46be persuaded by their apparent predictive prowess in selecting high-potential ventures. Additionally, the need to design winning term sheets with predetermined milestones makes it even more difficult for them to not hinder, let alone facilitate, effectual approaches. As a result, they may come to believe in the illusion of predictability with regard to their own investments and in turn set up obstacles in the way of entrepreneurs trying to build ventures effectually.

In general, private equity investors’ approaches, mimicked by so-called entrepreneurial states, consist in one or more of the following three strategies:

47An Effectual Analysis of Markets and States

Place a bet (net present value calculations). • Place many bets (portfolio diversification). • Place staged bets (real options). The effectual process, in contrast, is about not placing a bet. As explained in detail elsewhere, bets involve taking event spaces as given and outside one’s control. All one can do then is to calculate or estimate the event space to the best extent possible. The non-bet alternative is to focus on the conditioning assumptions that can be reified or falsified through effectual action so as to reshape the event space itself. For example, entrepreneurs are often taught to carry out market research to find out what potential customers want. In contrast, expert entrepreneurs discount market research because both presumptions of who potential customers are as well as any information they provide as to what they will or will not want can be inaccurate and unreliable. Instead, effectual entrepreneurs choose to cocreate product and market through precommitments, even before building prototypes, from actual customers. Actual sales, they learn, is the best form of market research. This further has the advantage that no major financial outlay is called for in starting new ventures.

This is precisely why it is important not to confound predictive investing and investors, especially those investing OPM with effectuating entrepreneurs. Discussions of entrepreneurial states or public entrepreneurs often confound the two, attributing entrepreneurial mindsets to investors and funding activities. This is not to say that investors cannot act or invest effectually. It is just that most investors, unless they are investing their own money, for example, angel investors, either do not or cannot act effectually. Just as states cannot or do not.

Only those investing their own money, with a willingness to lose what they invest for reasons or preferences of their own, can self-select into uncertain, isotropic projects. This is because reasons other than predicted upsides are called for in the effectual process. Variations in preferences and values and the infinitely splendored glass of textured lived experiences drive the effectual process. Unlike in the case of investing OPM, accountability is limited to delivering on particular commitments made and not to any overall promised upside outside the control of effectuators or a prespecified goal. In order to justify their own fundraising as well as to keep up some semblance of accountability, investors of OPM turn to predictive approaches even when aware that these may not be reliable. Interestingly, we found in our empirical work that the more experienced a venture capitalist, the more effectual their approach. This could simply be a side effect of working with expert entrepreneurs and having deal flows heavier in effectual ventures as a consequence. Also, in the case of angel investors investing their own money, we found that the more effectual the approach, the higher their overall hit rate without reducing the number of home runs, again attesting to the fact that effectuation is not about placing large bets (Wiltbank et al., 2009).

Since states, and their representatives, elected or otherwise, almost always invest OPM (monarchies and oligarchies may pretend otherwise), they are much more likely to act like causal investors rather than effectual entrepreneurs.

48S. D. Sarasvathy

Two Frameworks for Tackling Isotropy and Fostering

Innovation

In general, individuals can exhibit and leverage idiosyncratic variation in ways and to extents that become unjustifiable in the case of larger fiduciary organizations, especially states. Justification typically takes shape in stated goals and/or predictive information argued to lead to the achievement of those goals. Once goals are set, they become difficult to change, especially as they begin to generate payoffs. These payoffs become predictable opportunity costs that are then weighed against isotropic innovative possibilities. Since the latter are unpredictable, it becomes harder and harder to make a case for them and easier to dismiss them as infeasible. Consider how both large firms such as the automobile giants in Detroit as well as various states around the world acted or failed to act in the face of carbon emissions exacerbating climate change. On the one hand are predictable opportunity costs such as jobs lost. On the other are a variety of isotropic innovative possibilities, each of which may or may not succeed in technical, financial, and political terms.

Logically, one would expect states to lead the way in taking on isotropic possibilities in the face of Knightian uncertainty. Yet history shows that it is individual entrepreneurs, using market transactions and/or collective action that lead the way. Not because states are inherently myopic and individual entrepreneurs are clairvoyant. But because it is easier for individuals (and some budget-owners inside organizations) to act based on subjectively calculated affordable loss rather than pseudo-objectively calculated expected return. Larger organizations and states follow as upsides become clearer to predict and envision. Eventually. This is true even in the case of basic science or technologies for defense, in which states make large a priori investments. Take the case of the internet. State investments led to the internet. But in addition to targeted technical developments, a variety of actions and interactions, intended and unintended, as well as effectual entrepreneurship over 15 years, helped reshape it into the universe of endless possibilities that it has become today. This reshaping involved idiosyncratic, even idiotic, transformations such as technologists inventing UNIX to play video games and college kids inventing Facemash to rate females on campus hot or not that became Facebook, leading to the fount of fortune and misery that is social media today.

There is something about the lived experiences of conscious human beings that seems to be an important input into all creativity leading to any kind of innovation, even serendipitous or accidental innovations. A purely calculative process leading to innovation seems unlikely, even absurd, especially in innovations in goals themselves, innovations in what is deemed worth pursuing or not. We will get to these in the concluding section of this essay. For now, let us organize the arguments so far into a usable conceptual framework in two parts.

Figure 2a and b depict the analysis above in a simplistic two-part framework that can nonetheless be useful for thinking through the role of markets and states in innovation. Figure 2a considers cases characterized by the need for funding, especially funding using OPM—other people’s money. Figure 2b illustrates situations