Discovery and creation: Alternative theories of entrepreneurial action - Alvarez & Barney - Article

When entrepreneurship scholars talk about why entrepreneurs exploit competitive opportunities, they have two options: (1) to say that opportunities, like mountains, exist as objective phenomena just waiting to be discovered and exploited and (2) to say that entrepreneurial opportunities are rather competitive imperfections in markets, that are created by the actions of entrepreneurs, so mountain building instead of mountain climbing. These different views have important implications for entrepreneurial action. The first view would require ambitious entrepreneurs to discover the opportunities – using whatever data collection techniques exist – and then exploit them – using whatever strategies are required – all as quickly as possible, while in the second view entrepreneurs should engage in an iterative learning process that ultimately could lead to the formation of an opportunity. The purposes of this paper are to describe the theories of entrepreneurship that underlie these metaphors and to understand the implications for the actions of entrepreneurs.

Teleological theories of entrepreneurial action

Teleological theories of human action explain human behaviour in terms of the impact of that behaviour on the ability of individuals to accomplish their purposes. These theories assert that behaviour that facilitates the accomplishment of one’s purposes is more likely to occur than behaviour that does not facilitate the accomplishment of one’s purposes. All teleological theories of human action make three critical assumptions:

1. Assumptions about the nature of human objectives;

2. Assumptions about the nature of individuals;

3. Assumptions about the nature of the decision-making context within which individuals operate.

When different teleological theories generate different predictions about the same human actions, one or more of the assumptions is different.

Both of the theories identified in this paper – discovery theory and creation theory – are examples of teleological theory and thus have much in common. They both seek to explain the same dependent variable: actions that entrepreneurs take to form and exploit opportunities. Moreover, they both seek to explain these entrepreneurial actions in terms of their impact on the ability of entrepreneurs to form and exploit opportunities. Both theories also recognize that opportunities exist when competitive imperfections exist in a market or industry. However, discovery and creation theory often generate different predictions about when specific entrepreneurial actions will be more or less effective in enabling entrepreneurs to form opportunities.

Discovery theory

The three critical assumptions of discovery theory are summarized in table 1 (p. 13).

Discovery objectives

In discovery theory, competitive imperfections are assumed to arise exogenously, from changes attributes of the context within which an industry or market exists. This emphasis on exogenous shocks forming opportunities suggests that discovery theory is based on realist assumptions in the philosophy of science; that discovery opportunities are yet to be observed does not deny the reality of their existence. However, it is entrepreneurs who bring ‘agency to opportunity’ by exploiting them. Also, this emphasis suggests that discovery theory is predominantly about search. In this search process, entrepreneurs must consider both its direction and duration, and must also guard against confusing local search (modest opportunities) with more global search (substantial opportunities).

Discovery entrepreneurs

Discovery theory assumes that entrepreneurs who discover opportunities are significantly different from others in their ability to either see opportunities or, once they are seen, to exploit these opportunities. Kirzner (1973) summarizes the differences between entrepreneurs and nonentrepreneurs with the concept of ‘alertness’. The results of empirical research on systematic differences between entrepreneurs and nonentrepreneurs are mixed.

Discovery decision-making context

The decision-making context in which entrepreneurs choose to exploit an opportunity is assumed to be risky, rather than uncertain. A decision-making context is risky if, at the time a decision is being made, decision makers can collect enough information about a decision to anticipate possible outcomes associated with that decision, and the probability of each of those possible outcomes. A decision-making context is uncertain if, at the time a decision is being made, decision-makers cannot collect the information needed to anticipate either the possible outcomes associated with a decision nor the probability of those outcomes.

The decision-making context in discovery theory is risky because it assumes that opportunities are objective in nature and therefore the possible outcomes and the probability of these outcomes can be understood.

Creation theory

Creation theory is a logical theoretical alternative to discovery theory for explaining the actions that entrepreneurs take to form and exploit opportunities. However, unlike discovery theory, creation theory has yet to be articulated as a single coherent theory in the literature. The central organizing assumptions are also summarized in table 1 (p. 13).

Creation objectives

Opportunities in creation theory are created, endogenously, by the actions, reactions and enactment of entrepreneurs exploring ways to produce new products or services. In creation theory, entrepreneurs do not search – they act, and observe how consumers and markets respond to their actions. Creation theory suggests that, ex ante, before an opportunity is created, its links with prior industries or markets are unknown. It also assumes that entrepreneur’s actions are the essential source of the formulation of new opportunities. In acting, they form opportunities that could not have been known without the actions taken by these entrepreneurs.

Creation opportunities are social constructions that do not exist independent of entrepreneur’s perceptions. However, when entrepreneurs act to exploit these socially constructed opportunities, they interact with an environment – the market – that tests the veracity of their perceptions. This form of analysis is grounded in the evolutionary realist perspective. In both evolutionary theory and creation theory, a blind-variation – an action that emerges without any self-conscious planning or foresight – can begin a process of action and reaction that leads to the formation of opportunities. However, variations are likely to be quite myopic; entrepreneurs will rarely be able to see ‘the end from the beginning’. Opportunities cannot be understood until they exist, and they only exist after they are enacted in an iterative process of action and reaction. Myopic variations in creation theory are the raw materials from which selection processes cull those that are most suitable. As entrepreneurs act upon their initial beliefs about opportunities and then observe the market responses, beliefs are transformed reflecting the acquisition and creation of knowledge and information. The creation process therefore is path dependent, in that small differences in initial decisions and choices made by entrepreneurs can lead to large differences over time. The opportunities that result may be heterogeneous in costly-to-copy, and costly-to-reverse ways.

Creation entrepreneurs

Creation theory suggests that, ex ante, before entrepreneurs create opportunities, they may or may not be significantly different than those who do not create opportunities. Even very small differences between entrepreneurs and nonentrepreneurs, ex ante, could lead to some to form opportunities and others not to form opportunities. However, these small differences can become large differences. Creation theory suggests that individuals may be virtually indistinguishable, in terms of their cognitive characteristics before the creation process begins. However, those that take a more entrepreneurial path over time may find that certain cognitive attributes are more positively reinforced than other cognitive attributes. This process can create significant differences between entrepreneurs/nonentrepreneurs ex post.

Creation decision-making context

The decision-making context in creation theory is uncertain. This is because opportunities do not exist until they are created. So, relevant probability distributions cannot be estimated, even if entrepreneurs have a great deal of time or have unusual analytical abilities. The information for this estimation is simply not created yet.

Discovery and creation implications for effective entrepreneurial actions

Actions that entrepreneurs actually take can be thought of as a manifestation of the assumptions they make about the nature of the context within which they are operating – a discovery or creation context. If their hypothesis about the nature of this context is correct, and the theory they are applying is correct in its implications, then that activity will be relatively effective in the formation and exploitation of an opportunity. The implications of both theories for seven entrepreneurial actions are summarized in table 2 (p. 17).

Leadership

Expert leadership is likely to be important in exploiting discovery opportunities. When exploiting a discovery theory, specific knowledge and information associated with the opportunity are important, just like professional links within the market or industry where a discovery opportunity is being exploited. In creation theory, expertise knowledge is typically only known after that opportunity has emerged from the enactment process, and therefore the leader’s charismatic characteristics are far more important.

Decision-making

In discovery theory, entrepreneurs can, and should, apply a variety of risk-based data collection and analysis techniques, all of which are designed to collect the information required to estimate the risks associated with making a particular decision. These tools suggest that entrepreneurs understand their opportunity costs. Clearly, traditional risk-based data collection and analysis cannot be effectively applied in the uncertain setting of creation theory. Instead, entrepreneurs make decisions in other ways. In this setting, it is also not possible for entrepreneurs to effectively calculate the opportunity costs associated with their actions; they use the concept of ‘acceptable losses’.

Human resource practices

In a discovery context, entrepreneurs will generally be able to anticipate the specific kinds of skills they need to exploit an opportunity; they can effectively hire people with highly specialized human capital. Because they are able to explain the nature of the exploiting opportunity, they can recruit widely, including outside of their current social networks. In a creation context, entrepreneurs will not be able to anticipate the specific kinds of skills they will ultimately need to exploit the opportunity they form. Thus, entrepreneurs will hire individuals with broad human capitals and individuals with a great deal of flexibility. Also, they will recruit more effectively among their current social networks.

Strategy

In a discovery context, there is usually sufficient ex ante information so that critical assumptions in a strategy can be evaluated, and no big modifications are needed in the fundamental purposes or objectives of a business if the strategy is in place. In creation contexts, strategy plays a very different role since current and historical information are not available or not useful in describing the nature of an opportunity. The task of entrepreneurs is asking the right questions, designing new experiments, remaining flexible and learning. Strategies in this setting can suggest the general direction entrepreneurs are heading, but are subject to numerous fundamental changes.

Finance

Entrepreneurs operating under discovery conditions will often be able to obtain financing from external sources, including banks and venture capital firms. In this context, information asymmetries between an entrepreneur and its external capital sources should be either low or relatively easy to overcome. However, in creation setting traditional external sources of capital are unlikely to provide financing for entrepreneurs, because there is lack of information. ‘Bootstrapping’ is a likely way to finance activities, from the entrepreneur’s own wealth, or from ‘friends, family, and fools’. These sources invest in the entrepreneur, not in a particular business opportunity an entrepreneur plans to exploit.

Marketing

Entrepreneurs operating in a discovery context can effectively specify the product, price, distribution channel, promotion strategy and customer service strategies they are likely to pursue due to exogenous shocks. In a creation context, these shocks have not occur, and an entrepreneur may use these attributes of the marketing mix to explore possible opportunities to create.

Sustaining competitive advantages

In a discovery context, information about an opportunity and how to exploit it is likely to become publicly available soon and lead to rapid competitive imitation. Thus, if entrepreneurs are unable to erect barriers to entry into an industry, it is difficult for entrepreneurs to sustain any competitive advantages. Both the speed and the secrecy of which an opportunity is exploited are important on the profits it generates. In a creation context, this is much less important, because uncertainty and tacit knowledge play a more important role. The very act of creating an opportunity may give an entrepreneur an advantage in sustaining any competitive advantages associated with that opportunity.

Discussion: implications of theories

Discovery, creation and the field of entrepreneurship

By more fully developing a second theoretical perspective on entrepreneurship – creation theory – the assumptions of both theories are made more explicit. Future research will need to carefully examine the context under which entrepreneurs are operating.

Creation and evolutionary theories of entrepreneurship

The link between enactment, creation theory and an evolutionary theory of entrepreneurship is underdeveloped in the current paper. However, it does seem at least possible that creation theory may ultimately provide a link between micro-level processes of enactment and macro-level processes of variation, selection and retention.

Creation and resource-based theory

Resource-based theories examine the conditions under which heterogeneously distributed and costly to copy resources and capabilities can be sources of sustained competitive advantage for firms. Although this theoretical perspective is beginning to receive significant empirical support, an important question in resource-based theory remains unanswered – where do heterogeneous resources come from? Creation theory provides one answer to this question. Under conditions of uncertainty, the enactment process can have the effect of exacerbating what were originally small differences to create quite substantial differences over time. All the theories emphasize the importance of information and knowledge generated from the process of enacting an opportunity.

While path dependence is important in both discovery and creation theory, there are important differences between these concepts as they are applied in these two theories. Discovery theory sees this as first order path dependency, while creation theory suggests a second type of path dependency in which entrepreneurs create the path instead of being affected by the path.

Creation and the theory of the firm

The business processes identified can be scaled to the group, firm or organization. In this sense the identification of creation theory may ultimately have implications for research on the theory of the firm. It may be necessary to identify different bases for creating firms when entrepreneurs seek to create firms in a creation context.