the future, we do not need to predict it.

Creating the future• The future is not discovered but created

• Being in a market that can be predicted is not such a good idea, since there will always be someone smarter and with deeper pockets who will predict it better

• Being in an unpredictable market means that the market can be shaped through the decisions and actions of entrepreneurs working in conjunction with pre-committed stakeholders and customer-partners.

Creating the Future (cont.)

• Together entrepreneurs pre-committed stakeholders and customer-partners use contingencies along the way as part of the raw materials that constitute creation of the future

The Entrepreneurial Quadrant

Staging of Effectual and Causal Logic

Relationship between Causal and Effectual Logic