My Response to Shane (2012)

24 February 2013 at 10:48 pm 20 comments

| Peter Klein |

Peter Lewin blogged earlier on the ten-year retrospectives by Scott Shane and Venkataraman et al. on the influential 2000 Shane and Venkataraman paper, “The Promise of Entrepreneurship as a Field of Research.” As Peter mentioned, Shane acknowledges critics of the opportunity construct such as Sharon Alvarez, Jay Barney, Per Davidsson, and me, but dismisses our concerns as trivial or irrelevant.

The January 2013 issue of AMR includes a formal response by Alvarez and Barney, as well as rejoinders by Shane (with Jon Eckhardt) and Venkataraman (with Saras Sarasvathy, Nick Dew, and William Forster). The dialogue is well worth reading. I didn’t participate in the symposium but do have a brief response to Shane.

My critique of Shane’s work, and the opportunity-discovery perspective more generally, is that the scientific understanding of entrepreneurship has been held back by the focus on opportunities. The basic idea is simple: “opportunities” do not exist objectively, but are only only subjective images, or conjectures, about future possibilities. They exist in the mind of the entrepreneur, who takes actions to try to bring them about. The very concept of opportunity makes sense only ex post, after actions have been taken and future outcomes realized, leading to realized profits and losses. Under uncertainty, there are no opportunities, only entrepreneurial forecasts, which may turn out to be correct or incorrect. (My critique is slightly different from that of Alvarez and Barney, who argue that some opportunities are “discovered,”  but others are “created.” My position is that the whole idea of opportunity is at best redundant, and at worst misleading and harmful.) I maintain that the unit of analysis in entrepreneurship research should be action (investment) under uncertainty, not the discovery (or creation) of profit opportunities.

These arguments are laid out in my 2008 SEJ article and in the Foss-Klein 2012 book. They also came to the fore in a recent exchange with Israel Kirzner, the intellectual father of the opportunity construct.

In his January 2012 essay, Shane mischaracterizes this substantive critique as a terminological one. He says that subjective entrepreneurial perceptions of the future can be labeled “business ideas,” and are distinct from “opportunities,” which are objectively existing configurations of resources that generate potential gains from trade. As in the 2000 paper, he ignores the role of uncertainty. He claims, bizarrely, that without objectively existing opportunities, there is no way to explain objective profit. But this confuses an epistemic concept — entrepreneurial perceptions of an uncertain future — and an ontological concept — realized money profits and losses. Of course ex post profits and losses are objective. Why, then, call them “opportunities,” a forward-looking concept, rather than profits and losses? As I’ve argued before, every entrepreneurial phenomenon that can be described using the language of opportunities can be described even better in the language of beliefs, actions, and results. “Steve Jobs discovered an opportunity to make money by producing iPads” is misleading, because it implies that the future was known when Steve Jobs made his initial iPad investment. Far better to say “Steve Jobs believed he could make money producing iPads, so he started producing them, and he turned out to be right, earning huge profits.” What do we gain from using the concept of “opportunity,” rather than investments that will hopefully pay off?

Moreover, there is simply no way to explain losses in opportunity language. Shane (2012) dances around this point with some sleight-of-hand:

Venkat and I also argued that an entrepreneur’s conjecture about what will happen if resources are recombined and the output sold can turn out to be correct or incorrect. If it is correct, then the entrepreneur earns a profit. If it is incorrect, then the entrepreneur incurs a loss. Thus, our definition of entrepreneurial opportunities does not require them to be profitable; rather, our definition suggests only that the probability new goods, services, raw materials, and organizing methods could be introduced and sold at greater than their cost of production exceeds zero.

But, if opportunity simply means conjecture — what Shane now calls “business idea” — then the term is redundant. Using the same word for beliefs and for realized profits is obscurantist. If Shane now wants to use the term “business ideas” for beliefs well, fine, that is certainly an improvement in clarity. But then there is no role whatsoever for the term “opportunities.” There are simply the results of action.

I was amused that Shane mangled a quote from my 2008 article, making me appear to say the opposite of what I actually said. He writes:

If, as Klein explains, “opportunities for entrepreneurial gain are . . . inherently subjective — they do not exist until profits are realized” (2008: 180) — then unsuccessful entrepreneurship is a logical impossibility. No entrepreneur can fail to generate an entrepreneurial profit. And if entrepreneurs always generate a profit, then we cannot have failed entrepreneurs. If, however, objective opportunities make it possible for entrepreneurs to formulate subjective new business ideas, which are uncertain, then unsuccessful entrepreneurship can exist.

Of course, what I was criticizing in this passage was the concept of unsuccessful opportunities, not unsuccessful entrepreneurship! If entrepreneurship is defined, as I do (following Knight and Mises), as action under uncertainty, then of course it can be successful or unsuccessful. If entrepreneurship is defined, as Shane does (following Kirzner), as opportunity discovery, then it can only be successful. Here’s what I actually wrote on pp. 179-80 (with the sentence quoted by Shane in bold):

For Knight, in other words, opportunities do not exist, just waiting to be discovered (and hence, by definition, exploited). Rather, entrepreneurs invest resources based on their expectations of future consumer demands and market conditions, investments that may or may not yield positive returns. Here the focus is not on opportunities, but on investment and uncertainty. Expectations about the future are inherently subjective and, under conditions of uncertainty rather than risk, constitute judgments that are not themselves modelable. Put differently, subjectivism implies that opportunities do not exist in an objective sense. Hence, a research program based on formalizing and studying empirically the cognitive or psychological processes leading individuals to discover opportunities captures only a limited aspect of the entrepreneurial process. Opportunities for entrepreneurial gain are, thus, inherently subjective—they do not exist until profits are realized. Entrepreneurship research may be able to realize higher marginal returns by focusing on entrepreneurial action, rather than its presumed antecedents.

Only by taking that sentence completely out of context could Shane make me appear to be defining entrepreneurship as necessarily successful!

To summarize, Shane’s 2012 response to critics is a disappointment. He mostly ignoring the critics, rather than grappling with the substantive issues at hand. I hold to my (subjective) belief that entrepreneurship research has been hampered by the concept of opportunities, and that progress will come from adopting the Knightian emphasis on judgment and action under uncertainty.

Addendum: See also the dictionary.

Entry filed under: - Klein -, Austrian Economics, Entrepreneurship, Myths and Realities. Tags: .

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20 Comments Add your own

  • 1. Advocates of Reason | Economic Thought  |  25 February 2013 at 11:36 am

    [...] Peter Klein summarizes a debate of his with Scott [...]

  • 2. Randy  |  25 February 2013 at 12:12 pm

    Peter, you were a little easy on Shane and a little hard on Kirzner. In my reading of Shane’s reflection paper, I find his defense of objective opportunity to be rather base. That is, he claims his individual/opportunity nexus doesn’t have meaning if objective opportunities do not exist. (Otherwise the world collapses into some Kleinian subjectivity vortex…) And since the individual/opportunity nexus is Truth, he must invoke “business ideas” to deal with the messiness of perception, subjectivity, chance, and judgment.

    I see Kirzner’s entrepreneur as a metaphor for some tâtonnement process (that leads toward an equilibrium, but not to it) of reacting to prior errors, rather than as a model. In some ways, what the literature refers to as a Kirznerian opportunity is a peculiar reification of an abstract market process through the entrepreneur-as-metaphor, thence to THE alert type of entrepreneur (as opposed to THE creative type) and thence to an object — the objective opportunity. UGH.

  • 3. Peter Klein  |  25 February 2013 at 12:48 pm

    Good points, Randy, thanks. Actually I’ve defended Kirzner along these lines:

    http://organizationsandmarkets.com/2009/01/14/kirzner-on-kirzner/

    and

    http://organizationsandmarkets.com/2008/10/24/kirzners-tapestry/

  • 4. Jason Franken  |  26 February 2013 at 9:55 pm

    From the (unbiased?) perspective of a novice in this area, I could take issue with the statements: “The very concept of opportunity makes sense only ex post … Under uncertainty, there are no opportunities, only entrepreneurial forecasts, which may turn out to be correct or incorrect.” Given a working definition of “opportunity” (“Exploitable set of circumstances with uncertain outcome, requiring commitment of resources and involving exposure to risk.” – http://www.businessdictionary.com/definition/opportunity.html), “recognition of an (uncertain) opportunity” seems analogous to a “believing there is money to be made by doing something”.

    Clearly, this recogniztion/belief stage is important as it precludes investment, and Shane appears to neglect/confuse the role of uncertainty here. Perhaps, building around working conceptualizations of theoretical constructs (like the definition of “opportunity” cited above) could be more productive than recreating the wheel by creating scholarly definitions of “business ideas”, etc. (Similarly, “outcome measurement uncertainty” in the strategy literature, might be more succinctly termed “measurement difficulty”.)

    Finally, I submit that a theory of entrepreneurship is useful to the extent that it provides an additional lense to view various research questions. To that extent, for some purposes, perhaps the unit of analysis should be investment. However, I conceed that, if one purpose of a University is to develop successful entrepreneurs, then research identifying what contributes to successful “opportunity recognition” (accurate “beliefs money can be made”) and successfuly acquiring funding (convincing investors/lenders) may also be of interest. In short, the appropriate unit of analysis might depend on the research question. That’s my 2 pennies for the night … :)

  • 5. Randy  |  27 February 2013 at 12:58 am

    @Jason, the concept of the entrepreneurial opportunity is like the Easter Bunny. It is a metaphorical construct that allows discourse at a simpler level than is warranted by the metaphysics. I use the concept of opportunity with undergraduates in explicating the necessary passage from external trends to the entrepreneurial venture plan. It is a convenience. Yet, as a construct for research, the entrepreneurial opportunity is fraught with difficulties. The thread above points to one family of these difficulties: any opportunity that exists in an objective sense (and this is iffy) because of market processes, technological change, or other sources of friction in an industry must be perceived (as opposed to objectively measured) by humans. Judgment is applied to the prospect for entrepreneurial gains dependent upon human action (design, investment, communication) which is distinct from exogenous market forces. And then there are the perceptions by other human agents that affect the ultimate economic outcomes.

    At the risk of resorting to other metaphors, think of a genetic mutation that will allow great advantage to the organism. Note that this is incontestably an objective fact (compared to the rhetoric of opportunities). Will this genetic advantage be passed down to become a dominant genotypic (and hence, phenotypic) character in the species? Not if it is poorly expressed in the phenotype of the individual mutated organism and not if random selection pressures act against it being passed on, AND if all the traits in the organism do not lead to reproductive success despite the single advantageous gene.

    Sorry for belaboring this, Jason, but there are too many mediating variables between what is considered to be an opportunity and what may eventually be measured as a successful entrepreneurial (functional) outcome.

  • 6. Jason Franken  |  27 February 2013 at 10:50 am

    Thanks for enlightening me Randy. I find this research area fascinating, though admitedly my knowledge of it is limted. I’ll take a closer look at the links posted above. Hope all is well in MO!

  • 7. Steve Phelan  |  28 February 2013 at 2:16 pm

    Peter, I shared this post with the students in my advanced MBA entrepreneurship course last night (the topic just happened to be the market process). They were shocked to see so much uncertainty about key concepts in the field and felt that battling titans like you and Shane reminded them of Jedi warriors – you are now officially Darth Klein in this part of the world!

  • 8. Peter Klein  |  28 February 2013 at 3:35 pm

    Steve, thanks — now I know what I want on my tombstone!

  • 9. stevepostrel  |  3 March 2013 at 4:19 am

    I confess that this dispute seems idle to me. Entrepreneurial action is an uncertain search for opportunity. Is that a dollar bill on the sidewalk, a mirage, or a booby trap? It is reasonable to say that the answer to this question is objective, in that the wishes, hopes, or delusions of the entrepreneur will not turn a booby trap into a dollar bill. That’s an ontological point.

    It is also reasonable to say that before experiments try to pick up the potential dollar no one can say for sure what it really is. Epistemically we are in the realm of subjective beliefs and judgment.

    The opportunity construct could be useful for refining that judgment by developing taxonomies of success scenarios, i.e. different kinds of hypothetical configurations of demand, technology, and institutions that would make investments successful. Such a taxonomy might improve the search process by creating patterns to emulate or seek out. (You also might be able to do the same for mirages and booby traps.)

    Perhaps there is something more at stake that I’m missing.

  • 10. Peter Klein  |  3 March 2013 at 12:17 pm

    I think you’ve got it. But notice that exactly nothing in your analysis requires, or even benefits from, the construct of “opportunity.” Dumping it would greatly improve the clarity of these kinds of discussions, don’t you think?

  • 11. Randy  |  3 March 2013 at 12:30 pm

    One can be specific here. At the levels of method and methodology, is the opportunity construct necessary or sufficient in explanation or prediction? At the level of any successful or unsuccessful entrepreneurial venture (as measured by economic returns to the entrepreneurial function), is the opportunity construct necessary or sufficient to predict ex ante or explain ex post the outcome?

    See Shane’s Air DaVinci example in the 2012 reflection piece, as a place to begin.

  • 12. stevepostrel  |  3 March 2013 at 8:01 pm

    Peter:

    We probably should have a word like “candidate” to describe the category of apparent dollar bills lying on the ground that would either be “opportunities” or not.

    I think the ontological opportunity construct (under whatever name) could be useful for refining judgment, as I said above:

    “The opportunity construct could be useful for refining that judgment by developing taxonomies of success scenarios, i.e. different kinds of hypothetical configurations of demand, technology, and institutions that would make investments successful. Such a taxonomy might improve the search process by creating patterns to emulate or seek out. (You also might be able to do the same for mirages and booby traps.)”

    Another way to think of it is that many “candidate opportunities” come to us as putative “gaps”or “holes” in what is currently available in the market. (That’s reasonably consistent with the Kirznerian way of looking at things.) One class of such candidates was described in my old “Design Puzzles” post on this blog, but there are also non-design versions of this–what look like unsolved problems paired with unused or newly invented solutions. True opportunities–currently unexploited chances for creating and capturing economic surplus–might have distinct attributes that distinguish or probabilistically indicate them. For example, you would want a coherent account of why they hadn’t already been filled if they really were opportunities.

    So when you see one of these candidates, is there any kind of analysis you can do to better forecast whether it really is an opportunity before making sunk investments? If not, then we don’t have much to say about helping entrepreneurs. If yes, which probably only means weeding out the lower tail of mistakes, then the way to do it is by “reverse-engineering” scenarios in which the thing is a real opportunity versus when it is a mirage or a booby-trap to see what observable characteristics each of these is likely to have.

    In other words, I think there might be useful patterns, based on the economic requirements for the existence of an opportunity, that could somewhat help to ex ante improve the odds of guessing right (“judging”) investment prospects. That means the opportunity construct would be essential under whatever name one prefers.

  • 13. Peter Klein  |  3 March 2013 at 8:44 pm

    Steve, I don’t disagree with the substance of your comment at all, maybe just your ontological framing. Sure, call them candidate opportunities, or potential opportunities, or imagined opportunities, or — even better — business ideas, profit scenarios, projects that might make money, or some other term that isn’t ontologically misleading — and develop the heuristics and decision-making tools you describe. Imagining and evaluating these potential future configurations of demand, competitor behavior, regulator behavior, etc., is exactly what the exercise of judgment entails.

  • 14. stevepostrel  |  4 March 2013 at 6:04 pm

    I apologize for quibbling–I promise to drop it after this–but the ontological point is crucial. The heuristics and tools of business judgment can only be developed on the basis that any business idea that is sufficiently well defined has baked into it a hidden but unalterable profit outcome (possibly a probability distribution of outcomes). It’s a “reality bats last” perspective. There are two independent and equally important implications of this ontological understanding of opportunity:

    First, one goes backward from ontics to epistemics by asking “What would the data-generating process look like if this idea were really an opportunity?” It’s conceptually similar to a likelihood function–what should the evidence look like if the hypothesis were true?

    Second, “opportunities”–untried business ideas that would be profitable–represent a distinct set of “objects” about which we may be able to make scientific statements. The set of true business opportunities may be usefully constrained by thinking about necessary structural conditions for existence. These would include reasons why an opportunity hasn’t been taken already and restrictions on imitation if it initially were profitable. Such statements might enable us to rule out (or severely down-rate the prospects of) some ideas for membership in the set of opportunities.

    If improvements in ex ante classification cannot be accomplished in these ways, which depend entirely on the point that business ideas have success or failure built into them regardless of our beliefs, then I don’t see how we can help entrepreneurs.

  • 15. Steve Phelan  |  4 March 2013 at 6:14 pm

    stevepostrel, much of the current thinking in entrepreneurship seems to imply a search on a ‘dancing fitness landscape’ (see Beinhocker). Under such conditions, it may not be possible to provide ex ante rules to identify ‘true’ opportunities. Instead, we must use process rules to search the landscape. This is because the act of search itself deforms the landscape.

  • 16. stevepostrel  |  4 March 2013 at 9:12 pm

    Steve Phelan: (Not breaking my pledge, I swear). Thanks for the reference. I’ll have to look at that stuff. At first blush, it’s hard to see how “search” that is of the armchair/whiteboard/coffeeshop variety could perturb the landscape appreciably, but I guess tentative investments and/or public relations efforts might actually move things around. So then it comes down to what one means by “search.”

  • 17. Steve Phelan  |  4 March 2013 at 10:16 pm

    StevePostrel: search invariably involves action rather than speculation – in the same sense that evolution has been called a ‘blind’ search on a fitness landscape.

  • 18. Peter Klein  |  5 March 2013 at 11:04 am

    Steve — Steve P. — Steve Postrel (curse you, Phelan!) — I fear I’m being obtuse, because I continue to miss your point. Of course, reality bats last — you either have money in the cash drawer or you don’t. (Indeed, David Harper frames the problem in explicitly Popperian terms in his 2002 book: entrepreneurial plans are like Popperian conjectures, falsified or not by the data of reality.) I don’t see how putting some flesh on Knightian judgment — exploring how entrepreneurs form conjectures, what heuristics they use, how they revise their expectations, and so on — depends on the assumption that all possible objective configurations of ex post circumstances are somehow “baked in” ex ante. But I am probably just misunderstanding you.

  • 19. stevepostrel  |  5 March 2013 at 5:54 pm

    Peter and Steve Phelan are tempting me to break my pledge…must stay strong.

  • 20. Peter Klein  |  5 March 2013 at 5:56 pm

    The trick is to start a new thread on Strategy Profs — “Why Arguments About Opportunities Are Silly” — so you can keep needling us without breaking the pledge.

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