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What Makes Entrepreneurs, Entrepreneurial? Part 2

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dreaming imagination creativityPhoto by JamesWatkins

This is Part 2 of the series What Makes Entrepreneurs, Entrepreneurial? If you missed Part 1 check it out here as this will be a continuation of the last articles ideas.

To sum up Part 1 there are two main types of logical reasoning when solving complex problems: Casual Reasoning and Effectual Reasoning. Casual Reasoning deals with knowing the set of means or inputs and planning effects given these inputs. This is the prevailing thought process taught by universities and management training programs around the world

Effectual Reasoning on the other hands starts with who you are, what you know, and who you know then imagines the possibilities and combinations, then jumps directly into execution without much regards to planning at all. This is the thought process favored by entrepreneurs.

 

In Part 1 we laid out the two forms of reasoning and began to explain the processes behind effectual reasoning. In Part 2 I will explain some principles of effectual reasoning and explore the logic behind the two reasoning methods.

Principles of Effectual Reasoning vs. Casual Reasoning

Effectual Reasoning Casual Reasoning
Focuses on affordable loss Focuses on expected return
Built upon strategic partnerships, teams, and customers Depends upon competitive analysis
Stresses the leveraging of contingencies Emphasizes pre-existing knowledge and prediction (Eliminating contingencies)

The three principals we will delve into are:

  1. Affordable loss principle
  2. Strategic partnership principle
  3. Leveraging contingencies principle

1. Affordable Loss Principle

While managers are taught to analyze market and choose segments with the highest returns, entrepreneurs tend to find ways to reach the market with the minimum expenditure of resources such as time, effort, and money. Experienced entrepreneurs tend to not believe in market research and would rather take the product to the nearest possible potential customer even before the product was built.

This falls right in line with the entrepreneurs’ tendency of action and just going for it, instead of sitting down and planning and asking themselves questions. This leaves the entrepreneur open to positive randomness and allows the entrepreneur to maximize flexibility of what ultimate direction to take since the product/service has not been designed and built yet.

2. The Strategic Partnership Principle

Effectual reasoning leads the entrepreneur to look for strategic partnerships instead of doing a detailed competitive analysis and broad based market information gathering. Since the entrepreneur wants to limit to expenditure of resources (affordable loss principle) and launch their company with the lowest levels of capital outlay, entrepreneurs will look to key partnerships and customers very early on even before the product is built.

An example of this is obtaining pre-commitments from key stakeholders to help reduce the uncertainty in the early stages of creating a venture. I experienced this firsthand during an entrepreneurs pitch to a group of top decision makers at our University where the entrepreneur asked for a non-binding commitment at the end of his presentation. If the entrepreneur receives a positive response and a good number of pre-commitments then he will launch his venture and if not than he hasn’t expended any capital in designing his product, only his time.

3. Leveraging Contingencies Principle (or as I like to call it the Lucky Break Principle)

This principle is the heart of the entrepreneurial thought process in turning the unexpected into opportunity. Great entrepreneurial firms are products of contingencies (unexpected randomness that occurs) and the entrepreneurs inside the firm taking advantage of these particular events.

Although it is not the specific contingencies themselves that shape the ventures but it is how the entrepreneur leverages these contingencies that forms of the core of effectual reasoning. The main takeaway is that all surprises are not bad, and surprises whether good or bad, can be used as inputs into the new venture creation process. Casual reasoning tends to focus on the avoidance of contingencies as much as possible. 

 

The Underlying Logic Between Effectual and Casual Reasoning

  • Casual reasoning is built upon the logic of “To the extent that we can control the future, we can control it.”
  • Versus effectual reasoning is built upon the logic of “To the extent that we can control the future, we do not need to predict it”

This difference in belief opens up the questions: Is the future largely a continuation of the past? To what extent can human action actually change its course?

Casual reasoning favors the belief that the distribution of events can be discovered over time, and the learnable future becomes predictable over time. This is why academics and practitioners spend an enormous amount of time and resources creating predictable models.

On the other hand effectual reasoning favors the belief that the future is not “out there” to be discovered but it is created through the strategies of the players within the system. This might be just a hopeful belief rather than the reality, and many entrepreneurs in the real world fail.

But on the whole entrepreneurs are in the business of creating the future, which entails having to work together with a wide variety of people over a long period of time. Which is why effectual logic is people dependent since the people the entrepreneur brings together to transform the inputs of human imagination into the fulfillment of human aspirations through economic means.

This is why people in the business of venture creation (venture capitalists, lawyers, angels, etc) have always agreed that finding and leading the right people is the key to successful venture creation. And these “right people” need emotional ownership in the goals of the venture and can only be incentivized by the belief that their effects they create will embody their deepest passions and aspirations while enabling them to achieve their best potential.

Have you ever wondered why people would take deep pay cuts, stressful work environments, and social work life imbalance? The paragraph above is the reason why. No amount of money can satisfy the soul of an entrepreneur working in a meaningless job, the entrepreneur craves to be in a place where they can make a large impact and feel deeply connected to the greater mission of the company.

To end Part 1 and Part 2 of this series lets revisit the question what makes entrepreneurs, entrepreneurial? Entrepreneurs are entrepreneurial because they think effectually, the believe in a yet-to-be made future that is shaped by human action thus have no need to predict the future, and since there is no point of trying to predict the future they strive to work and understand with the people who are engaged in the decisions and action that bring our future into existence.

 

What do you think shapes our future? Please share any thoughts or stories in the comment section below!

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2 Responses

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  1. This article is wonderful. And to answer your question of what shapes our future, I believe it is simply our desires to the degree that we feel confident in our ability to bring them into fruition.

    Dominique (@DominiqueClay)

    January 7, 2013 at 5:57 pm


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