How entrepreneurs connect the dots to identify new business opportunities - Baron - Article


How do entrepreneurs recognise patterns to identify new business opportunities?

How do entrepreneurs connect the dots to identify new business opportunities? Within the field of entrepreneurship, opportunity recognition is widely viewed as a key step in the entrepreneurial process – one from which, in many cases, all else follows. Three factors have been identified as especially important for opportunity recognition: (1) engaging in an active search for opportunities, (2) alertness to opportunities and (3) prior knowledge of a market, industry or customers as a basis for recognizing new opportunities in these areas.

Actively searching for information is an important factor in the recognition of many opportunities by entrepreneurs, although such searches must be carefully directed to succeed and in some cases, searches can proceed in a relatively “automatic” manner rather than in a conscious and carefully directed on.

Alertness, in contrast, emphasizes the fact that opportunities can sometimes by recognized by individuals who are not actively searching for them, but who possess “a unique preparedness to recognize them” when they appear. Kirzner defined it as “alertness to changed conditions or to overlooked possibilities”, even when passive searching. It has been suggested that alertness rests, at least in part, on cognitive capacities possessed by individuals such as creativity, high intelligence, optimism and perceptions of risk.

Prior knowledge, information gathered through rich and varied life experience, can be a major “plus” for entrepreneurs in terms of recognizing potentially profitable opportunities.

This is just a small part of the evidence suggesting that the three factors play a key role in opportunity recognition. However, they have been studied separately and viewed as largely independent aspects of opportunity recognition till now. In other words, no framework has been developed. As noted below, integration is important both for understanding the basic nature of opportunity recognition and for identifying ways of helping entrepreneurs to be more proficient at this task. It is suggested in this paper that pattern recognition can provide such integration. Pattern recognition is the process through which specific persons perceive complex and seemingly unrelated events as constituting identifiable patterns. In essence, pattern recognition, as applied to opportunity recognition, involves instances in which specific individuals “connect the dots” – perceive links between seemingly unrelated events and changes. The patterns they perceive then become the basis for identifying new business opportunities.

Several lines of evidence suggest that pattern recognition may indeed play a key role in opportunity recognition:

  • Many opportunities exist for years before they are noticed and developed;

  • Pattern recognition is proven to be a basic aspect of our efforts to understand the world around us;

  • Recent findings suggest that entrepreneurs indeed closely relate pattern recognition to opportunity recognition.

Opportunities and opportunity recognition: some basic propositions

Three central characteristics of opportunity have been cited most:

  1. potential economic value (i.e., the capacity to generate profit),

  2. newness (i.e., some product, service or technology that did not exist previously) and

  3. perceived desirability (e.g., moral and legal acceptability of the new product or service in society).

    Opportunity in this paper will be defined as a perceived means of generating economic value (i.e., profit) that previously has not been exploited and is not currently being exploited by others. Opportunity recognition is defined as the cognitive process (or processes) through which individuals conclude that they have identified an opportunity. Opportunity recognition is only the initial step in a continuing process, and is distinct both from detailed evaluation of the feasibility and potential economic value of identified opportunities and from active steps to develop them through new ventures. The focus here is on innovative opportunities.

Propositions concerning the nature of opportunities and opportunity recognition

Two basic assumptions are required in order to apply models of pattern recognition to the process of opportunity recognition.

Proposition 1: Opportunities emerge from a complex pattern of changing conditions – changes in technology, economic, political, social and demographic conditions. They come into existence at a given point in time because of a juxtaposition or confluence of conditions that did not exist previously but is now present (example: Second Time Around).

Proposition 2: Recognition of opportunities depends, in part, on cognitive structures possessed by individuals – frameworks developed through their previous life experience. These frameworks, which serve to organize information stored in memory in ways useful for the persons who possess them, serve as “templates” that enable specific individuals to perceive connections between seemingly unrelated changes or events. In other words, they provide the cognitive basis for “connecting the dots” into patterns suggestive of new business opportunities (example: small device for fire fighters that indicates their location at all times).

How do individuals connect the dots into meaningful patterns?

If opportunity recognition is indeed a cognitive process that involves recognition of complex patterns, then the following question arises: how does recognition of such patterns actually occur?

Models of pattern recognition: opportunities as emergent, noticeable patterns

Many different models of pattern recognition exist, but all agree on the following basic point: individuals notice various events in the external world and then utilize cognitive frameworks they have developed through experience to determine whether these events are related in any way – if they form a discernible pattern.

Prototype models

A widely accepted model suggests that individuals employ prototypes as a basis for recognizing patterns. Prototypes are idealized representations of the most typical member of a category. Basically, newly encountered events or trends are compared with existing prototypes to determine whether they belong to specific categories or can be seen as being connected in some manner. Prototypes represent the modal or most frequently experienced combination of attributes associated with an object or pattern.

Entrepreneurs may use prototypes as a means for identifying patterns among seemingly unrelated events or trends. Much evidence suggests that individuals do indeed form prototypes, and when used to recognize patterns, prototypes may play an important role in opportunity recognition.

Exemplar models

Exemplar models emphasize the importance of specific knowledge, rather than prototypes. Such models suggest that as individuals encounter new events or stimuli, they compare them with specific examples (exemplars) of relevant concepts already stored in mind. Exemplar models seem especially relevant to opportunity recognition because they do not require the construction of prototypes. This fits well with the fact that entrepreneurs “just know a good opportunity when they see it”, and do not have to engage in complex processing to reach this conclusion. Moreover, it fits with recent findings that indicate that experienced, repeated entrepreneurs generally search for opportunities in areas or industries where they are already knowledgeable.

Overall, research in cognitive science suggests that both prototype and exemplar models may be necessary to fully understand how individuals recognize emergent patterns, and hence identify new business opportunities. Other cognitive frameworks may also be involved.

Opportunity recognition as a repeated search for patterns

Thus far it seems that opportunity recognition occurs in a single step, but basic research on pattern recognition suggests that often the process is one involving many steps and repeated efforts to recognize emergent patterns. Although individuals may notice that two or more variables are related, additional information is required to examine it more closely and create a pattern. Example: Expedia.com. Most of the time, founders of new ventures do not initially recognize all aspects of an opportunity. Rather, they notice some aspects and proceed with these. Then, as they obtain experience and information, their view of the opportunity is expanded and refined. In a sense, the process is never completed and new ventures rarely will take the form presented in business plans. Therefore, venture capitalists value very highly founders’ abilities to adapt and change, and often seek entrepreneurs who demonstrate these characteristics.

While opportunity recognition does indeed often involve repeated efforts to identify patterns in seemingly independent events or trends, the search for these patterns remains an essential part of the process well beyond the point at which new ventures are actually launched.

Models of pattern recognition: how they help to integrate the effects of search, alertness and knowledge

One key advantage of models of pattern recognition is that they provide a means of integrating active search for opportunity, alertness to opportunities and prior knowledge within a single perspective.

Active search: in the context of pattern recognition, this would involve searching for links or connections between seemingly unrelated events and trends. First, key changes, trends and events would be identified, then a search for potential links would be instituted. Example: Bay Einstein Company.

Alertness: refers to the capacity to recognize opportunities when they exist. This capacity may rest on possessing the appropriate cognitive structures – prototypes or exemplars. These structures help specific persons to “connect the dots”.

Prior knowledge: knowledge of a particular market, industry or group of customers would help entrepreneurs know where to search for new patterns that suggest business opportunities. Knowledge will enable individuals to develop more accurate and appropriate prototypes and a broader range of exemplars. These cognitive frameworks can in turn facilitate the identification of new opportunities.

See figure 1 (p. 112) for the potential role of pattern recognition in opportunity recognition. It should be noted that the three factors as described above might be interrelated. Next to this, another factor, the breadth of entrepreneurs’ social networks, has recently received growing attention, and also appears to play an important role in opportunity recognition. Finally, as the model in fig. 1 suggests, not all patterns connecting diverse events, changes or trends perceived by entrepreneurs serve as the basis for founding new ventures. Such patterns lead to new ventures only when they suggest new products or services that seem to be feasible.

Assessing the accuracy of a pattern recognition approach: directions for future research

Most of the evidence presented above is somewhat indirect in nature, so there is certainly a need for more direct tests of this framework. One way to proceed, involves comparing novice and highly experienced entrepreneurs in certain relevant aspects. A recent study shows that experienced entrepreneurs appear to focus in their efforts to identify opportunities on factors likely to influence success, while novice entrepreneurs tend to become fascinated with sheer newness or novelty. These findings suggest that opportunity recognition may indeed be closely linked to pattern recognition. Future research is necessary.

Not all repeat entrepreneurs are highly successful. While a pattern recognition perspective suggests that the cognitive frameworks of successful repeat entrepreneurs are more focused on key business-related factors, less successful repeat entrepreneurs might be relatively similar to novice entrepreneurs, suggesting that they have not benefited from their experience. However, another perspective can explain this as well. For instance, research on expertise suggests that growing experience in a domain can be curvilinear rather than linear.

Practical implications of a “connect the dots” perspective

It appears that a “connect the dots” perspective can help to answer two questions:

  • Why do certain persons, but not others, identify specific opportunities? and

  • Can individuals be trained to be more proficient at performing this task?

(1)several possible answers are possible. First, specific individuals may recognize specific opportunities that many others overlook because they possess the cognitive frameworks (e.g., prototypes, exemplars) needed to perceive patterns among seemingly unrelated trends or events. Example: Chester Carlson, inventor of the copy machine. Another answer could be that because life experiences are unique, different persons may possess prototypes for a given domain that differs in terms of clarity or degree of development. They possess cognitive frameworks useful for recognizing specific opportunities.

(2): a pattern recognition perspective suggests that individuals can be trained to be more proficient at identifying opportunities if following different steps. First, individuals should be taught not merely be “alert” to opportunities or to search actively for them, but rather, to search in the best places and in the best ways. Second, while engaging in such searches, they should also focus on actively seeking to search for emergent patterns. When individuals focus their attention on pertinent factors and also attempt to perceive ways in which these may be related, the likelihood that they will perceive (recognize) emergent patterns is increased. This suggests that entrepreneurs can be trained to recognize opportunities. Next to this, a pattern recognition perspective also suggests that providing potential entrepreneurs with a very broad range of experience can enhance opportunity recognition. Finally, if exemplars play a role in opportunity recognition, exposing individuals to a wide range of business opportunities that vary greatly in quality might well prove beneficial. Overall, a “connect the dots” perspective on opportunity recognition is quite optimistic: it suggests that entrepreneurs can learn to be more adept at this task, and that this can be taught in business education. It also suggests the potential value of exposing business students to a wide range of exemplars. Understanding the “how” of recognizing new opportunities may help us to achieve one of the key goals of entrepreneurship education: assisting entrepreneurs to reach their goals.

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