Why (a Theory of) Opportunity Matters: Refining the Austrian View of Entrepreneurial Discovery
Abstract: The concept of entrepreneurial opportunity has undergone a period of useful critique and refinement since Venkataraman (1997) and Shane and Venkataraman (2000) employed the term as one of the defining features of entrepreneurship studies. This paper presents a novel Austrian reinterpretation of this concept as an intersubjective phenomenon that emerges from the dual entrepreneurial process of discovery and judgment. Just as markets can be described as price discovery procedures for existing goods, services, and resources, entrepreneurship can be usefully described as a price discovery procedure for future goods, services, and resources. This view retains the essential elements of Kirzner’s (1973) approach while also refining the opportunity discovery concept within an evolutionary realist framework for understanding entrepreneurial motivation and action.
Gregory M. Dempster ([email protected]) is Elliott Professor of Economics and Business at Hampden-Sydney College.
Since Israel M. Kirzner’s (1973, 1979) groundbreaking work on entrepreneurial discovery over forty years ago, the concept of opportunity has been central to the academic literature on venture creation and innovation. Sankaran Venkataraman (1997) and Scott Shane and Venkataraman (2000) made opportunity a primary operational construct in their definition of the field of entrepreneurship studies. Though some views, such as those of Frank H. Knight (1921), Joseph A. Schumpeter (1934), and Buchanan and Vanberg (1991) deemphasize the concept in favor of other factors such as uncertainty, innovation, and creativity, the opportunity discovery view has remained a primary construct, often integrated with these other concepts as separate but interrelated aspects of venture creation. Indeed, there is general agreement in the field of entrepreneurship studies that scholars need to “explain the role of opportunities in the entrepreneurial process” and to “clarify the central role that opportunities play in a framework for entrepreneurship” (Eckhardt and Shane 2003, 333).
Recent scholarship, however, has displayed a great deal of ambiguity toward the use of the concept of opportunity, and some have questioned the coherence and usefulness of the term altogether. Distinctions between “Kirznerian” and “Schumpeterian” opportunity are made to distinguish equilibrating from dis-equilibrating entrepreneurial innovations (Shane 2003); “discovery” and “creation” have been proposed as alternate views of how opportunities come into existence (Alvarez and Barney 2007); and both epistemological and methodological objections to the concept itself have been suggested (Klein 2008; Foss and Klein 2012; McCaffrey 2014). The fact that many of these objections come from scholars working in the Austrian scholarly tradition of Kirzner suggests that they represent serious challenges to the viability of the opportunity discovery construct as a research tool in understanding the nature, causes, and consequences of entrepreneurial activity.
This paper seeks to better define the role of opportunity in entrepreneurial discovery. It focuses on entrepreneurship as a collaborative process of intersubjective knowledge generation and integration, and reconceptualizes the idea of entrepreneurial opportunity as neither a purely “preexisting” entity nor a creation of the entrepreneur, but the emergent result of the collaborative process of discovery and judgment. Instead of things in the mind of an entrepreneur, to be either recognized or created as independent constructs, opportunities in this view are defined as decision alternatives that emerge from a set of collaborative procedures for uncovering and integrating localized knowledge, widely dispersed among potential stakeholders, into coherent mean-ends frameworks from which interdependent paths of value creation may be identified and potentially exploited for mutual benefit among stakeholders.1 In other words, opportunities are endogenous to the process of intersubjective experimentation, selection, and retention that characterizes the market process in general.
This paper places opportunity back in the limelight as a central concept for understanding the causes and effects of entrepreneurship. We argue that this is important for at least three reasons. First, there is the issue of how context affects both motivation and decision analysis behind entrepreneurial actions. Koellinger (2008) argues that examining entrepreneurial behavior involves at least two fundamental questions: (1) What motivates entrepreneurs to choose among alternatives, and (2) where do these decision alternatives come from? Profit motives under uncertainty (i.e., judgment) can, at best, offer only a general answer to the first of these questions, because in complex settings involving nonalgorithmic uncertainty, the very possibilities for ex ante profit cannot be “prestated” (Koppl, Kauffman, Felin, and Longo 2015); characteristics of latent demand and supply are not operational apart from the process by which they are discovered or enacted, and computability limits the effectiveness of policies that presume otherwise (Koppl 2008). In other words, before an entrepreneur can exercise judgment, he or she must hold beliefs in the present about the prospects of profiting from judgment in the future, and both the generation and validation of those prospects in the present is a matter, we argue, of entrepreneurial discovery. Ludwig von Mises (1949 ), who served as one of the primary inspirations for Kirzner’s view, suggested that this role of the entrepreneur as both organizer and evaluator is the “driving force” behind the market process; entrepreneurs both “speculate” on uncertain futures and “promote” specific ways of exploiting prospects for advantage from those speculations (250).
Second, there is the issue of differentials among entrepreneurial strategies (see Hitt, Ireland, and Hoskisson 2013). Entrepreneurial strategies are methods by which decision alternatives are evaluated, selected, and pursued. There is a crucial distinction between these strategies and the conditions that motivate or enable their use, because the strategies’ attributes are contingent on the uncertain unfolding of the market discovery process over time. Not all strategies are equally effective in all contexts; external conditions have much to say about what strategies are effective and under what circumstances. Beliefs about the effectiveness of strategies can be correct or incorrect, and the context of entrepreneurial action, or the opportunity conditions under which it operates, is what ultimately affirms (or not) the correctness of such beliefs. In other words, the existence of opportunity validates not only entrepreneurial beliefs about consumer preferences (ends), but also their beliefs about the best ways to meet those preferences (means).
Finally, there is the issue of differential welfare impacts of entrepreneurial action. Research since Baumol (1990) has confirmed that the entrepreneurial process will produce variability in social welfare outcomes based on the extent to which policies and institutions incentivize value-creating (productive) versus value-dissipating (unproductive) forms of entrepreneurship. More generally, the results of the entrepreneurial process are not confined to the results experienced by individual entrepreneurs; there is a social dimension to entrepreneurial outcomes determined by the character of the institutional capital structure within which they are generated. This social dimension is defined, in part, by the “nexus” (Shane 2003) between the motivations, beliefs, and skills of individual entrepreneurs and the contexts that incentivize and constrain the expression of those motivations, beliefs, and skills. In other words, negative social outcomes do not always come from incorrect beliefs or faulty strategies on the part of entrepreneurs, but often from the limited array of decision alternatives produced by poor institutional contexts.
Simply put, without a meaningful opportunity discovery construct, it is difficult to properly understand the impacts of context, contingency, and institutional capital on entrepreneurial outcomes. This paper represents an attempt to further develop such a meaningful concept, drawing on the work of Kirzner but also on the rich literature that has developed in response to its ambiguous construction and role. The remainder of the paper is organized as follows. First, the role of opportunity in the study of entrepreneurship is surveyed, beginning with Kirzner’s seminal view and proceeding to recent developments. Both Kirzner’s approach and the more recent extensions and modifications of the opportunity construct are critiqued, including those that suggest an outright abandonment of the term. Next, a theory of opportunity development is provided that addresses the major shortcomings of existing versions while retaining their important contextual role, noting similarities to other approaches. Finally, some implications are outlined of this reconceptualization of entrepreneurship as an emergent, collaborative procedure of opportunity discovery and judgment for both strategy research and policy.
THE ROLE OF OPPORTUNITY IN ENTREPRENEURSHIP STUDIES
Although the systematic study of the entrepreneur goes at least as far back as Richard Cantillon (1755), Jean-Baptiste Say ( 1880), and John Stuart Mill ( 1871), it was the work of Knight (1921), Schumpeter (1934), and, especially, Kirzner (1973) that did the most to incorporate the theory of the entrepreneur into economic and social analysis. Likewise, although the term opportunity has a long history in both academic and popular works on entrepreneurship, the primary theoretical role it plays in entrepreneurship studies derives from the work of the Austrian school, again most directly from Kirzner (1973). One of the best-known expositions of this view is presented in Kirzner (1979, 62), where he outlines the essential aspects of what he calls “entrepreneurial discovery,” which he describes as the “driving force behind [the] systematic process” of market equilibration.
Kirzner’s entrepreneurial discovery view developed primarily out of the insights of Austrian scholars Mises and F. A. Hayek, who were in turn heavily influenced by the ideas of earlier scholars in the Austrian tradition. From Mises ( 1996) comes the concept of entrepreneurship as a process of action under uncertainty, while Hayek (1945, 1948) contributes the concept of knowledge acquisition as a fundamental aspect of market interactions (Kirzner 1997, 67). As Kirzner explains, Hayek conceived of markets as processes whereby “market participants acquire better mutual information concerning the plans being made by fellow market participants,” while Mises contributed the recognition that “this process is driven by the daring, imaginative, speculative actions of entrepreneurs who see opportunities for pure profit in the conditions of disequilibrium” (Kirzner 1997, 68).
There are two important aspects of the preceding views that come to bear on an examination of the opportunity construct. First, from Hayek, opportunities arise as the result of acquiring “better” information about what market participants intend than was previously possessed, a process that Hayek later described as “discovery” (see, e.g., Hayek 1978). Second, from Mises, it is the entrepreneur that recognizes opportunities and engages in actions designed to exploit them. Kirzner (1997) refers to these aspects as the discovery role and the entrepreneurial role, respectively.2 Thus, discovery in the Austrian view does not refer to the recognition of opportunities per se, but to the general role of markets as a knowledge acquisition process, from which entrepreneurs learn what opportunities might exist and how to act in order to profit from them. To quote from Hayek (1948, 97), markets and competition exist “to teach us who will serve us well: which grocer or travel agency, which department store or hotel, which doctor or solicitor, we can expect to provide the most satisfactory solution for whatever particular personal problem we may have to face.”3
The Kirznerian entrepreneur is one who looks for “opportunities for pure entrepreneurial profit created by temporary absence of full adjustment between input and output markets” (1973, 69), whether that absence of adjustment is in the present or the future. Full adjustment of input and output markets requires the absence of surpluses and shortages, but also the lack of profit above the opportunity cost of all resources employed in the process. So, for a forward-looking entrepreneur, the ability to correctly foresee a profit situation requires that he, in some way, be able to discover something that is not reflected in the current pricing of resources and/or consumer goods and services. The entrepreneurial roles of recognition and risk taking require the discovery role of knowledge acquisition. Hayek (1945, 1948) adds the proposition that this knowledge is often of the localized, tacit, and intersubjective type that cannot be uncovered without actions (experiments) that submit various ideas to market tests. The picture of entrepreneurship that emerges is very similar to the creative trial-and-error processes that characterize “constructivist” conceptions of venture development, like those of Buchanan and Vanberg (1991) and Sarasvathy (2001). It also bears resemblance to the role of the financial market speculator in Mises ( 1996).4
Unfortunately, Kirzner (1973, 1997) illustrates this process by employing a framework that assumes an actual, existing supply and demand for consumer goods and services, thus reducing the entrepreneurial function to one of discovering current market inefficiencies, essentially as an arbitrageur. An important aspect of this characterization, as pointed out by Peter G. Klein (2008), is the lack of investment and, thus, risk taking on the part of the entrepreneur. By contrast, Knight (1921) suggests that only when characteristics of future supply and demand are uncertain will an entrepreneurial investment in current resources be necessary, so that the entrepreneur acts as innovator, speculator, and resource allocator in markets for future goods and services, not merely an arbitrageur of divergent market expectations.
Though Klein acknowledges Kirzner’s purpose in using the arbitrageur as an illustration, stressing the equilibrating aspect of entrepreneurship in the market process, and that Kirzner himself acknowledged the speculative role of entrepreneurship in other works (see, e.g,, Kirzner, 1985, 56), the focus on arbitrage is nonetheless problematic.5 Chief among the issues is the idea that entrepreneurs are defined by the characteristic of “alertness” to opportunities, that is, that their primary function is to look for situations where yet unrecognized market inefficiencies already exist. Not only does such a function ignore the important role of uncertainty bearing that creating new goods and services entails, but it is also difficult to operationalize apart from the very actions (investments) that create those goods and services. Essentially, we can only see the ex post results of alertness, and that only when risky investments in assets turn out to have been correct.6 By contrast, it is problematic to ascribe unsuccessful investments to “lack of alertness” to an opportunity, as there is no direct evidence that an opportunity existed in the first place; nor can one merely substitute the idea of alertness to a “nonopportunity” to explain unsuccessful investments, because the very idea of alertness implies that something exists to be aware of.
Nonetheless, there is a considerable literature in entrepreneurship that derives its emphasis from this framework. Drawing from Kirzner, Shane and Venkataraman (2000, 200) identify opportunity as a key construct in the definition of what entrepreneurs do and what those who examine entrepreneurship study. They define entrepreneurial opportunities as “situations in which new goods, services, raw materials, and organizing methods can be introduced and sold at greater than their costs of production.” Importantly, this definition is noncommittal on the questions of both the nature and sources of entrepreneurial opportunities. The opportunity discovery approach has been employed to fruitfully explore knowledge transfer (Shane 2000), the nature of entrepreneurial searching (Hsieh, Nickerson, and Zenger 2007), venture development in transitional markets (Mainela and Puhakka 2009), the role of transactions costs and property rights (Foss and Foss 2008), the use of intellectual capital (Puhakka 2010), and entrepreneurial networks (Shu, Ren, and Zheng 2018), among numerous other applications.
Management scholars have spent considerable effort trying to better formalize the role of opportunity in the framework of entrepreneurship studies. For example, Sarasvathy, Dew, Velamuri, and Venkataraman (2003) distinguish between three views of entrepreneurial opportunity they identify as allocative, discovery, and creative views. An allocative view of opportunity implies a current misallocation of existing resources; thus, the emphasis is on recognition of discrepancies in current supply and demand, much as illustrated in Kirzner (1997). A discovery view implies that there is one important aspect of a potential market that is undeveloped—i.e., a (latent) demand without a supply or a (latent) supply without a demand. The emphasis in this view of entrepreneurial opportunity is on “discovering” where latent supply or demand exist, such as a service without a provider (latent demand) or a resource without a use (latent supply), and completing the market by implementing the missing piece. Finally, a creation view implies that there is neither a supply nor a demand for the good or service in question; in this case, the entrepreneur creates the opportunity by providing both a new good or service and a new set of means by which the good or service is created.
Sharon A. Alvarez, Jay B. Barney, and Susan L. Young (2010) employ a similar approach in their article on opportunity formation. They also use a threefold categorization scheme, focusing on three philosophical approaches to opportunity: realist, social constructionist, and evolutionary realist. Despite the different nomenclature, their views essentially correspond to those of Sarasvathy et al. (2003), with their realist view corresponding to the recognition view, the constructionist to the creation view, and the evolutionary realist to the discovery view of the latter. Confusingly, they refer to methods of “discovery” as applicable to the realist framework, although their description of realism corresponds closely to that of the allocative view in Sarasvathy, et al., (2003); likewise, they ascribe methods of “creation” to the evolutionary realist framework, although their description of this framework corresponds closely to that of discovery in the latter.
A rich literature has developed around constructivist views linked to the “creation” approach since Alvarez and Barney (2007) proposed the basic dichotomy between creation and discovery, including Alvarez and Barney (2010, 2013), Wood and McKinley (2010), Alvarez, Barney, and Anderson (2013), and Alvarez, Young, and Woolley (2015).7 The emphasis in each of these extensions is on the idea of “enactment,” rather than discovery, of opportunities; as explained by Wood and McKinley (2018), the “causal influence of the entrepreneur on the opportunity is more strongly highlighted” than in the discovery view (8). The opportunity creation literature has expanded considerably to include the examination of niche construction (Luksha 2008), information technology startups (Ojala 2015), entrepreneurial affect (Goss and Smith 2018), the conditions of uncertainty underlying entrepreneurial actions (Mitchell et al. 2012), and social entrepreneurship (Gonzalez, Husted, and Aigner, 2017). Several studies have also attempted to bridge and/ or reconcile the opportunity discovery and opportunity creation approaches (see, e.g., Zahra 2008; Edelman and Yli-Renko 2010; Martin and Wilson, 2016; and Chetty, Karami, and Martin, 2018).
Although maintaining the importance of opportunity, however, the essence of the creation view still locates it solely in the mind of the entrepreneur. In doing so, this view fails to address the important problems of where entrepreneurial beliefs come from and why entrepreneurs perceive the decision alternatives that they do, particularly those alternatives that ultimately prove successful. The idea that successful entrepreneurship requires some knowledge of future conditions outside the mind of the entrepreneur seems to also require that there be entrepreneurial methods of “discovering” what those conditions are. Thus, at the heart of the dichotomy between creation and discovery are the questions of what ultimately makes entrepreneurial profit seeking successful, and whether it lies entirely within the entrepreneur’s imagination or at least in part in the recognition of external realities that give it credence.
Other extensions of the opportunity literature have attempted to better integrate it with more traditional views in psychology and evolutionary economics, such as the cognition-based approach of “opportunity recognition” (see, e.g., Baron 2004, 2006; Baron and Ensley 2006; and Ozgen and Baron 2007) and the idea of opportunities as “propensities” (Ramoglou and Tsang, 2016, 2017). Baron (2004, A1) proposes opportunity recognition as a form of pattern recognition, the “process through which individuals perceive emergent patterns among seemingly unrelated stimuli or events.” As such, opportunity recognition is a form of discovery informed by theories of human cognition and perception. Similarly, Ramoglou and Tsang (2016, 2017) propose that opportunities are real propensities for a future, emergent state of the world and that entrepreneurs sometimes recognize these propensities and act to bring them to fruition, much as one who recognizes the future plant within a seed must act to bring the plant into being. This evolutionary-realist view of opportunities as propensities is further examined below.
One way to examine the validity and completeness of alternate views of entrepreneurship is to ask how entrepreneurial behavior would be different under the different approaches. For example, consider the distinctions between discovery and creation as illustrated by Sarasvathy et al. (2003) and Alvarez, Barney, and Young (2010). Under the realist approach of Alvarez, Barney, and Young, analogous to Sarasvathy, Dew, Velamuri, and Venkataraman’s allocative view, the entrepreneur acts as the Kirznerian arbitrageur; entrepreneurs seek pure profit by addressing an existing market disequilibrium. Although such a view is plausible in many cases, it does not address the important Knightian roles of risk taking and investment under uncertainty, which characterize ventures to provide future goods and services. By contrast, under Alvarez, Barney, and Young’s constructionist approach, analogous to Sarasvathy et al.’s creation view, individuals develop both the opportunity and the market for it through their actions. They “do not recognize opportunities first and then act; rather, they act, wait for a response—usually from the market—and then they readjust and act again” (Sarasvathy et al. 2003, 30, emphasis mine). The implication is that it is entirely the actions of entrepreneurs that produce an opportunity—no latent market characteristics (demand or opportunity cost) exist independently that can be employed as motivation for actions or justification for beliefs.
However, the idea that entrepreneurs act without either motivation from or beliefs about latent external characteristics does not hold up to logical scrutiny, because it dodges the question of why entrepreneurs act at all. Although it is true that a yet undiscovered objective opportunity cannot serve as its own motivation for discovery, neither can purely subjective perceptions of an opportunity do so. The real question here is one of incentives—why do entrepreneurs believe that there are ex ante profit opportunities available? Do they not expect that, in some objective sense, their actions will result in an expected benefit above the opportunity cost of the action? What is the basis for a belief of this kind, and from where does the feedback that potentially affirms or alters the belief come? Hayek suggests that it comes in the form of information (i.e., revealed preferences) about the subjective perceptions of consumers and resource owners regarding the expected benefits and opportunity costs of
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