Start-Ups: Effectuation & the Random Walk

Why do start-ups succeed? Why do so many of them fail?

The answers to these questions should obviously be of great value to entrepreneurs. Fortunately, the investment world might offer some insights.

The random walk hypothesis, courtesy of economist Burton Malkiel, suggests that stock prices are essentially unpredictable, which explains why investment professionals have such a hard time beating the market. So even if a few money managers can beat the market consistently, these folks are essentially unicorns. Starting a company might be the same way, and success comes more from luck than any of the other explanations people provide to explain their success, such as smarts, skill, passion, grit, determination, etc.

So what’s an entrepreneur to do?

Thanks to some excellent research from Professor Saras Sarasswathy, there is a guide to help entrepreneurs position themselves for success, even though they cannot predict the future. Her principles of effectuation lay out a strategy to reduce risk of failure and increase the possibility of success, thereby helping the entrepreneur control what happens. What are the principles?

  1. Bird in Hand. Take advantage of what you have at hand already, whether that’s your identity, your knowledge, your skill, or your network. What you have will serve you well, and others will have more confidence that you know your stuff.

  2. Affordable Loss. Given that so many new ventures fail, give some initial thought to the downside impact and what could go wrong, instead of dreaming only about the upside payoffs.

  3. Lemonade. Things will go sideways as you progress, and you should position yourself to capitalize on what you learn from adversity, instead of sticking doggedly to your plan.

  4. Crazy Quilt. Build your network of people you know and organizations that can help. These contacts will be much more valuable than your efforts to analyze, predict, and capitalize on market opportunities.

  5. Pilot in the Plane. To the extent that you do have your hands on the wheel, take full advantage of that opportunity to steer toward success. Just as it is for a pilot who cannot control the weather, other planes, birds flying, or the airplane food, many other things will be beyond your control, but you should exercise whatever control you have.

For me, principles like these seem much more comfortable than embracing some romantic notion that a new venture is meant to be, or that the entrepreneur was the only person in history who could have made it happen. What do you think?

Many thanks to David Touve at the iLab for his recent talk that tied these concepts together nicely.