(2023-05-29) Chin When Action Beats Prediction

Cedric Chin: When Action Beats Prediction. One of the big ideas that we’ve covered in the past couple of weeks is the notion that ‘management is prediction’ — the W. Edwards Deming observation that you cannot run your business effectively if you are unable to predict the outcomes of your actions

I think it’s worth talking about business situations where prediction is overrated.

It turns out that we’ve covered various variations of this idea over the course of Commoncog’s history: (list of past articles)

And in What I Learnt From Complexity I mentioned in passing that Dr Saras Sarasvathy’s work on effectuation (effectual reasoning) better captures the sorts of thinking that entrepreneurs do — and that kind of thinking is diametrically opposed to prediction. (2021-11-10-ChinWhatILearntFromComplexity)

Effectuation, as it turns out, is the best articulation of when action trumps prediction. I’ve mostly shied away from talking about effectuation directly, as I’ve assumed that it was well known

If nothing else, the implications of effectuation are useful — they tell us that the types of thinking involved in early-stage businesses are different from the types of thinking we are taught to use in most other contexts

Effectuation is a fancy term used to describe a specific kind of thinking. The word ‘effectual’ is the inverse of ‘causal’, and it’s probably easiest to think of effectuation as the opposite of causal thinking — that is, the kinds of thinking taught in most MBA courses and business books.

You work forwards from existing resources; the end product is unknown.

Saravasthy points out that most entrepreneurial stories employ the second type of thinking. It’s worth pausing here to say that there are many kinds of entrepreneurial stories, too many to count.

What is rarer is the linear path of “founder seeks an idea; founder lists a number of possibilities and does some market research; founder picks the best idea from that list and pursues it; the idea works and said founder builds an amazing business.” This type of story fits right into a causal business framework

Most entrepreneurial stories are not like this: what you usually get is a series of events where the founders bounce from random good event to random bad event before falling into something that works

The trite answer is that entrepreneurship is fundamentally about navigating uncertainty, and uncertainty is by definition impossible to predict

But all of this is besides the point. Sarasvathy’s research is not interested in why entrepreneurship is random; it is interested in the more useful question of how successful entrepreneurs deal with this irreducible uncertainty.

how do you think about business?

They deal with uncertainty through execution. They embrace the fact that they can know nothing with certainty and that they cannot even calculate the probabilities of anything working

The Principles of Effectuation

often, they start very small with the means that are closest at hand, and move almost directly into action without elaborate planning.

Plans are made and unmade and revised and recast through action and interaction with others on a daily basis. Yet at any given moment, there is always a meaningful picture that keeps the team together, a compelling story. (coherence, auteur theory)

Eventually, certain of the emerging effects coalesce into clearly achievable and desirable goals — landmarks that point to a discernible path beginning to emerge in the wilderness.

effectual reasoning emphasizes affordable loss

effectual reasoning is built upon strategic partnerships

effectual reasoning stresses the leveraging of contingencies.

Effectual reasoning emphasises affordable loss

successful entrepreneurs tend to look for methods to reach markets with a minimum expenditure of resources (be it time, effort, or money).

One entrepreneur she interviewed told her that they would just ignore market research and just attempt to sell a product — any product, before the product was even made.

She notes that multiple expert entrepreneurs she’s interviewed all seemed to have the same bias towards sales in order to validate an idea

entrepreneurs do not tie themselves to any theorised or pre-conceived ‘market’ or strategic universe for their idea. Instead, 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

The strategic partnerships principle

Experienced entrepreneurs tend to assume that they don’t know which market their initial idea will target — or even what their final idea will look like! — which means competitive analysis is largely useless at the early stages of a startup.

early on in a business’s life, most entrepreneurs focus more on building ‘strategic partnerships’ with their customers.

The leveraging contingencies principle

Sarasvathy calls this “the heart of entrepreneurial expertise (...) the ability to turn the unexpected into the profitable.”

Effectual reasoning, however, is based on the logic, ‘To the extent that we can control the future, we do not need to predict it.’” (The Best Way To Predict The Future Is To Invent It)

the earlier it is a company’s life, the more effectuation dominates. Effective founders are primarily effectual thinkers; good managers are primarily causal thinkers

I presume that entrepreneurs who aren’t able to switch modes tend to fail as the company grows. If true, this might be one reason founders leave companies

The Worldview of Effectuation

entrepreneurs choose to view the future through effectual logic. Consciously, or unconsciously, they act as if they believe that the future is not “out there” to be discovered, but that it gets created through the very strategies of the players. In other words, the entrepreneur using effectual logic says: “Whatever the initial distribution of balls in the urn, I will continue to acquire red balls and put them in the urn. I will look for other people who own red balls and induce them to become partners and add to the red balls in the urn. As time goes by, there will be so many red balls in the urn that almost every draw will obtain one. On the other hand, if I and my acquaintances have only green balls, we will put them in the urn, and when there are enough, will create a new game where green balls win. ”

How Much Can We Trust This?

Sarasvathy’s PhD supervisor was Herbert Simon.

I bring this up because the method Sarasvathy used to validate effectuation is what we now know as a ‘think-aloud protocol’ built around highlighting expert-novice differences. This is fancy name for a research approach where a small number of experts and novices are given a task to complete and are asked to ‘think aloud’ as they complete it. Simon co-wrote the ‘bible’ on think-aloud protocols in the early 1980s.

The other co-author of that ‘bible’ on think-aloud protocols was a researcher by the name of K. Anders Ericsson

It means that, first of all, we need to pay special attention to who the study regards as ‘expert’.

But I should note that there is limited evidence from the administered protocol that founders regarded their network as the basis for entrepreneurship — perhaps because the thinking tasks they were given were too far removed from their real-world entrepreneurial networks. Whatever claims Sarasvathy makes on entrepreneurship as being built on networks of people are probably from broad observation, not from this study alone.

this is the tricky thing about expertise research — if you interview a whole bunch of experts from some domain, and realise that all of them think in the exact same way, you can’t really tell what properties of the domain lead them to think in this manner.

But, to be clear, this is good enough for me.

How Can We Use This?

I think there are several takeaways from this body of work. The first thing is a reminder that not everything in business is causal in nature. New venture creation is a crapshoot

What falls out of this is a worldview that prizes action above analysis. This explains why, when push comes to shove, founders don’t think probabilistically. They can’t afford to

And of course I’ve been reflecting on these three elements as applied to my life. I’ve spent some time — as one does — learning about the type of person I am in a variety of situations, and I’ve racked up a fair number of skills over the years. But what have I done in building networks (scene) of people? The honest answer is: not much

I may be missing the point. The bigger lesson here is to roll with it. Don’t think too much about what you have, or what you’ve done to get ‘ready’. There’s only so much you can do before you begin. Entrepreneurship is, after all, the art of turning random events into profit. (See (2007-08-27) Andreessen Entrepreneur Luck)