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Schumpeters Theory Of Innovation Business Essay

Paper Type: Free Essay Subject: Business
Wordcount: 3437 words Published: 1st Jan 2015

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Describe how entrepreneurship evolved from economic theory. Discuss small business as a dimension of entrepreneurship.


Entrepreneurship and economic development are interdependent. Economic development takes place when a country’s real rational income increases overall period of time wherein the role of entrepreneurs is an integral part.


One who accepts the risks and opportunities of creating, operating and growing a new business and engages in entrepreneurship.


The process of seeking businesses opportunities under conditions of risk


Vocational courses

Blue nail polish


Entrepreneurship Characteristics


Concerned for good customer relations

Desire to be their own boss

Can deal with uncertainty and risk


Rely on networks, business plans, and consensus

Have different views on how to succeed, to automate a business, and when to rely on experience or business acumen

Schumpeter’s Theory of Innovation

Schumpeter’s theory of entrepreneurship is a pioneering work of economic development, development in his sense, implies that carrying out of new combination of entrepreneurship is basically a creative activity. According to Schumpeter an entrepreneur is one who perceives the opportunities to innovate, i.e. to carry out new combinations or enterprise. In his view, the concept of new combination leading to innovation covers the following 5 cases-

The introduction of new good, that is the one with which consumers are not yet familiar, of a new quality

The introduction of new method of production

The opening of new market

The concept of new source of supply of raw material

The carrying out of new organization

In the view of the above, Schumpeterian theory of entrepreneurship has got the following features-

Distinction between invention and innovation

Schumpeter makes a distinction between innovation and invention. Invention means creation of new things and innovation means applicable of new things onto practical use

Emphasis on entrepreneurial function

Schumpeter has given emphasis on the role of entrepreneurial functions in economic development. In his view, development means basic information of the economy that is brought about by entrepreneurial functions

Presentation of disequilibrium situation through entrepreneurial activity

The entrepreneurial activity represents a disequilibrium situation, a dynamic phenomenon and a break from the routine or a circular flow or tendency toward equilibrium

Entrepreneurialism dream and the will to found a private kingdom

The motives of creating things and applying these things into practice inspire the entrepreneur to undertake innovation

The Different Cultural Dimensions

Hofstede argued that in society some people have more power than others and therefore can determine the behavior of others. This phenomenon he called power distance and argued that in different societies some people can openly disagree with their superiors while in others subordinates do not disagree with their superiors. The former is a low power distance and the latter is a higher power distance.

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In conditions where the power distance is great and there is high respect for authority, Hofstedes studies concluded that in African and Asian countries, the power distance was high. Such situations are typicalised by over centralization of authority and deep hierarchies. The result is slow decision making, lack of initiative and low creativity. This is against the tenets of entrepreneurship.

Another dimension is that of individualism versus collectivism, individualism characterizes societies where individuals look after themselves and are not dependent. In collectivist societies, people are integrated into strong cohesive groups. The concept of the extended family working for the common good tends to be prevalent in collectivist societies. Business works well under individualistic cultural patters. African society and indeed Asian societies are collectivist. Entrepreneurship will work better in conditions where there is pursuit and desire by an individual to succeed.

In the femininity verses masculinity concept, the former pertains to societies where the gender roles are distant and men are regarded as assertive and tough while women are seen as modest and tender. In the feminist society the gender roles overlap. Western societies are said to be masculine and in the economic arena the best man wins. Managers are assertive and decisive. In the African and Asian societies, the work place is characterized by compromise and negotiation. The masculine society tends to agree with the entrepreneurial roles while the feminine society does not.

The uncertainity avoidance dimension is what Hofstede calls the extend by which people feel threatened by uncertain situations. While Hofstede does not define this as risk taking, it amount to attitudes to risk. In the African societies there is a high degree of uncertainty avoidance while in the Western and Asian societies there is a low degree of uncertainty avoidance. Entrepreneurship behavior is associated with risk taking and consequently the African entrepreneur may not necessarily be a risk taker.

Q2. Explain how entrepreneurship has influenced economic development and productivity in recent years?


The contribution of technological innovation to national economic growth has been well established in the economic literature, both theoreti- cally (Solow, 1956; Romer, 1986) as well as empirically (Mans¬eld, 1972; Nadiri, 1993). How- ever, a closely related concept, entrepreneurship, has for a long time not found a proper place in mainstream empirical economic research on the sources of economic growth. Although copious amounts have been written theoretically and descriptively on how entrepreneurship a¬€ects the economy (Porter, 1990; Baumol, 1993; Lumpkin and Dess, 1996), there is dearth of evidence based on empirical data. This is partially due to the di¬ƒculty in de¬ning the role of the entrepreneur and formalizing its measurement for empirical modelling. The work of the Global Entrepreneur- ship Monitor (GEM) potentially closes this gap by providing new empirical data on entrepreneur- ship as a process of forming new businesses (Rey- nolds et al., 1999). This paper leverages on the GEM data to explore the impact of entrepreneur- ship (as de¬ned by new business creation), in con- junction with innovation, on macro level economic growth.

Role of entrepreneurship and innovation in economic Growth

The early work of Schumpeter (1911) established conceptually the ”entrepreneur as innovator” as a key ¬gure in driving economic development. The innovative activity of entrepreneurs feeds a creative ”destruction process” (Schumpeter,

1942) by causing constant disturbances to an eco- nomic system in equilibrium, creating opportuni- ties for economic rent. In adjusting to equilibrium, other innovations are spun-o¬€ and more entrepreneurs enter the economic system. In this way, Schumpeter’s theory predicts that an increase in the number of entrepreneurs leads to an increase in economic growth.

This theory, while in¬‚uential, is largely descriptive and di¬ƒcult to formalise econometri- cally. Consequently, entrepreneurship is missing from most empirical models explaining economic growth. Arising from Schumpeter’s original the- ory, subsequent empirical economic literature have seized on the idea of innovation as a source of economic growth. A considerable body of empirical evidence now exists across countries (Lichtenberg, 1993; Coe and Helpman, 1995; Engelbrecht, 1997; Guellec and van Pottelsberghe de la Potterie, 2001). In contrast, conceptual and descriptive literature on the role of entrepreneurs has ¬‚ourished, but the empirical literature has for a long time remained mute on this subject. This is in part due to the di¬ƒculty in measuring and operationalising entrepreneurial activities.

Innovation and economic growth

The attraction of innovation as a determinant of growth in empirical research is its straightfor- ward measurement. Researchers may use either input measures such as R&D expenditures (Mans¬eld, 1972) or innovation outcomes such as patents (Griliches, 1990). A large body of empirical work has evolved from this focus on technological progress and innovation. These studies have established that the level of techno- logical innovation contribute signi¬cantly to eco- nomic performance, particularly at the ¬rm and industry level.

Studies on the impact of technological innova- tion on growth have been predominantly based on the neo-classical tradition established by Solow (1956), where growth is driven by enhancements to capital and labour inputs, whether in terms of quantity or quality and pro- ductivity. Nadiri (1993), provided a summary of studies in this tradition, where a Cobb-Douglas production function is used to link innovation to output and productivity growth. Permanent long- run growth depends on the growth rate of inven- tions, which is exogenously determined.

More recently, researchers have begun to examine growth that is endogenously determined by technical change resulting from decisions of pro¬t-maximising agents. Verspagen (1992) and Ruttan (1997), provide surveys of such innova- tion and R&D based endogenous growth models. The latest class of models developed in this tradi- tion has arisen from the works of Romer (1986,

1990), Grossman and Helpman (1991) and Aghion and Hewitt (1992). In contrast to the Solow-like models, productivity growth results from intentional innovation by rational, pro¬t- maximising agents and is therefore endogenously determined. Endogenous growth models empha- sise the importance of knowledge, knowledge spillovers and technological substitution in the process of economic growth, conceptually paral- lel to Schumpeter’s early growth theory.

Such research, especially the Solow (1956) neo-classical models of economic growth, does not explicitly address the issue of entrepreneur- ship, which is the underlying cause for technolog- ical innovation in the Schumpeterian context. The new class of endogenous growth model pio- neered by Romer (1990) recognises some aspect of entrepreneurship by modelling the process of invention and deriving the motives for invention from the microeconomic level. We can summarise that the Schumpeterian tradition has given rise to models that are focused on innovation as a source of economic growth. Unlike the original Schumpeterian theory, however, these models do not provide any direct test of the e¬€ect of entre- preneurial ¬rm-formation activities on economic growth.

Entrepreneurship and economic growth

Davidsson (2003) discusses various current views of entrepreneurship from di¬€erent perspectives and supports Kirzner’s (1973) notion that ”entre- preneurship consists of the competitive behaviours that drive the market process”. This view includes any introduction of new economic activity to the marketplace as an instance of entrepreneurship. As such, entrepreneurship is manifested not only by market entry of new ¬rms, but also by innovative and imitative entries into new markets by established ¬rms. From this perspective, technological innovation is a form of entrepreneurship. This implies that existing mod- els linking innovation to growth have in fact addressed a speci¬c aspect of entrepreneurship, that of innovative entry. The contribution of this paper is to additionally include another aspect of entrepreneurship, that of new ¬rm entry and new business creation, as a determinant of growth. To avoid confusion over terminology, future ref- erences to this new business creation aspect of entrepreneurship will make speci¬c mention of it.

Q3. Explain the concepts of “Windows” and “Corridors” for new ventures. Describe the main factors that lead to success for new ventures.


A window is time horizon during which opportunities exist before something else happens to eliminate them. A unique opportunity, once shown to produce wealth, will attract competitors, and if the business is easy to enter, the industry will become rapidly saturated. Bicycles did not become viable commercial products until people needed them as transportation. When that need occurred, hundreds of bicycle manufactures rushed to take advantage of the “window of opportunity.” Literally every successful product and service has had an optimal period of time for commercialization. Those introduced too early have usually failed, and those introduced too suffered from crowded markets. A brief period of opportunity opened for electronic spreadsheets when micro-computer hit the fast growth curve. Several entrepreneurs entered the market with good spreadsheet products. The first, VisiCalc was designed for the Apple PC. Vesicle was quite successful, and later versions for Ms-Dos systems were even more successful. But lotus 1-2-3 and Microsoft’s Multiplan and Excel programs forged into industry markets. By 1986, Lotus had set the industry standard, and today a handful of firms offering spreadsheets virtually control the market. Entrepreneurs, therefore, must not only recognize opportunities, but also take advantage of them while windows exist to be successful.

Another aspect of many successful ventures is called the corridor principle. The corridor principle suggests that opportunities evolve from entrepreneurs being positioned in similar work or having had experience with related ventures so that when a window opens it is easy for them to move quickly into a new venture. A corollary is that as a venture becomes expert in one activity, related opportunities evolve, and many of them are more rewarding than the initial activity.

William Gates of Microsoft, for example, was first approached by IBM in 1980 to program an operating system for the PC; Gates turned down the offer. He had a fledgling software company and was “hacking” with minor programs he hoped to sell; the idea of a major software effort was inconceivable. However, he and several friends realized the opportunity and began working independently to create the MS- DOS system. His early efforts probably would have kept Gates in an obscure part of the software industry, but the brief opportunity to create the operating system led to enormous success. Howard Head, the founder of Head Ski, leveraged his “sports manufacturing” experience to create prince manufacturing and a revolution new line of tennis rackets. This does not mean that entrepreneurs must first work aimlessly and wait for a twist of fate to create opportunities. It means that entrepreneurs who are active and watching for changes are more likely to recognize opportunities when they occur. For new ventures arise through “luck” which is one of the popular and inaccurate myths about entrepreneurial success we address next.

The concept of single window principle for new ventures means that in the process of conducting state registration of entrepreneur, the authorized body shall give an extract from the Unified register of legal entities and individual entrepreneurs, providing details of recognition in the Statistics Service, the Tax and Pension Fund. The extract shall be given on the next working day and free of charge when an entrepreneur opens a bank account he just needs to show such an extract,” Brodsky said. The law shall enter into force six months after its publication.


There are various factor and element which lead to success for new ventures but some major and important are describe as under

Key Success Factor Stability:-

Requirements for market success are likely to change radically with market evolution. Superior performance arises from a fit between the key success requirements and the competencies of a venture. And while pioneers commit to a number of key factors they believe will lead to success within the competitive environment changes in that environment may render the venture at a competitive disadvantage. Later followers are often better able to recognize and respond to market opportunities as well as minimize costs of entry through cutting R&D corners and/or leapfrogging the pioneering technology.

Lead Time:

Barriers to entry initially provide pioneers with a period of monopoly. The lead-time between the pioneer’s entry into the market and the appearance of the first follower, at least initially, delays competitive rivalry within the industry. Lead time and competitive rivalry, in tandem; provide a greater understanding of new venture performance by identifying how an advantage is first obtained and the means by which over time it slowly erodes. A longer lead time may increase pioneering advantages by helping the pioneer establish an even stronger brand name and enabling the venture to move customers’ ideal points closer to the pioneer’s attribute mix. Further, increasing lead time provides pioneers with the opportunity to broaden their product line, and can return superior profits to the venture which enables them to better prepare for new battles. Longer lead times also provide an opportunity to increase share while charging premium prices. The pioneer may also achieve cost advantages in the short- and long-run via the experience curve. These cost advantages have the effect of putting later entrants at a distinct competitive disadvantage. Pioneers may also be able to erect barriers that virtually lock out followers, further increasing lead time and its commensurate advantages. Therefore, the market momentum supported by lead time helps pioneers maintain significant advantages. However, if lead time is short, there is less opportunity to fully develop and exploit these advantages which, of course, diminishes the advantages of early entry. Hence, it is argued that venture capitalists’ assessment of profitability increases with earlier entry. Further, this increase will vary as a function of lead time.

Competitive Rivalry:-

Competitive intensity usually reduces overall industry profitability while concurrently reducing pioneering advantages developed through lead time. In other words, competition can quickly erode any advantages gained by a pioneer and creates pressures to respond both strategically and tactically. Often this will result in a reduction in prices and, in turn, profitability. In contrast, when competitive rivalry is low, the pioneering advantages developed during lead time are likely to be more sustainable.

Educational Capability:-

There is often considerable uncertainty about the rate at which customers will substitute new technology for old. A pioneer’s potential customers often lack a frame of reference for understanding a new product concept and its benefits. A frame of reference needs to be constructed in order to encourage new thinking and substitution on the part of potential customers. They need to be informed and persuaded that the benefits of purchase are greater than the risks. In terms of time, as well as financial and human resources, a customer’s frame of reference can be difficult and costly to alter.

Industry-related Competence:-

Success is more likely to be achieved by those entering an industry in which the experience of the management team is relevant to the endeavor. It’s found successful founders of start-up firms had related backgrounds in rapid growth firms that often competed in the same industry. Opportunities are likely to be less clear and may not be fully exploited by the uninitiated or may occur too rapidly to be grasped and capitalized on by industry “outsiders”. The successful new ventures must possess the requisite skills a priori.


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