A Creation Theory of Entrepreneurial Opportunity Formation

A Creation Theory of Entrepreneurial Opportunity Formation
Sharon A. Alvarez
Jay B. Barney
Fisher College of Business
2100 Neil Avenue, 850
Columbus, Ohio 43210
614-688-8289
Alvarez_42@cob.osu.edu
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A Creation Theory of Entrepreneurial Opportunity Formation
Entrepreneurial opportunities may exist, independent of the actions of entrepreneurs, or
may be created by the actions of entrepreneurs. The latter opportunities are emphasized
in a Creation Theory of entrepreneurship. The central assumptions of Creation Theory,
and how they differ from alternative approaches to understanding entrepreneurial
opportunities, are described. Then the paper examines how these differences in
opportunity formation result in variation of the firms organized to exploit these
opportunities. Firm formation and the implications of Creation Theory for decisionmaking,
knowledge creation, and resource heterogeneity in these newly emerging firms
are discussed.
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A Creation Theory of Entrepreneurial Opportunity Formation
Entrepreneurial opportunities exist when competitive imperfections in a market or
industry generate the potential for the creation and appropriation of economic profits
(Venkataraman, 1997). One view of entrepreneurial opportunities is that the competitive
imperfections that create them are caused by exogenous shocks to a market or industry.
Because of this, from the perspective of those seeking to exploit them, entrepreneurial
opportunities appear as real and objective phenomena—like lost luggage in a train
station—just waiting to be discovered and exploited. This view of how entrepreneurial
opportunities are formed and exploited goes by several different names, including the
“individual/opportunity nexus perspective” (Shane & Venkataraman, 2000) and the
“discovery theory of entrepreneurship” (Shane, 2003) Much of the extant
entrepreneurship literature examines the empirical implications of this Discovery Theory
(Shane, 2003).
There is, however, another view about how entrepreneurial opportunities are
formed. In this view, opportunities do not exist, just waiting to be discovered such as in
the realist Discovery perspective. Rather, in this view an evolutionary perspective,
opportunities do not exist until entrepreneurs engage in an iterative process of action and
reaction to create them (Aldrich & Ruef, 2006; Gartner, 1985; Weick, 1979). That is, in
this view, entrepreneurs themselves can be the sources of competitive imperfections in a
market or industry. Far from being “lost luggage in a train station waiting to be claimed,”
in this perspective, entrepreneurs may end up exploiting opportunities that did not exist
until they were created by their own actions.
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This second approach to understanding the formation and exploitation of
opportunities has also been labeled in the literature. It has been called Creation Theory
(Venkataraman, 2003). However, while the theoretical underpinnings of this perspective
have been in the economics (Knight, 1921) and social psychology (Weick, 1979)
literatures for decades, and while important fragments of this theory have been examined
in the entrepreneurship literature (Aldrich et al., 2006; Baker & Nelson, 2005; Gartner,
1985; Sarasvathy, 2001; Schumpeter, 1934), this perspective has yet to be presented in a
integrative and systematic way. Indeed these varying approaches have spawned a
bewildering array of unspecified assumptions that has resulted in little cumulative
knowledge. This paper offers an integrative framework of opportunity formation
assumptions, which illustrates the role of entrepreneurs and the interaction with
opportunities that provide a logical alternative to Discovery Theory. That is the purpose
of this paper.
Opportunities can be exploited in several ways, through the market, alliances,
organizations, even arbitrage if the opportunity is simple enough. However, traditionally
entrepreneurship research has primarily been concerned with the start-up of new firms
(Brown, Davidsson, & Wiklund, 2001). Therefore this paper examines the implications
between the opportunity formation process and the efficient organization forms for these
start-up firms that exploit opportunities. This paper suggests that opportunity formation
results in antecedents that have important consequences for the new organizational form
for firms which pursue these entrepreneurial opportunities. The organization form’s
dimensions that will be examined are decisions and routines (Nelson & Winter, 1982),
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the use of knowledge (Kogut & Zander, 1992), and resource heterogeneity (Barney,
1991).
The paper begins by briefly describing the four central assumptions of Discovery
Theory. Then, these same four assumptions are examined for Creation Theory. Next,
some important implications of Creation Theory in the formation of organizational forms,
and how they differ from Discovery Theory, are discussed. The paper concludes by
discussing the implications of Creation Theory for the field of entrepreneurship and its
relationship with other social science disciplines.
Discovery Theory of Entrepreneurial Opportunities
Discovery Theory has a long history in the study of entrepreneurship (Casson,
1982; Kirzner, 1973, , 1979). Much of this history, and the underlying assumptions and
key assertions of Discovery Theory, have been summarized by several different authors
(Kirzner, 1997; Shane, 2000; Shane, 2003; Shane & Venkataraman, 2000). This work is
the basis of the summary of Discovery Theory presented here.1 The four central
assumptions of Discovery Theory concern the nature of entrepreneurial opportunities, the
nature of entrepreneurs, the nature of the information context within which entrepreneurs
operate, and finally its epistemological origins. These four assumptions are summarized
in Table One.
[Insert Table One About Here]
1 Shane (2003) lists five assumptions of discovery theory. Some of these assumptions (e.g., bounded
rationality) hold in most current social science theories and thus are not emphasized here. Other
assumptions listed by Shane are closely related to the three that are discussed here.
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First, with respect to the nature of opportunities, Discovery Theory assumes that
opportunities arise from competitive imperfections in markets due to changes in
technology, consumer preferences, or some other attributes of the context within which
an industry or market exists (Kirzner, 1973: 10). In particular, opportunities are assumed
to emerge independent of entrepreneurial action (Kirzner, 1973: 10). The task of the
entrepreneur, in Discovery Theory, is to become “alert” to the existence of these
opportunities and to “claim” those that hold the greatest economic potential (Casson,
1982; Gaglio et al., 2001; Kirzner, 1997; Shane, 2003). In this view, entrepreneurs bring
“agency to opportunity” (Shane, 2003:7).
Second, with respect to the nature of entrepreneurs, Discovery Theory assumes
that entrepreneurs and non-entrepreneurs must differ is some important ways. Without
these differences, anyone in an economy could become aware of and then exploit an
opportunity. However, if entrepreneurs and non-entrepreneurs differ, then not everyone
in an economy will know about particular opportunities, or, even if they do, not everyone
will be predisposed to exploit them.
Several possible differences between entrepreneurs and non-entrepreneurs have
been examined in the literature (Kirzner, 1973; Shane, 2003). Most of these differences
lead to the development of information asymmetries between entrepreneurs and nonentrepreneurs
(Shane, 2000) with respect to the existence of particular opportunities.
Kirzner (1973: 67) summarizes the differences between entrepreneurs and nonentrepreneurs
by simply asserting that entrepreneurs are more “alert” to the existence of
opportunities than non-entrepreneurs.
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Finally, with respect to the informational context within which entrepreneurs
operate, Discovery Theory assumes that entrepreneurs must generally combine old and
new information in novel ways to exploit opportunities (Shane, 2000) . Entrepreneurs
may already possess some of this information from previous experience in an industry or
market, or they may collect it as they begin to search for possible opportunities in a
recently changed market or industry (Casson, 1982). Alert (or just lucky (Barney,
1986)) entrepreneurs may even discover opportunities without engaging in a systematic
search.
By gaining access to this information before others, entrepreneurs may gain some
first mover advantages from exploiting an opportunity. However, because information
about these opportunities and how to exploit them typically diffuses quickly (Barney,
1991; Grant, 1996), these first mover advantages are often difficult to sustain (Lieberman
& Montgomery, 1988).
Finally, Discovery theory is grounded in realist epistemological origins. The
realist perspective has its roots in classic positivism and dates back to August Comte
(Blanchard, 1855) and Ernst Mach’s (Kockelmans, 1968) views that any theory not based
on observable fact is meaningless. Moreover, Comte claimed, that the goal of science is
prediction based only on observable terms. Unobservable objects, processes and events
in current realist views are ascribed the same properties as the observable (McKelvey,
2002). In this view unobservables exist objectively and mind-independently. There is a
real world existing independently of our attempts to know it; that we humans can have
knowledge of that world; and that the validity of our knowledge-claims is, at least in part,
determined by the way the world is (Azevedo, 1997). Theory in this view either correctly
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or incorrectly describes the unobservable and it can be tested as either true or false. In
other words, realists know the “truth” about genuinely existing unobservable entities. For
realists, the objects of scientific knowledge are phenomena and take the form of general
laws that must be testable by experience and show logical links between specific
phenomena and these laws.
Creation Theory of Entrepreneurial Opportunities
As shown in Table One, Creation Theory also makes assumptions about the
nature of opportunities, the nature of entrepreneurs, the informational context within
which entrepreneurs operate, and the epistemological origins. However, these
assumptions are different than those used in Discovery Theory.
The Nature of Opportunities
In Creation Theory, entrepreneurial opportunities are not created by exogenous
shocks to a market or industry. Instead, they are created by the actions of entrepreneurs
themselves. In this sense, according to Creation Theory, opportunities do not exist until
entrepreneurs act to create them (Baker et al., 2005; Gartner, 1985; Sarasvathy, 2001;
Weick, 1979).
In Creation Theory, entrepreneurs do not just respond to preexisting opportunities
they have discovered, but rather, act to create new opportunities. The model of
entrepreneurial action in Creation Theory is different than the model in Discovery
Theory. In particular, in Creation Theory, entrepreneurs do not recognize opportunities
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first and then act; rather, they act, wait for a response from their actions—usually from
the market--and then they readjust and act again (Weick, 1979). In this sense, the
formation of opportunities in Creation Theory is both a path dependent (Arthur, 1989)
and emergent process (Mintzberg & Waters, 1985). In acting and reacting, entrepreneurs
enact the opportunities they ultimately exploit (Weick, 1979).
This enactment process is consistent with evolutionary theories of entrepreneurial
action (Aldrich et al., 2006; Campbell, 1960; Weick, 1979). In both this evolutionary
approach to entrepreneurship and Creation Theory, blind-variation can begin a process of
action and reaction that may lead to the formation of opportunities. In both models, blind
variations are the raw materials from which selection processes cull those entrepreneurial
activities that are most likely to ultimately constitute an opportunity (Aldrich et al.,
2006).
Of course, in Creation Theory, entrepreneurial actions need not be “completely
blind.” However, they are likely to be quite myopic. Entrepreneurs may have
hypotheses about how a market will react to their efforts, but rarely will entrepreneurs be
able to see “the end from the beginning.” This is because, in Creation Theory, there is no
“end” until the creation process has unfolded, i.e., opportunities cannot be understood
until they exist, and they only exist after they are enacted in an iterative process of action
and reaction (Berger & Luckmann, 1967; Weick, 1979).
The enactment of entrepreneurial opportunities will often be a messy, non-linear
process. However, if an entrepreneur is able to complete this enactment process and
create an opportunity—and this is far from certain—the knowledge that has been created
while this opportunity was being enacted may be specific to this entrepreneur. It may be
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tacit, and socially complex, and thus not likely to rapidly diffuse among potential
competitors (Dierickx and Cool, 1989; Barney, 1991). Thus, even though information
about the existence about an enacted opportunity may become widely known after it has
been exploited, knowledge about how to exploit such an enacted opportunity may be less
widely known. In this sense, exploiting enacted opportunities is more likely to be a
source of sustained competitive advantage than exploiting opportunities formed by
competitive imperfections to pre-existing industries or markets (Barney, 1986a; 1986b).
The Nature of Entrepreneurs
Creation Theory also adopts different assumptions about the nature of
entrepreneurs than Discovery Theory. As suggested earlier, systematic differences
between entrepreneurs and non-entrepreneurs are a central cause of entrepreneurial action
in Discovery Theory. In Creation Theory, such systematic differences—if they exist—
are mostly the effect of the entrepreneurial process, not the cause of that process
(Hayward, Shepherd, & Griffin, 2005; Sarasvathy, 2001). That is, in Creation Theory,
the path dependent process of enacting opportunities may create significant differences
between entrepreneurs and non-entrepreneurs, ex post, even if these differences were
virtually undetectable, ex ante.
For example, two individuals may be indistinguishable with respect to their
personality, their cognitive abilities, their social position, and so forth. However, very
small variations in their local environment—who they happen to know or where they
happen to live—might lead one of them to begin the process of becoming an entrepreneur
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while the other chooses to not engage in this process. Luck (Barney, 1986) and “blind
variations” may play a significant role in determining who does and does not become an
entrepreneur.
Initially, differences between these two individuals may remain small. However,
the enactment process of creating opportunities through the interaction of the individual
and the context may more positively reinforce certain individual attributes. For example,
cognitive biases that are dysfunctional in non-entrepreneurial settings—including a
willingness to generalize from small samples and overconfidence (Busenitz and Barney,
1997)—may be quite functional in an entrepreneurial context. Indeed, a continuing
willingness to learn from failed experiments may be very functional for entrepreneurs,
but may be thought of as irrational stubbornness in non-entrepreneurial settings
(Bowman, 1982; Makadok & Walker, 1996; March, 1991). Over time, behaviors,
beliefs, and actions that are functional in an entrepreneurial setting may become more
common among entrepreneurs, even if they are non-functional in non-entrepreneurial
settings (Cyert & March, 1963). Ex post, the enactment process may have the effect of
exacerbating what were originally virtually undetectable or subtle differences between
entrepreneurs and non-entrepreneurs.
The Nature of Information
In the opportunity formation process described by Creation Theory, entrepreneurs
have considerably less useful ex-ante information about the opportunities they are
forming than is assumed to be the case in Discovery Theory. Creation Theory assumes
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that the end of an evolutionary enactment process cannot be known from the beginning.
In this perspective, future opportunities may be unrelated to currently available
information (Sine, Haverman, & Tolbert, 2005), current industry information may
actually hinder the entrepreneur (Ingram & Baum, 1997; Repenning & Sterman, 2002)
and extensive new knowledge and information may have to be created, de novo
(Schoonhoven, Eisenhardt, & Lyman, 1990). In this setting, neither the possible
outcomes associated with forming an entrepreneurial opportunity, nor the probability of
those outcomes, can be known, ex ante. This informational condition is similar to the
definition of uncertainty originally proposed by Knight (1921). Thus in Creation Theory
the information that is needed is often obtained as part of the opportunity formation
process and becomes available only after actions and decisions of entrepreneurs are
made.
In Creation Theory, entrepreneurs do not become aware of new opportunities by
re-combining existing knowledge in new ways. Rather, in this theory, entrepreneurs
create new knowledge about previously non-existent opportunities by acting, then closely
observing the market’s responses to those actions, learning, and then acting again (Choi,
1993; Huber, 1991). Failure to learn from these entrepreneurial experiments will almost
certainly prevent entrepreneurs from ever creating opportunities, unless they are lucky.
More frequently, this enactment process is characterized by numerous failed experiments,
failures that suggest only the next experiment in a process of unknown duration (Nelson
& Winter, 1977). Indeed, after several iterative actions, evaluations, and reactions,
entrepreneurs may even decide that they misinterpreted the results of previous actions
and go back several sequences and start again, or even abandon the process altogether
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(Cyert et al., 1963; March & Simon, 1958; Mosakowski, 1997). In general, the more
novel the opportunity that is ultimately created by this process, the more new knowledge
and information the entrepreneur will need to create through this series of experiments
(Galbraith, 1977).
In this enactment process, prior industry or market experience, far from being a
benefit, may actually hinder entrepreneurial learning (March, 1991; Sine et al., 2005;
Weick, 1979). This is because, according to Creation Theory, opportunities do not
necessarily emerge out of competitive imperfections in pre-existing industries or
markets—where prior industry or market experience may actually help entrepreneurs
combine pre-existing knowledge in new ways—but, instead, may emerge out of the
enactment process itself. In Creation Theory, entrepreneurs face the challenge of creating
new knowledge themselves (Aldrich et al., 2006). Being too closely tied to prior
industries or markets may make it difficult for individuals to recognize the creation of
new opportunities (Aldrich & Kenworthy, 1999; March, 1991; March et al., 1958;
Mosakowski, 1997; Simon, 1973).
On the other hand, experience in the enactment process—the process of acting,
observing, learning, and acting (Rindova & Kotha, 2001)—can be very valuable. Thus,
Creation Theory suggests that “serial entrepreneurs”—i.e., entrepreneurs with experience
in the opportunity enactment process—need not confine their efforts to exploiting a series
of new opportunities in a single industry or market, but may, instead, repeat the
enactment process in creating what turn out to be very different new opportunities.
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Epistemological Tradition
The epistemological origin of Creation Theory is an evolutionary realist
perspective (Azevedo, 2002; Campbell, 1960; McKelvey, 1999). Evolutionary realist
perspective does not deny a constructionist perspective of knowledge nor an objective
external reality that serves as an ultimate criteria (McKelvey, 1999). In this evolutionary
approach first suggested by Campbell (1960), humans through blind variation begin to
act, then through a trial and error approach these actions, which are then selected for or
against based on the environment or culture which embodies the variation. Campbell
contends that the blind-variation and selection-retention process are fundamental to all
inductive achievement, to all genuine increases in knowledge, and to all increases in fit of
a system to its environment (Aldrich et al., 1999). Campbell’s evolutionary approach has
been extended to organization science primarily by McKelvey (1997) and to
entrepreneurship specifically by Aldrich & Kenworthy (1999) and Aldrich and Ruef
(2006). In Creation Theory knowledge may be constructed by individuals but it is
validated through social cross validation.
Organizational Forms of Entrepreneurial Firms
Discovery and Creation theories of entrepreneurial opportunity formation have
very different implications for the organizational forms of firms that seek to exploit these
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different types of opportunities (Ruef, 2000)2. The impact of these differences on three
organizational processes—decision making routines (Nelson et al., 1982; Van de Ven,
Venkataraman, Polley, & Garud, 1989), the type of knowledge accumulated in a firm
(Grant, 1996; McKelvey, 1982; Polanyi, 1967), and the resources controlled by a firm
(Barney, 1991; Penrose, 1959) —are discussed here.
Decision-making Routines
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The decision-making routines consistent with the kinds of opportunities described
in Discovery Theory include tools that are appropriate under conditions where current
and historical information and knowledge are available and useful in describing and
exploiting opportunities (Casson, 1982; Fiet, 2002). In this approach analysis of the
situation, trends and alternatives are helpful in forming and exploiting the opportunity
(Wiltbank, Dew, Read, & Sarasvathy, 2006). Normative decision-making tools in this
setting help the entrepreneur integrate information in ways that both describe the
opportunity and how that opportunity is to be exploited (Delmar & Shane, 2004).
To collect information in these settings, entrepreneurs can use government
reports, trade association reports, customer surveys, focus groups, and direct observation
(Christensen, Anthony, & Roth, 2004; Timmons, 1999). They can also rely on their own
experience in a market or industry as a source of important information (Johnson, 1986;
2 Entrepreneurial opportunities may be exploited in several different ways. Certainly, they may be
exploited through markets, alliances, arbitrage. However, opportunities that require the organization of
resources often must be exploited through a firm which is why the firm is the context in which these two
theories are examined.
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Shane, 2000; Von Mises, 1949). To determine if an opportunity is worth pursuing,
entrepreneurs can apply any of a variety of risk-based decision-making tools--including
net present value analysis (Brealey & Myers, 1988), real options analysis (McGrath,
1997) and scenario planning (Schoemaker, 1995) to the information they have collected.
In Creation Theory where the future is uncertain the use of predictive rational
models such as risk-based decision-making tools are of limited benefit (March, 1991;
Mintzberg, 1994; Simon, 1973; Wiltbank et al., 2006). In these settings, entrepreneurs
can make decisions in at least two ways: By applying biases and heuristics (Busenitz &
Barney, 1997; Hayward, Shepherd, Griffin, 2005) or by engaging in an emergent
adaptive decision-making process (Mintzberg, 1994; Wiltbank et al., 2006).
Biases and heuristics can be used to make decisions when risk-based decisionmaking
tools do not apply (Kahneman, Slovic, & Tversky, 1982). Indeed, cognitive
psychologists have emphasized the utility of biases and heuristics in enabling people to
make decisions when the amount of information available to decision makers is less than
what is required by fully rational decision-making approaches (Bazerman, 2002).
For example, Busenitz and Barney (1997) identified two cognitive biases that are
particularly functional for entrepreneurs making decisions under conditions where current
and historical information and knowledge are not available or not useful in forming or
exploiting opportunities: the over confidence bias and the representativeness bias or the
willingness of decision makers to generalize from small samples. Creation Theory
suggests that entrepreneurs may use these (and other) biases to enable them to make
decisions about whether or not to engage in specific entrepreneurial activities (Fischhoff,
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Slovic, & Lichtenstein, 1977; Hayward et al., 2005) even when the amount of
information available falls well short of the perfectly rational decision-making ideal.
A second set of tools for decision-making can also be applied in these settings.
These tools can be used in conjunction with, or as a substitute for, cognitive biases.3
This alternative approach to making decisions has been studied in many different fields,
and goes by several different names. In organization theory, this approach is known as
logical incrementalism (Quinn, 1980); in anthropology it is known as bricolage (Levi-
Strauss, 1967; Baker et al., 2005); in strategic management, it is known as emergent
strategy formulation (Mintzberg et al., 1985); in entrepreneurship it is known as
effectuation (Sarasvathy, 2001); in mathematics it is known as Bayesian updating (Bayes,
1764); and in political science, it is known as “muddling through” (Lindblom, 1959).
While these different decision making processes may have been developed using
very different theories and language, with very different objectives, they, nevertheless,
have several features in common. For example, they are incremental in nature, decision
makers make small decisions based on whatever information they currently have. They
are iterative, they involve making and remaking decisions until desired outcomes are
achieved. And finally, they are inductive, data to evaluate the quality of decisions is
collected after decisions are made. This is the kind of decision making process that is
likely to be most effective when the future is uncertain (Wiltbank et al., 2006).
Too rigorous an approach to decision-making in an effort to apply risk-based
decision-making tools to the opportunity enactment process can thwart and adversely
affect this inductive adaptive process. For example, entrepreneurs using customer focus
3 Although, cognitive psychologists suggest that most decision makers, most of the time, make decisions in
systematically non-rational ways (Kahneman & Tversky, 1979).
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groups to collect information about potential opportunities are likely to face the difficult
problem of having to ask potential customers to evaluate possible products or services
that the entrepreneur does not yet fully understand and products or services that potential
customers have never even conceived of. The decision to not exploit an opportunity until
the risks associated with it are known, ex ante, when the future is uncertain, will lead to
decisions never being made. Indeed, the use of risk-based decision-making tools in these
highly uncertain settings may create a potentially harmful illusion of having information
where none might exist (Mintzberg, 1994; Weick, 1979).
In Creation Theory, the task facing entrepreneurs is not so much combining
information in novel ways, but, rather, asking the right questions, designing new
experiments, remaining flexible, and learning as new information emerges (Mintzberg,
1994). When the future is uncertain and unpredictable, learning is generally more
important than using normative decision-making tools (Argote, 1999; Wiltbank et al.,
2006). Opportunities in these settings have few, if any, precedents. Entrepreneurs in this
setting can only very imperfectly anticipate the nature of the opportunities they may
ultimately form and exploit and must learn about those opportunities as they emerge.
Approaches such as learning and adaptive decision-making help entrepreneurs to avoid
defining future event spaces, and instead to position themselves to learn and respond to
the uncertain and unpredictable events that are likely to emerge. Since the process of
action and re-action can happen quickly adaptive approaches such as learning that
emphasize where the environment is rather than predicting where it will be become a
more effective guide to decision-making than normative decision-making models
(Wiltbank et al., 2006). Entrepreneurs in these uncertain settings develop their own
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knowledge structures through repeated experiments and then use those knowledge
structures to give the information they create form and meaning (Walsh, 1995).
One important difference between Creation Theory decision-making tools and
Discovery Theory decision-making tools concerns the role of opportunity costs. Under
conditions of risk and moderate uncertainty, entrepreneurs can typically estimate their
opportunity costs. These estimates reflect the value of the opportunities forgone if an
entrepreneur pursues a particular course of action (Casson, 1982) and are included in
formal analyses as the discount rate applied to the cash flows that exploiting an
opportunity is expected to generate (Milgrom & Roberts, 1992).
When opportunities are enacted, over time, in an inductive and highly uncertain
process, it is difficult, if not impossible, to estimate an entrepreneurs opportunity costs in
traditional ways. In this setting, prior work suggests that entrepreneurs do not use
opportunity cost logic in deciding whether or not to continue pursuing yet to emerge
opportunities. Rather, they apply a concept called “acceptable loss” (Sarasvathy, 2001).
Acceptable loss is that amount of time and money entrepreneurs believe they can afford
to lose before they end the creation process. Entrepreneurs with higher levels of
affordable loss are likely to pursue the opportunity enactment process longer than those
with lower levels of affordable loss.
The determinants of acceptable loss have yet to be fully described in the literature
(Sarasvathy, 2001). However, factors such as the amount of money a person has saved,
competing demands for a person’s financial and other resources (e.g., supporting a
spouse and/or children), and their likely salary if they abandon their entrepreneurial
efforts, all seem likely to be important in determining an individual’s acceptable loss.
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That said, it must also be acknowledged that the opportunity enactment process is
exactly the kind of process that can lead individuals to become subject to an escalation of
commitment (Staw, 1981). As noted earlier, a willingness to continue experimenting is a
pre-condition to continuing the creation process. But psychological processes can lead
individuals to continue their search long after any hope of creating a real opportunity is
gone. Creation Theory thus suggests that the overconfidence and stubbornness that are so
essential to the opportunity enactment process must be carefully balanced by objective
evaluations concerning whether or not this process should actually continue (Mintzberg,
1994).
Knowledge
In Discovery Theory knowledge can be either explicit (Grant, 1996; Kogut &
Zander, 1996), or tacit (Polanyi, 1967), but in either case exists prior to the formation of
the opportunity (Shane, 2000) 4. In Discovery Theory the entrepreneur’s knowledge both
exists ex-ante to the discovery of the opportunity and is specific to the opportunity
(Shane, 2000). Knowledge in this view is specific to the market to be entered, the ways
to serve this market, and about the customer problems in this market (Shane, 2000; p
452). This specific idiosyncratic prior knowledge about a particular market provides a
base from which the entrepreneur can comprehend and convert new incoming
information into useful knowledge about the opportunity. In discovery theory knowledge
4 Knowledge is considered to be a resource in resource-based theory. However, the use of knowledge is of
key importance as a distinctive property of an organizational form thus it is treated separately from the
section on resources.
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is used to formulate a hypothesis and then it is tested through the actions of the
entrepreneur.
The knowledge and information of entrepreneurs in discovery theory is restricted
by their specific experiences with markets. Entrepreneurs in this view will exploit
opportunities that are either the same as or closely related to those they have experience
with (Shane, 2000). If the entrepreneur exploits the opportunity through the formation of
a firm, this firm will have direct links to the dominant organizational form of the market
in which the entrepreneur’s knowledge and information is embedded. In order for this
new firm to be successful it will take on the characteristics that surround its early
establishment. This new firms will be culturally embedded and historically specific,
reflecting societal conditions at a particular historical conjecture that result from a
particular time in history and take on the characteristics of the environment that surround
its early establishment (Stinchcombe, 1965).
Even though the organization founder will have impact as to how the firm varies
from others within the same population, the newly founded organization will none-theless
be constrained by the dominant organizational form in the population in which it is
founded (Selznick, 1957; Stinchcombe, 1965). The entrepreneur in this view will have a
dual challenge, to make sure that there is a distinctiveness about the firm that they are
launching, but also to make sure that this new firm is similar to other firms in the
population (Romanelli, 1991). These firms tend to become institutionalized within the
basic structure of an already existing structure and may remain relatively stable over a
very long time (Kimberly, 1975; Romanelli, 1991; Stinchcombe, 1965).
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In creation theory the role of knowledge is different than in discovery theory. In
discovery theory knowledge about the opportunity exists prior to the entrepreneur
recognizing the opportunity and it is possible to use historical and ex-ante existing
knowledge to form an opportunity (Shane, 2000). However, in creation theory
knowledge that is specific to the market to be entered, the ways to serve this market, and
about the customer problems in this market does not exist ex-ante to the formation
process. Opportunities in these settings have few, if any, precedents. Entrepreneurs in
this setting can only very imperfectly anticipate the nature of the opportunities they may
ultimately form and must learn about those opportunities as they emerge. Knowledge in
Creation Theory is often the result of an iterative process of understanding natural
phenomena and becomes available ex post to the opportunity formation process.
Created knowledge is socially constructed (Kogut et al., 1992). Constructed
knowledge is the response to different interpretations of the entrepreneur to their world
(Berger et al., 1967; Romanelli, 1991; Weick, 1979) and their heterogeneous expectations
of resources (Barney, 1986). The process of knowledge creation in this view starts with
the actions of the entrepreneur in forming an opportunity and reflects the construction,
deconstruction, and reconstruction that result in the new opportunity. The actions of the
entrepreneur may have started through a blind or random variation, but potentially the
actions will lead to a new understanding and a transformation of how things are done
(Campbell, 1960).
The interaction of the entrepreneur with the environment in an iterative process
enables learning and helps the entrepreneur to define the properties of the opportunity.
Thus meaning, understanding, and learning about the opportunity are defined relative to
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the entrepreneur’s actions and not through some self-contained or abstract structure
(Kogut et al., 1996). The specific knowledge that emerges through the trial and error
process will require the development of higher-order organizing principles in which to
codify the opportunity in a way and with language that make this opportunity accessible
to a wider circle of individuals (Kogut et al., 1992). The learning that occurs from the
formation process is what produces new knowledge. Entrepreneurs in this view develop
their own knowledge structures through repeated experiments and then use those
structures to give the knowledge they create form and meaning (Walsh, 1995). The
entrepreneur grounds this localized learning in a path dependant manner to develop a
foundation of knowledge (Kogut et al., 1992).
An important point to note is that the formation of an opportunity may or may not
coincide with the formation of a new product or technology. There are several
explanations that link technological formation to opportunity formation (Shane, 2000) or
technology to the development of novel arrangements (Tushman & Anderson, 1986).
However, technological perspectives provide inadequate explanations for the emergence
of new organizational populations. Indeed, when the timing of technical innovations and
the emergence of an organization form is considered in detail, there is very little coupling
between the two events (Ruef, 2000). Thus knowledge of a basic innovation in this view
is not necessarily the knowledge needed to form the opportunity. Technological
innovations need to be filtered through institutions and gain societal acceptance in order
to gain legitimacy (Aldrich & Fiol, 1994; Meyer & Scott, 1983). Opportunity formation
in this view often is about the process of knowledge creation and accumulation that is
socially constructed through the collective actions of the entrepreneur. In Creation
24
Theory the new firm instead of being embedded or part of an existing organizational form
may be the initial organization from which a new form is emerging (Hannan & Carroll,
1992).
Heterogeneous Resources
In discovery theory entrepreneurs may value resources differently than the
market, or they may put resources to different use, or they may recombine resources in
novel ways, however regardless of how entrepreneurs in discovery theory use resources
they exploit currently available resources (Shane & Delmar, 2004; Shane et al., 2000). In
discovery theory the entrepreneur “recognizes when resources are not being put to their
“best use” obtains the resources, recombines them, and sells them at more than they cost
to obtain and recombine them” (Shane, 2000: p. 451). Therefore, the value to be
extracted is the difference between the current resource owner’s value and the
entrepreneur’s expectation of the resource’s value. In this view the source of value
creation is the entrepreneur’s judgment in allocating resources.
Resource-based theory (Barney, 1991) suggests that if the acquisition cost of a
resource equals the value created by implementing that resource in a new way, a market
imperfection may be caused and normal returns may be made. Put simply, resources that
are acquired or traded for, even when recombined in novel ways or put to new use, will
probably only lead to a short-term above normal return and then to a normal return. By
using their entrepreneurial judgment in acquiring and redeploying resources,
entrepreneurs may gain some first mover advantages, although, because information
25
about these resources diffuses quickly (Barney, 1991; Grant, 1996), these first mover
advantages are often difficult to sustain (Lieberman et al., 1988).
This means that, absent external constraints, discovery opportunities are likely to
diffuse quickly among those entrepreneurs in a position to take advantage of what was an
information asymmetry. This is why secrecy and speed to market are important in a
discovery view. The speed at which knowledge about an opportunity to generate value
diffuses among a set of entrepreneurs has an impact on the ability of any one of those
entrepreneurs to extract value generated associated with that opportunity. As the number
of entrepreneurs who possess knowledge about the opportunity increases, competition
will also increase (Schumpeter, 1934). Indeed, other entrepreneurs will develop
competing opportunities until the cost of investing in this opportunity rises to equal the
economic value it generates (Barney, 1986).
When forming opportunities in creation theory, many of the resources needed to
develop and later exploit the opportunity may not exist at the time the process is started.
In Creation Theory, entrepreneurs can make at relatively low cost small decisions based
on their heterogeneous expectations of resource use or resource recombination. As the
entrepreneur allocates resources to either different uses or recombines resources in new
ways, attributes of the resources that were previously unknown become known. As the
attributes of resources become known, the entrepreneur learns about the resource and
new resources may emerge. The incremental trial and error process in creation theory,
allows for resources to evolve that can result in resource heterogeneity.
The incremental process of creation theory makes it possible for entrepreneurs to
change paths and put resources to different uses when surprises arise. These alternative
26
paths lead to other alternative paths in which idiosyncratic resources that are path specific
and opportunity specific may be the outcome. However, it is not any one resource that
has changed through this process. Individuals working on the opportunity formation
process may combine different skills and knowledge through cooperation and
communication that may lead to new resources and opportunity specific infrastructure
that complements the opportunity being formed. Actual processes of opportunity
creation can involve intricate interactions among technologies, society, networks, raw
materials, founders and entrepreneurs.
The transformation of resources through the opportunity formation process may
have had to go through cultural, administrative, and institutional variations, and
selections. Through this process of shaping and selection, bundles of resources that have
co-evolved may result. The resulting resource bundle is likely to be a combination of
socially complex resources such as the development of a network or specialized human
resource skills, a product or service, and an infrastructure.
However, just as environmental and institutional forces have shaping and
selection effects on the resources that comprise an emerging opportunity, the
opportunities themselves have effects on the environment and institutions. These
opportunities may shape the environment with new expectations and perhaps even
generate new language. Just as coffee was around before Starbucks, Starbucks changed
the expectations of the environment toward coffee and created a new “coffee culture”.
The result is the creation of new resource expectations by the environment that place a
different value on the resources.
27
In creation theory the new organizations that result from the opportunity
formation path may be isolated from competitors since there will only be a few
organizations that have the newly created knowledge or resources. If the new
organizational forms succeed in establishing a new population those organizations will
have a relative advantage based on their path dependent abilities to exploit evolving
resource conditions and competencies. Not have gone through the path dependent
shaping process it is difficult if not impossible for existing organizational forms to adapt.
Indeed, the new resources and competencies that emerge from these successful
organizational forms may destroy the established resources and competencies of existing
organizations (Christensen et al., 2004; Schumpeter, 1939).
In a similar vein, Creation Theory may also address another important issue in
another social science discipline. In particular, resource-based theory in the field of
strategic management examines the conditions under which heterogeneously distributed
and costly to copy resources and capabilities can be sources of sustained competitive
advantages for firms (Barney, 1986). While this theoretical perspective is beginning to
receive significant empirical support (Barney & Arikan, 2001) an important question in
resource-based theory remains unanswered—where do heterogeneous resources come
from? (Barney, 2001).
Creation Theory provides one answer to this question. Under conditions of high
or Knightian uncertainty, the enactment process can have the effect of exacerbating what
were originally very small differences between individuals to create quite substantial
differences over time. This may be true of individual cognitive biases. It may also be
true of the kinds of resources and capabilities an entrepreneur and an entrepreneurial firm
28
accumulate over the opportunity enactment process. In this sense, enactment can create
heterogeneity in resources and capabilities which, in turn, can enable some firms to
conceive of and implement strategies that other firms can neither conceive of nor
implement. Put differently, opportunity enactment may create valuable, rare, and costly
to imitate resources and capabilities that can then be used to implement strategies that
generate sustained competitive advantage.
This link between Creation theory and resource-based theory points to the central
role of path dependence (Arthur, 1989), both in Creation Theory, resource-based theory,
and by implication, in evolutionary theory and theories of the social psychological
enactment processes. In a sense, all these theories emphasize the importance of
information and knowledge generated from the process of enacting an opportunity. As
that process evolves differently for different individuals and firms, these individuals and
firms become heterogeneous in costly to copy, and costly to reverse ways.
Of course, Discovery Theory also includes a notion of path dependence in its
analysis of the formation and exploitation of entrepreneurial opportunities. In particular,
Discovery Theory suggests that an individual’s prior knowledge and experience with an
industry or market can enable that individual to combine information in new ways to
discover opportunities that could not have been discovered by individuals without this
prior knowledge or experience.
While path dependence is important in both Discovery Theory and Creation
Theory, there are important differences between these concepts as they are applied in
these two theories. Path dependence in Discovery Theory might be thought of as first
order path dependence: that the opportunities that are identified by the entrepreneur are
29
linked to knowledge and information of an already existing path which influences the
actions of the entrepreneur. In this view entrepreneurs continue along an already
established path.
This type of first order path dependence also exists in Creation Theory. However,
Creation Theory suggests the possibility of another type of path dependence. In this
second type of path dependence, entrepreneurial action is not only affected by an existing
path through time, it can create that path (Arthur, 1989). That is, Creation Theory
suggests that entrepreneurial action can be both dependent variable—the thing affected
by the path an entrepreneur takes over time—and independent variable—the actions
taken by an entrepreneur that create this path in the first place (Dosi, 1984).
This second type of path dependence links Creation Theory to scholars that
emphasize the role of founding conditions as a blueprint that in determines a firm’s initial
form and subsequent evolution (Hannan & Freeman, 1977; Nelson et al., 1982). In this
sense, Creation Theory suggests that a firm’s founding conditions may themselves be the
result of actions that entrepreneurs take to form and exploit an opportunity. Indeed, it
may be in these early actions of the entrepreneur that the seeds of an organization’s future
form are sown.
Discussion
The articulation of Creation Theory has a variety of important implications both
for the study of the field of entrepreneurship and the relationship between
30
entrepreneurship and other social sciences. Some of these implications are discussed
here.
Opportunities in the Field of Entrepreneurship
Recently, some management disciplines have been criticized for having too many
theories, and not enough theoretical and empirical integration (Hambrick, 2005; Pfeffer,
2005). This paper suggests the opposite for the field of entrepreneurship. This is a field
where only one opportunity formation and exploitation process has been systematically
described in the literature—Discovery Theory. By more fully developing a second
theoretical perspective—Creation Theory—the assumptions of both Discovery and
Creation Theories are made more clear. This is likely to encourage a broader debate in
the field of entrepreneurship.
For example, Discovery Theory-based research has asked a variety of important
empirical questions about the formation and exploitation of entrepreneurial opportunities,
including: “How do changes in an industry create new opportunities?” “Are
entrepreneurs really different than non-entrepreneurs?” and “How do entrepreneurs
estimate the riskiness of their decisions?” However, efforts to answer these Discoveryinspired
questions has left other questions—questions more consistent with Creation
Theory—not just unanswered, but often not even asked. These questions include: “How
does entrepreneurial action create opportunities?” “Are differences between
entrepreneurs and non-entrepreneurs the cause, or effect, of entrepreneurial action?” and
“How can entrepreneurs use incremental, iterative, and inductive processes to make
31
decisions?” Early empirical efforts designed to answer some of these Creation Theory
questions suggests significant potential in pursuing this line of work (e.g., Baker et al.,
2005).
Of course, suggesting that Creation Theory is a logical alternative to Discovery
does not imply that Discovery Theory should be abandoned in favor of Creation Theory.
Rather, future research in entrepreneurship will need to carefully examine the
assumptions under which entrepreneurs are operating. When entrepreneurs have unique
information, and the opportunity is pre-existing, and there is useful pre-existing
information Discovery Theory seems most likely to apply. When entrepreneurs do not
have information that is useful to the opportunity formation process, and when the
entrepreneur learns and changes through the process, and when there is little ex-ante
information available, Creation Theory seems most likely to apply. By acknowledging
the importance of both theories, it will be possible to begin to articulate a truly general
theory of entrepreneurship (Osigweh, 1989).
Of course, this paper takes only a “first step” in analyzing Discovery, Creation,
and the formation and exploitation of entrepreneurial opportunities. A great deal of work
is left to be done.
For example, as information and knowledge are developed Creation processes
might evolve into Discovery processes. However, the exact details of that evolutionary
process—when and how the setting shifts from creation to discovery or back—and its
implications for the impact of entrepreneurial actions on the formation and exploitation of
opportunities are not fully discussed here.
32
Also, the paper is silent concerning whether or not entrepreneurs can know the
informational conditions under which they are operating. On the one hand, the existence
of certain cognitive biases (e.g., the overconfidence bias) may lead entrepreneurs to
conclude that the setting within which they are operating is risky (or even certain) when,
in fact, it is highly uncertain. Alternatively, it may well be the case that some
entrepreneurs, some of the time, may be able to see the informational setting within
which they are operating for what it is—either risky or highly uncertain. It seems likely
that differences among entrepreneurs in the accuracy of their perceptions about the
informational attributes of the context within which they are operating may have
significant impact on their actions, and on the impact of those actions on the ability of
entrepreneurs to form and exploit opportunities. This is yet another area that deserves
further attention.
These, and many other questions, are likely to emerge as the implications of the
integration of Discovery and Creation Theory within the field of entrepreneurship are
explored further. In the end, the integration of these two theories may be important as the
field of entrepreneurship continues to enact its opportunities to grow and develop.
Empirical Implications of the Alternative Theories for
Business Planning and Financing of Entrepreneurial Opportunities
Understanding the boundary conditions between Creation Theory and Discovery
Theory will help resolve several apparent prescriptive contradictions in the
entrepreneurship literature (Bhide, 1992, , 1999; Carter, Gartner, & Reynolds, 1996;
33
Delmar & Shane, 2003; Delmar et al., 2004). Many of these contradictions focus on the
relationship between entrepreneurial actions and the ability of entrepreneurs to form and
exploit opportunities. Two areas where there has been significant contradictory literature
- business planning and financing - can be understood when properly applying the
assumptions of Creation Theory or Discovery Theory. These areas are of primary
importance in the study of entrepreneurship and have had many contradictory empirical
and prescriptive findings (Bhide, 1992; Carter et al., 1996; Casson, 1982; Delmar et al.,
2003; Fried & Hisrich, 1995; Gorman & Sahlman, 1989). Much of this confusion exists
because what constitutes “effective entrepreneurial action” varies, depending on whether
an entrepreneur is operating in Discovery Theory or Creation Theory.
For example, in Discovery Theory a business plan, helps the entrepreneur
integrate information and knowledge in ways that both describe what an opportunity is,
and how that opportunity is to be exploited (Delmar et al., 2003; Van de Ven et al.,
1989). However, business plans play a very different role in Creation Theory, where
current and historical information and knowledge are not available or not useful in
describing the nature of an opportunity. Indeed, entrepreneurs in this setting may not find
traditional forms of business planning to be beneficial. In Creation Theory, the task
facing entrepreneurs is not so much combining information and knowledge, but, rather,
asking the right questions, designing new experiments, remaining flexible, and learning
(Mintzberg, 1994). In the same way that formal strategic plans under conditions of
uncertainty can inappropriately constrain an established firm’s strategic choices
(Fredrickson, 1983, , 1986; Mintzberg, 1994), too rigorous business planning in Creation
Theory can short circuit the opportunity enactment process (March, 1991; Weick, 1979).
34
Only as this enactment process reaches its conclusion—may more traditional forms of
business planning be likely to be helpful to these entrepreneurs.
Another area where there are many apparent contradictory findings is in the area
of financing. Discovery Theory suggests that entrepreneurs will often be able to obtain
financing from external sources—including banks and venture capital firms. When
current and historical information and knowledge are available and useful, information
asymmetries about the nature of opportunities between entrepreneurs and potential
external capital sources can be overcome. Entrepreneurs in this context will often be able
to explain to outside sources of capital the nature of the opportunities they are planning to
exploit, the financial implications of exploiting these opportunities, and the riskiness of
exploiting these opportunities (Sapienza & Gupta, 1994). The ability to communicate
this information helps enable entrepreneurs obtain funding from these external sources
(Admati & Pfleidere, 1994).5
However in Creation Theory, traditional external sources of capital—including
banks and venture capital firms—are less likely to provide financing for entrepreneurs
who can not predict an uncertain future (Bhide, 1992; Christensen et al., 2004). In these
conditions, it will be difficult if not impossible for entrepreneurs to overcome the
information asymmetries that limit the ability of traditional outside parties to invest in
entrepreneurial activities since much of the knowledge and information needed has yet to
evolve. Entrepreneurs cannot explain the nature of the opportunities they are planning to
exploit to outside sources of capital because they may not fully understand the nature of
5 Of course, agency problems between entrepreneurs and external sources of capital may, nevertheless, still
emerge (Jensen and Meckling, 1976).
35
these opportunities themselves. Rarely will these entrepreneurs possess all that is
required for funding by these external sources of capital.
The Relationship between Entrepreneurship and Other Social Sciences
Not only does the introduction of Creation Theory into conversations about
forming and exploiting entrepreneurial opportunities have implications for the evolution
of the field of entrepreneurship, it also links this field more closely to other social science
disciplines.
For example, the enactment process that is central to a Creation Theory of
opportunity formation and exploitation can be understood as the individual-level process
that underlies a broader evolutionary theory of entrepreneurship(Nelson et al., 1982).
Indeed, in his discussion of the social psychology of enactment, Weick (1979) observes
that enactment at the individual level can lead to evolutionary processes at the
organizational level. Also, in his discussion of evolutionary theories of entrepreneurship,
Aldrich (2006) observes that organizational-level evolution assumes some sort of
enactment process at the individual level, of the type described by Weick (1979).
Obviously, the link between enactment, Creation Theory, and an evolutionary
theory of entrepreneurship can be further developed beyond this 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. This link may be built on the informational characteristics of the settings
36
within which entrepreneurs operate, and the impact of these settings on the relationship
between entrepreneurial actions and the formation and exploitation of opportunities.
Finally, the identification of Creation Theory may ultimately have implications
for research on the theory of the firm (Alvarez & Barney, 2005). Currently popular
theories of the firm—including transactions cost economics (Williamson, 1975) and
incomplete contract theory (Hart & Moore, 1988) adopt the assumption that at the time a
firm is created, parties to this exchange can either estimate the relative value of
transaction specific investments they must make to complete an exchange (for
transactions cost theory) or estimate who has the most to gain from that exchange (for
incomplete contract theory). Of course, when the future is uncertain such as that
described in Creation Theory, it is unlikely that those contemplating the founding of an
entrepreneurial firm will be able to know this information, especially early in the
opportunity enactment process.
In such settings, is it necessary to found entrepreneurial firms? And if the answer
to this question is yes, then how is this done—when the value of specific investments and
who has the most to gain from an exchange cannot be known. It may be necessary to
identify different bases for creating firms under conditions where Creation Theory is
assumed to hold. These are questions that have not been fully linked to the opportunity
formation process. A greater understanding of the opportunity formation process and its
potential implications for firm heterogeneity is potentially an area of rich investigation.
37
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Table One
Assumptions
Discovery Theory
Creation Theory
About
Entrepreneurs
Entrepreneurs are unusually alert
individuals and differ from nonentrepreneurs.
(Casson, 1982;
Kirzner, 1997; Shane, 2000;
Shane, 2003; Shane et al., 2000).
Entrepreneurs may or may not be
different than non-entrepreneurs and
may be changed by the opportunity
formation process.
About
Opportunities
Opportunities exist, independent
of entrepreneurial actions, just
waiting to be discovered and
exploited (Casson, 1982; Kirzner,
1997; Shane, 2000; Shane, 2003;
Shane et al., 2000).
Opportunities do not exist until
entrepreneurs engage in an iterative
process of action and reaction to
create them (Aldrich et al., 2006;
Gartner, 1985; Weick, 1979)
About Information
Conditions
The possession of ex-ante
information that is appropriate to a
particular opportunity leads to
opportunity discovery (Shane,
2000).
The end of an evolutionary enactment
process cannot be known from the
beginning. Opportunities may be
unrelated to currently available
information (Sine et al., 2005), and
extensive new knowledge and
information may have to be created,
de novo (Schoonhoven et al., 1990).
43