Monday, 4 November 2013

5. Entrepreneurship

With this item I start a series on entrepreneurship.

Entrepreneurship is essential for innovation, but what does it entail? In time, in the literature there have been various notions of it, as follows:

- risk taking
- configuring resources
- creative destruction
- novel combinations
- creating or entering new markets
- management
- inspiring people

Currently, the emphasis lies on the dimensions of innovation: risk taking, novel combinations, and new markets. The rest is seen as less a matter of entrepreneurship and more a matter of management.

A debate that goes back to Schumpeter concerns the questions whether small or large firms and perfect or imperfect competition most produce innovation. Schumpeter proposed that in early capitalism it was the small, independent outsider who produced innovation, while in later capitalism it was more the large firms that could sustain the specialized, knowledge intensive labour needed for high tech innovation, with large laboratories and deep pockets for the long slog of development.

Concerning competition an argument was that while it gives an incentive for innovation, long, costly and risky processes of development require a buffer of profit that can only arise under limited competition. Empirical research indeed indicates a curvilinear relationship: some competition has a positive but much competition a negative effect.

Concerning the issue of large versus small firms, the strength of large firms lies in resources of specialized knowledge, deep pockets, spread of risks across products and/or markets, market access and power, a longer-term perspective, and strategic action.

Weaknesses lie in conservatism, for several reasons. One is that decisions have to pass multiple levels, which slows down decision-making and increases the chance that innovative ideas will be voted down. Another is that with established products, and investments sunk in corresponding technologies and markets, large, established firms have an interest in halting or postponing innovations that cannibalise existing products and destroy existing competencies and investments. Also, because of their size and corresponding power of employment, economic leverage and lobbying in networks of supervisory boards and politicians, they can exert political power to achieve their ends. They have an interest and the capability to establish a focus of policy on incremental rather than radical innovation, to protect their investments, while they legitimise their actions by contributing to incremental innovation.

Paradoxically, small, independent outsiders are efficient in the innovation system because of their weakness in survival under failure. Failures are efficiently weeded out, while in large firms and government they may be propped up with subsidization from successful projects or from taxes, to protect the reputation of decision makers. Also, to the extent that they are not yet involved in existing markets, outsiders have no vested interests to protect, and decision-making is often up to the entrepreneur by him/herself.

To a large extent, the advantages of smaller firms are behavioural: in flexibility, fast decisions, motivation and willingness to sustain setbacks. I conclude that for radical innovation, the strength lies mostly in the smaller firm. I will dedicate a separate item to a further analysis of the strengths and weaknesses of small firms.

However, in view of the opposite strong and weak points of small and large firms, it is best to focus on their complementarity, seeking combinations that benefit the economy. Also, by decentralization into more autonomous units large firms can try to approach the advantages of small firms, and by collaborating in alliances and networks small firms can achieve some of the benefits of large size. The relative strengths of large and small firms also depend on the extent of economies of scale. I will dedicate the next item to that.

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