A TESTABLE TYPOLOGY OF ENTREPRENEURIAL OPPORTUNITY: EXTENSIONS OF SHANE & VENKATARAMAN (2000)

Saras D. Sarasvathy University of Maryland

Nicholas Dew S. Ramakrishna Velamuri Sankaran Venkataraman University of Virginia

For submission to: Academy of Management Review (First Draft August 16, 2002)

Shane & Venkataraman (2000) has provoked a healthy and lively debate in the entrepreneurship research community about the ontology and epistemology of entrepreneurial opportunity. In more mundane words, whether entrepreneurial opportunities exist in the world in some objective sense waiting to be discovered by the enterprising agent, or whether they are socially constructed has become a topic of urgent conversation on the floors of our scholarly meetings and in the hallways afterward. While we do not presume to resolve the issue in any way for the long term, we would like to propose a testable framework here for addressing it in the immediate future. Our hope is that this framework will nudge our empirical work forward within the excitement of the philosophical polemics that are spicing up our recent discussions. Our position is pluralistic without falling into the mire of unvarnished ontological relativism. In plain English, we propose (expressly for empirical testing) that all entrepreneurial opportunities1 are not alike. While some opportunities lie around waiting for the neo-classical arbitrageur to stumble onto them, others lie buried in the soil waiting to be dug out by the Kirznerian alert individual. Yet others require several stakeholders, including founding

entrepreneurs to act effectually to create them (or nurture them into being) in a dynamic and interactive process of contingency, design, and negotiation. We first define an entrepreneurial opportunity for the purposes of the framework we develop here. Then we root our framework in two seminal streams of theory in our field. We then present and argue for the central proposition that all entrepreneurial opportunities are not alike. Finally, we develop a detailed and testable typology of three types of entrepreneurial opportunities that embody key constructs both from our existing theories and empirical evidence. Along the way we illustrate the typology with practical examples.

Throughout this paper, whenever we refer to opportunities, we mean entrepreneurial opportunities i.e. opportunities to act in the creation of economic value (as defined in more detail later in the paper).

ENTREPRENEURIAL OPPORTUNITY: A DEFINITION For the purposes of this paper we start with the premise that all opportunities are opportunities to act. We define entrepreneurial opportunities, therefore, as opportunities to act in the creation of economic value. Whether any particular set of entrepreneurial actions actually results in positive economic value or not, we contend that only actions that aspire to create positive economic value constitute the notion of entrepreneurial opportunity. aspiration may occur at the level of the individual, the firm or the economy as a whole. We recognize that positive value created at one level may or may not be positive at the other levels. But the desire to create value at one level at least is a necessary condition for inclusion into the set of entrepreneurial opportunities. That is because even unintended Also, this

economic value creation occurs within the context of human aspirations for a better future for oneself and/or for others -- and, as argued elsewhere (Sarasvathy, 2001c), is driven by the imagination that Northrup Frye talks about: The fundamental job of the imagination in

ordinary life is to produce, out of the society we have to live in, a vision of the society we want to live in. (1964: 140) The Oxford English Dictionary defines opportunity as A time, juncture, or condition of things favorable to an end or purpose, or admitting of something being done or effected. Assuming that ends are not always specified prior to the pursuit of an entrepreneurial opportunity, but may emerge endogenously over time, we can develop constituents of our definition of entrepreneurial opportunity from the second part of the above sentence. An

entrepreneurial opportunity, therefore, consists of a set of ideas, beliefs and actions that enable the creation of future goods and services in the absence of current markets for them (Venkataraman, 1997). For example, the entrepreneurial opportunity that led to the creation of

Netscape involved (a) the idea of a user-friendly Web browser (Mosaic); (b) the belief that the internet could be commercialized; and, (c) the set of decision-actions that brought together Marc Andreesen (the creator of Mosaic) and Jim Clark (the ex-founder of Silicon Graphics) to set up base in the small town of Mountain View. In sum, an entrepreneurial opportunity consists of: 1. New idea/s or invention/s that may or may not lead to the achievement of one or more economic ends that become possible through those ideas or inventions; 2. Beliefs about things favorable to the achievement of possible valuable ends; and, 3. Actions that generate and implement those ends through specific (imagined) new economic artifacts (the artifacts may be goods such as products and services, and/or entities such as firms and markets, and/or institutions such as standards and norms).

MARKET PROCESS, UNCERTAINTY, AND ENTREPRENEURIAL OPPORTUNITY We draw upon three major streams of economic literature pertinent to entrepreneurial opportunity each with a very different view of the market process. For a detailed review of each of the three streams, see Sarasvathy et. al. (2002). The antecedents for the three views

specifically draw upon three works, i.e., Hayek (1945), Knight (1921), and Buchanan and Vanberg (1991) -- all of which grapple with the central problem in economics as demarcated by Arrow (1974a): ... the uncertainties about economics are rooted in our need for a better understanding of the economics of uncertainty; our lack of economic knowledge is, in good part, our difficulty in modeling the ignorance of the economic agent. The first stream (neo-classical economics) views the market as an allocative process where the market is the familiar notion of the invisible hand that equilibrates known sources of

demand and supply, allocating scarce resources amongst an inexhaustible lading list of human wants and desires in a Pareto optimal fashion. The second one (Austrian economics a la Kirzner) views the market as a discovery process, where disequilibrium forces dominate and alert entrepreneurs discover ways to move the invisible hand toward Pareto optimal solutions. The third and final one (Buchanan & Vanberg, 1991) views the market as a creative process where the market does not exist to optimize. In this view, The market economy, as an aggregation, neither maximizes nor minimizes anything. It simply allows participants to pursue that which they value, subject to the preferences and endowments of others, and within the constraints of general rules of the game that allow, and provide incentives for, individuals to try out new ways of doing things. (1991: 181) We will now elaborate on this third view by connecting it to its historical antecedents. In an important essay in 1945, Hayek postulated the concept of dispersed knowledge where no two individuals share the same knowledge or information about the economy. Hayek distinguished between two types of knowledge: first, the body of scientific knowledge, which is stable and can be best known by suitably chosen experts in their respective fields; second, the dispersed information of particular time and place, whose importance only the individual possessing it can judge. Hayek pinpointed the harnessing of this latter type of knowledge as a key and underestimated element in the economic development of society. This dispersion has two extremely important implications as far as entrepreneurial opportunities are concerned. First, dispersion of knowledge is a root explanation for the presence of uncertainty, which gives rise to opportunities in the first place. Second, dispersion of knowledge is another root

explanation of the nexus of the enterprising individual and the opportunity to discover, create and exploit new markets (Venkataraman 1997, Shane 2000). Without this nexus of the

individual and the opportunity, most inventions will lie fallow. Frank Knight (1921) clearly realized this and delved into the implications of uncertainty for economic organization and genesis of entrepreneurial opportunities2. In his seminal dissertation, Risk, Uncertainty, and Profit, Knight distinguished between three types of uncertainties about the future that an economic agent may face: The first consists of a future whose distribution exists and is known, and therefore decisions would only involve calculating the odds of a particular draw and placing one's bets based on the analysis. In this case, risks can be reduced through diversification. This assumes that all the possible outcome scenarios are all equally likely, ex ante. The second consists of a future whose distribution exists but is not known in advance. The agent, in this case, has to estimate the distribution through repeated trials and can then treat it the same as the first case. Furthermore, as the environment changes dynamically, successful strategies evolve through adaptive processes including careful experimentation and learning over time. Although we do not know the probabilities attached to each of the outcome scenarios, the probabilities do exist, and their distribution can be uncovered over time. The third type of uncertainty, which Knight called true uncertainty, consists of a future that is not only unknown, but also unknowable -- with unclassifiable instances and a non-existent distribution. The economic agent, or entrepreneur, who takes on this true uncertainty, gets compensated for it through "profit" -- a form of residual return after the normal factors of production are paid for and all market contracts fulfilled. Knight did not explicate how the entrepreneur deals with this true uncertainty. But, instead he argued that:

Schendel (19xx) argued the same that uncertainty is the source of opportunity.

The ultimate logic, or psychology, of these deliberations is obscure, a part of the scientifically unfathomable mystery of life and mind. We must simply fall back upon a capacity in the intelligent animal to form more or less correct judgments about things, an intuitive sense of values. We are so built that what seems to us reasonable is likely to be confirmed by experience, or we could not live in the world at all. In this third case of Knightian uncertainty, there is no meaning to the attachment of probabilities to the opportunity vectors. Instead, we need to understand the process through which the different levels of actors interact. The benefits get created endogenously, in the very unfolding of those interactions. Later researchers, especially Austrian economists such as Von Mises (1949) and Kirzner (1997), and subjectivists such as Lachmann (1976) and Shackle (1979), have tried to tackle this problem of Knightian uncertainty. Fixing a rather penetrating philosophical gaze on the works of these economic theorists since Hayek and Knight, Buchanan and Vanberg (1991) contrast the three views of economic theory presented here as follows: "The market as an allocative process, responding to the structure of incentives that confront choice-makers; the market as a discovery process, utilizing localized information; or the market as a creative process that exploits man's imaginative potential..." They argue that the perceptual vision of the market as a creative process offers more insight and understanding than the alternative visions that elicit interpretations of the market as a discovery process, or, more familiarly, as an allocative process. In either of the latter alternatives, there is a telos imposed by the scientist's own perception, a telos that is nonexistent in the first instance. And removal of the teleological inference from the way of looking at economic interaction carries with it significant implications for any diagnosis of the failure or success, diagnosis that is necessarily preliminary to any normative usage of scientific analysis."

Recent empirical evidence that examines in detail how expert entrepreneurs make decisions when faced with building a firm for a new product without any given existent market (i.e., when faced with Knightian uncertainty), provides considerable support for the view of the market as a creative process that neither ignores teleology nor assumes it a priori in the research endeavor. Sarasvathy (1998) found that the entrepreneurs not only did not assume the existence of the market, but also explicitly expressed their belief that the existence of the market cannot be demonstrated or known in advance. Rather than using the causation-based logic 'To the extent you can predict the future, you can control it', the subjects in the study overwhelmingly (74% of the subjects over 63% of the time) followed the logic of effectuation that 'To the extent that you can control the future, you do not need to predict it.' (Sarasvathy, 2001a). This logic overcomes the problem of true Knightian uncertainty in a curiously paradoxical way: On the one hand, it eschews prediction altogether i.e., eliminates the need for prediction, and on the other, it transforms the future into near certainty i.e., makes it highly predictable -- by creating the distribution. But, both in Buchanan and Vanberg's theoretical exposition of the market as a creative process and Sarasvathy's empirically grounded conceptualization of effectuation, the key issue is not which of the three views is "right", but rather which view is more useful under what conditions of uncertainty. Such a pragmatic approach allows us to utilize the three views explicated so far to begin constructing a testable typology of entrepreneurial opportunities based on the pre-conditions for their existence, as follows: 1. Opportunity Recognition If both sources of supply and demand exist rather obviously, the opportunity for bringing them together has to be "recognized" and then the match-up between supply and demand has to be

implemented either through as existing firm or a new firm. Examples include arbitrage and franchises. 2. Opportunity Discovery If only one side exists -- i.e., demand exists, but supply does not, and vice versa -- then, the nonexistent side has to be "discovered" before the match-up can be implemented. Examples include: Cures for diseases (Demand exists; supply has to be discovered); and applications for new technologies such as the PC (Supply exists, demand has to be discovered). 3. Opportunity Creation If neither supply nor demand exist in an obvious manner, one or both have to be "created", and several economic inventions in marketing, financing etc. have to be made, for the opportunity to come into existence. Examples include Wedgewood Pottery, Edison's General Electric, U-Haul, AES Corporation, Netscape, Beanie Babies, and the MIR space resort. In sum, both the literature on multiple views of market process and uncertainty, and some preliminary empirical evidence on entrepreneurial expertise suggest the following proposition: Central Proposition: All entrepreneurial opportunities are not alike. In fact, based on the literature review, we could argue that there are at least three categories of entrepreneurial opportunities, each characterized by the particular market process it participates in and the particular type of uncertainty that gives rise to it. Table 1 presents a summary comparison of the three types of entrepreneurial opportunities along several different dimensions. We will examine these in greater detail next and develop more fine-grained

propositions for empirical testing. Note: Although we have set up the typology as distinct, there is room for substantial overlap between the categories on particular aspects of entrepreneurial opportunities. For

example, while strategies dealing with opportunities under the creative view will be predominantly effectual, strategies dealing with opportunities in the allocative and discovery view may both be predominantly causal. Also, certain cases of modeling opportunities under the discovery view may easily be confounded with those under the creative view. Details of

categorization choices and their implications for particular conclusions will have to be argued on a case by case basis in future empirical work.

TESTABLE TYPOLOGY OF ENTREPRENEURIAL OPPORTUNITIES Most economic theories tend to begin with individuals and firms, and then aggregate to the level of the economy. We recognize that individual imagination and aspirations are to some extent products of the socio-cultural imagination and historical aspirations. In the following exposition, although we use the economic approach of beginning with the individual, we believe that our arguments (without substantial modification) can be made compatible with the view that the individual is but society writ small. (Douglas, 19xx) or even more easily with the view that human agency and social environments construct each other in a recursive fashion over time (Giddens, 19xx). For the purposes of this paper, beginning with the individual is a theoretical convenience, rather than an ontological position. Moreover, the propositions we derive from our arguments can be empirically operationalized at any level of analysis individual, group or society. That is why we use the word entrepreneur to denote not only the individual

entrepreneur, but also firms/organizations and economies. 1. Propositions relating beliefs about the future to types of opportunity The fundamental parameter for differentiation in the typology in Table 1 consists in Knights thesis about the three types of uncertainty. These three types of uncertainty with their

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assumptions about probability distributions and informational requirements can be translated both into the general beliefs of the entrepreneur about where the future comes from as also beliefs about particular futures with regard to particular market contexts. These beliefs in turn

influence what types of opportunities for action the entrepreneur perceives and pursues. These beliefs also often prevent the same entrepreneur from seeing other types of opportunities. In other words, Propostion 1a: When an entrepreneur believes a particular future is largely predictable (except for completely random acts of God), s/he will b more likely to pursue opportunities that involve clear sources of supply and demand. (Example: Franchises and well-researched business such as theme restaurants and services) Propostion 1b: When an entrepreneur believes a particular future is largely unpredictable, but almost entirely driven by an independent environment, s/he will be more likely to pursue opportunities that involve either a clear source of supply or a clear source of demand. (Example: Propostion 1c: R&D based solutions for existing problems; new uses for well-established technologies) When an entrepreneur believes a particular future is largely unpredictable and mostly a product of human agency, s/he will be more likely to pursue opportunities that involve markets with substantially incomplete structures (such as lack of distribution channels or absence of revenue models or no clear sources of supply and demand). (Example: U-Haul; RFID tags) These propositions can be tested through the development of a survey instrument to extract beliefs about the future, and relating particular belief profiles to the types of opportunity pursued by the subject either in the lab or in the field. Note: The beliefs about the future will themselves be influenced by socio-cultural and historical factors including past experiences and

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training etc. But we recognize that these complications are beyond the scope of this paper and leave them to future expositions. 2. Proposition relating types of opportunity to temporal lags In his 1974 exposition on the role of limited knowledge in economic analysis, Arrow (1974a) admitted that "Although we are not usually explicit about it, we really postulate that when a market could be created, it would be." We would like to argue that there is no such inevitability in the case of entrepreneurial opportunities, except perhaps in the case of the neoclassical arbitrageur. In the case of opportunity discovery and creation, the coming into being of the opportunity is contingent upon the perceptions and actions of entrepreneurs. Therefore, we would expect the following: Propostion 2: Retrospectively speaking, we will find the largest time lags between the coming into being of sources of supply and demand, and entrepreneurial opportunities that create complete markets, in the case of the effectuator; the smallest lags will be found in the case of the arbitrageur. (Example: Netscape came into being several years after the discovery of the internet) Whereas in the case of discovery, time lags could be explained in terms of scientific progress or other historical explanations, in the case of opportunities within the creative view, the question almost always arises, Why didnt someone think of this before? For example, in the case of cures for diseases, although there may be time lags involved, they may be explained within the rubric of scientific research rather than entrepreneurial opportunity. In general, this proposition would be most amenable to historical analyses. 3. Propositions relating risk management to types of opportunities

Since our typology of entrepreneurial opportunities is differentiated on the basis of types of future uncertainties, we should be able to find evidence of particular strategies of dealing with

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the three types of uncertain futures in the pursuit of different types of entrepreneurial opportunities. In particular, Propostion 3a: Standard risk management techniques including diversification will be found in cases of the successful pursuit of allocative opportunities. (Example: product line extensions in large corporations) Propostion 3b: More creative risk management techniques such as the use of real options will be found in cases of the successful pursuit of discovery opportunities. (Example: cures based on bio-technology) Propostion 3c: Effectuation techniques that combine affordable loss with precommitments from stakeholders and leveraging of contingencies will dominate cases of the successful pursuit of creative opportunities. (Example: RealNetworks)

The set of propositions stated above may best be verified using case study methodologies that identify particular strategies used by particular firms and then relate these to relevant parameters of the types of opportunities that the firms ended up creating. 4. Propositions relating types of strategies to types of opportunities The pursuit of a set of necessary and sufficient conditions for success has been one of the holy grails of entrepreneurship research. We believe that while no such complete set might exist, it may still be possible to relate particular factors to firm performance at least in a co-relational manner. For example, the mere availability of particular resources may explain performance only in the case of allocative opportunities. How particular resources get used may vary greatly in the cases of opportunity discovery and creation. More precisely, Propostion 4a: Propostion 4b: Exploitation strategies based on planning and prediction will drive the use of resources in the case of allocative opportunities. Adaptive strategies based on organizational learning will drive the use of resources in the case of discovery opportunities.

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Propostion 4a:

Effectual strategies based on the logic of non-predictive control will drive the use of resources in the case of opportunity creation.

Again, case study methods combined with industrial analyses may be used to test these propositions. In particular, we expect that different stages in an industrys evolution will give rise to different types of opportunity and therefore exhibit different strategies such as those mentioned above. In the foregoing exposition of the typology presented in Table 1, we have outlined and briefly discussed three views of entrepreneurial opportunity under the broader umbrella of the three views of the market process as allocative, discovery, and creative. We now turn to the question of how to integrate the three views into our practice and pedagogy and future scholarship, particularly in the area of entrepreneurship.

INTEGRATING THE THREE VIEWS OF ENTREPRENEURIAL OPPORTUNITY In their landmark book on semantic cognition rooted in basic conceptual categories of metaphor, Lakoff and Johnson (19xx) argued soundly against both the myths of subjectivity and objectivity, and established the basis for experiential approaches to understanding human cognition. Our approach to the study of entrepreneurial opportunities embraces such a third position. We take the ontological stance that while the world does exist outside of our minds, the only way we can understand it is through our cognition embodied in our experiences. Such a stance allows us to accept the validity of a pluralistic perspective on entrepreneurial opportunity without allowing all possible perspectives to be equally valid and therefore essentially unverifiable.

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One way to look at the three views we have discussed above would be to simply consider them three equally valid and non-overlapping modes of thinking about entrepreneurial opportunities. Such an approach focuses only on the distinctions between the views and

overlooks both the possibilities of relationships and interactions between them, and also the fact of empirical confounding in the way they are embodied in economic phenomena. For example, looking at the operationalization of the three views as the recognition, discovery, and creation of opportunities suggests that the creative view might be more general than and prior to the other two views. This is because creative processes contain recognition and discovery as necessary inputs, while recognition and discovery can do without most key aspects of design. A simple example of this point is that before we can recognize or discover great art, that art has to have been created. Similarly, entrepreneurial opportunities may be posited to have been created through the decisions and actions (conscious or unintended) of economic actors before someone can recognize or discover them. For instance, once specific goals, values and preferences have been formed through the creative process, discovery processes can discover various means to achieve the goals. And when both ends and means become manifest, allocative processes figure out which particular means can best achieve which particular ends. We could argue the case of Starbucks as an illustration. The original founders (before Howard Schultz came into the picture) acted effectually to create a shop selling fresh roasted beans in Seattle, mostly because one of the founders happened to love coffee from fresh ground beans. It did not even strike them to brew coffee and allow customers to taste it, let alone a vision of the Starbucks coffee bar market as it exists today. After customers actually asked to taste the coffee, the firm turned into a coffee shop that then allowed Schultz to discover the potential market for coffee bars and franchise the idea nationally. Today, almost anyone with the

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basic resource requirements can open up a Starbucks franchise. In this particular case, we can see how each of the three views of entrepreneurial opportunity is empirically valid at different stages of market creation. Another way to integrate the three views would be to recognize that they are extremely context-dependent. In other words, as our propositions indicate, each view is useful and will show up empirically under different circumstances, problem spaces and decision parameters. For example, when resources are clearly specified and goals are given, the allocative view will be the most appropriate. In contrast, when the problem spaces are characterized by enormous uncertainties, and value criteria for making choices are highly ambiguous, a creative approach might be called for. CONCLUSION In conclusion, every invention3 engenders opportunities for the creation of several possible economic (as well as other types of socially significant) effects. In the foregoing sections we have examined three sets of views with regard to how these effects come to be. Approaches based on the view of the market as an allocative process focus entirely on the final effects of opportunity creation, treating the processes leading to these final effects as mere detail; approaches based on the view of the market as a discovery process emphasize only the origins of the opportunity for creation, treating the final effects as inevitable products of competitive markets; and finally, approaches based on the view of the market as a creative process emphasize the decisions and actions of the agents, making both origins and final effects contingent upon those decisions and actions.

The term "invention" need not be limited to technological (i.e., science-based) inventions. Inventions can occur in all spheres of human activity -- in the arts (surrealism), in sports (snowboarding) and in philosophy (pragmatism), to name only a few.

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Table 1:Comparing the three views of entrepreneurial opportunity View Allocative View Discovery View (Neo-classical Arbitrageur) (Kirznerian alert individual) Creative View (Effectuator)

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What is an opportunity

Possibility of putting resources to good use to achieve given ends

Possibility of correcting errors in the system and creating new ways of achieving given ends Focus on Process Opportunities discovered through inductive processes Only one or the other (supply or demand) known Existent, but unknown probability of opportunity vectors Complete information at the aggregate level, but distributed imperfectly among individual agents Homogeneous expectations at the macro level; heterogeneous expectations at the micro level Uncertainty managed through: Experimentation Success is outliving failures

Possibility of creating new means as well as new ends

Focus Method

Focus on System Opportunities recognized through deductive processes When both supply and demand are known Opportunity vectors are equally likely

Focus on Decisions Opportunities created through abductive processes When both supply and demand are unknown Probabilities for opportunity vectors are completely non-existent Only partial information even at the aggregate level, and ignorance is key to opportunity creation Heterogeneous expectations at both micro and macro levels

Domain of application Distribution of opportunity vectors Assumptions about information

Complete information available at both aggregate and individual levels

Assumptions about expectations

Homogeneous expectations both at the micro and macro levels

Management of uncertainty

Uncertainty managed through: Diversification Success is a statistical artifact

Uncertainty managed through: Effectuation

Definition of success Unit of competition Outcomes

Success is a mutually negotiated consensus among stakeholders Values compete

Resources compete

Strategies compete

Strategies for: Risk management

Strategies for: Failure management

Strategies for: Conflict management

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