Venkataraman 1997

[Sebastian Thorndike]

ProfessorVenkat R. Subramanian received his B.Tech. degree in chemical and electrochemical engineering from the Central Electrochemical Research Institute (CECRI), Karaikudi, India, in 1997 and his Ph.D. degree in chemical engineering from the University of South Carolina, Columbia, SC, USA, in 2001. Professor Subramanian is an elected ECS Fellow, is a past elected chair of IEEE division of the Electrochemical Society. He is also a past elected technical editor of the Electrochemical Society. He is also a past elected chair of Area 1e: (Electrochemical Engineering) of the AIChE.

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.

However, while adequately addressing the evaluation and exploitation of potential opportunities for profit, judgment does not address the motivation for such judgments or the generation of decision alternatives any better than alertness (of objective circumstances) or creation (around purely subjective beliefs) do. The problem centers on an important flaw that is common among constructivist critiques of the opportunity concept: the idea that, since the actual existence of opportunity can never be revealed except where (successful) entrepreneurial action confirms its existence, opportunity itself must be entirely subjective, i.e., it exists only in the mind of the entrepreneur. Klein (2008) states this succinctly when he writes:

Consistent with this line of reasoning, Foss and Klein (2012) propose the alternative judgment-based approach (JBA) focusing on beliefs, actions, and results. Employing this approach, they suggest that the notion of opportunity can only be understood as an ex post construct and that the ex ante correlate is entrepreneurial beliefs, which are translated into actions stemming

from 1) more or less articulated business plans ultimately based on knowledge and beliefs about current conditions and 2) estimates of future profits and losses that result from realizing the business plans. (Foss, Klein, and Bjrnskov 2019, 1204, emphasis mine)

Treating opportunities as purely subjective entities ignores the most important aspect of what Kirzner was trying to convey with his entrepreneurial arbitrageur, namely, the systematic search for and recognition of situations, whether temporally located in the present or in the future, where the characteristics of latent supply and demand (i.e., preferences) do not match objective price conditions. These situations are what we refer to as opportunities, and they are revealed when market tests show entrepreneurial beliefs about underlying preferences to be accurate and/or when they provide additional information necessary to adjust entrepreneurial actions to accurately reflect or influence those preferences.9 Discovery is the process that reveals this information to the entrepreneur.

Disentangling opportunities into their exogenous, third-person and endogenous, first-person components goes a long way in clarifying the role of opportunity in motivating entrepreneurial action. Third-person opportunities may exist independently of entrepreneurial actions; they can be missed or misperceived; they can be well exploited, imperfectly exploited, or go unexploited; they represent the commonsense notion of opportunity as a set of conditions favorable to action that is value enhancing (i.e., produces benefits in excess of opportunity cost) for some set of stakeholders. They can serve as motivation (incentives) for engaging in actions intended to reveal characteristics of latent supply and demand for goods and services that are not yet in existence. However, first-person opportunities are not revealed independently of entrepreneurial actions; they are contingent upon those actions. They exist only in the sense that actions show them to be valid when entrepreneurs submit their initial and subsequent perceptions of benefit and opportunity cost to market tests. This conforms to the notion of opportunities as conditions of value creation revealed via correct judgments of future preferences.

The third-person/first-person distinction, however, does not go far enough in many ways. It does not address the generation of decision alternatives, nor the tendency (or lack thereof) for those alternatives to match actual preferences. This discovery of intersubjective agreement between entrepreneurial beliefs and consumer preferences, and the subsequent replacement of less correct prices with more correct prices for both resources and goods, is the sine qua non of the Austrian approach to entrepreneurship and is what distinguishes the role of entrepreneurship in the Austrian tradition from its passive role in neoclassical economics and its uncertainty-enhancing role in post-Keynesian approaches (see, e.g., Dempster 1999). The discovery approach of Mises, Hayek, and Kirzner thus conceives of entrepreneurship as an essential error correction procedure within the market process.

In this article the concept of discovery is refined as the processing of information into knowledge (Foss, Klein, and Bjrnskov 2019, 1204) that allows entrepreneurs to replace less correct prices with more correct ones based on the revelation of unsatisfied preferences for new goods and services in new markets. In other words, discovery and opportunity coevolve as mutually reinforcing components of the entrepreneurial process. There can be no recognition of opportunity without successful discovery, just as there can be no revelation of opportunity without successful judgment. In this sense, the idea of discovery as the result of alertness to preexisting (objective) opportunities is merely being replaced with a more plausible idea of discovery as a corollary to the emergence of (intersubjective) opportunities. Unlike the former, this view allows not only for the possibility that opportunities are real things, with real properties that correspond to actual states of the world, but also for the possibility that discovery fails to identify an opportunity, either because the characteristics of the opportunity were different from what the entrepreneurs imagined (a missed opportunity) or because there was never an opportunity in the first place (a nonopportunity).11

The preceding discussion, therefore, highlights four important aspects of opportunity discovery for the study of entrepreneurship: (1) motivations for entrepreneurial actions, (2) generation of decision alternatives, (3) convergence of subjective beliefs and subjective preferences, and (4) welfare impacts of variability in entrepreneurial strategies. We address these aspects by employing a simple model of the entrepreneurial process. The model abstracts from admittedly important elements in the process. Nonetheless, it provides a useful framework for understanding the important differences between subjective and intersubjective phenomena, and the corresponding differences between discovery and judgment that are important for delimiting the role of the opportunity construct. Figure 1 below illustrates the model.

A useful analogy is that of entrepreneurial strategy as an options-producing (or options-writing) process. In finance theory, option writers obligate themselves to future courses of action without the certainty of knowing that those courses of action will turn out to be profitable; they provide options for others to submit as tests of those expectations. The writer obligates himself or herself to a course of action that depends on the subsequent decision of the purchaser of the option to exercise it or not. If conditions turn out to be favorable for exercise, the option writer stands as the counterparty (buyer for the option to sell, seller for the option to buy) to the option holder; if not, the option expires unexercised along with the obligation of the writer. Option writers seek to benefit from future market conditions by receiving more in profit from the sale of options than they incur in costs of obligations.14 One can define entrepreneurial strategy as the options-writing process applied to the creation of new paths of future resource allocation, i.e., the writing of real, as opposed to financial, options. It is, to paraphrase Jean-Baptiste Say, the application of knowledge to a potentially useful purpose (Hebert and Link 1982, 31), and the process that produces this knowledge and its application is the work of entrepreneurial discovery, both within and without existing firms.

Notice that in the analogy of the options process to the entrepreneurial process, the entrepreneur promoter takes the role of the options writer, while the capitalist-entrepreneur takes the role of the option purchaser. Mises ([1949] 1996, 215) realized that these two roles are often entangled because we use one term, entrepreneur, to express both aspects of the entrepreneurial process. Therefore, the tension between Schumpeterian innovation and Kirznerian price discovery is the result of linguistic confusion over what aspect of the entrepreneurial process is being emphasized. This paper has argued that the tension between creation and discovery is, in part, the result of this same confusion. The very term entrepreneur is an umbrella concept that describes several functions of innovation, promotion, and risk taking (Hebert and Link 1982) that evolve within the same process.

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