For this blog post, we asked Peter G. Klein to reflect on his article “Opportunity discovery, entrepreneurial action, and economic organization” which was published in the Strategic Entrepreneurship Journal in 2008 and which won the SEJ Best Paper Prize in 2018. In this post, Peter not only summarizes the main idea of his piece, but also recounts how the idea of entrepreneurial judgment emerged in the first place.
by Peter G. Klein
I began my career as an industrial organization economist with little knowledge of the modern entrepreneurship literature. I was trained at Berkeley in the late 1980s and early 1990s by Oliver Williamson, focusing on corporate governance and organizational economics. I was particularly interested in how large firms manage information flows and provide incentives, especially in rapidly changing environments. Eventually I drifted into strategy and entrepreneurship, partly from dissatisfaction with static, equilibrium models of firms and industries and partly from my interest in dynamic capabilities, Schumpeterian competition, and evolutionary and Austrian economics.
As I read more widely in the contemporary entrepreneurship literature, I became aware that Israel Kirzner’s concept of entrepreneurship as the discovery of previously unexploited profit opportunities was extremely influential (as reflected, for example, in Shane and Venkataraman’s 2000 paper). However, the role of uncertainty—central to Frank Knight’s theory of profit—was neglected. If entrepreneurship is simply alertness, then once you recognize the thing to which you’re alert, then boom! You’ve got it! It seems hard to explain how entrepreneurs lose money.
Around 2001, Nicolai Foss and I were invited to contribute to a Festschrift in honor of Kirzner. We assumed that most of the participants would write about entrepreneurial discovery and we wanted to do something different. My wife, also a trained economist, reminded me that Kirzner wrote an interesting and underappreciated book on capital theory (Kirzner, 1966). There Kirzner argued, building on earlier work by Ludwig Lachmann (1956), that the nature and value of an asset or resource is determined not by its objective properties (size, weight, location, construction, technical capabilities), but by its imagined place in the subjective production plans of a forward-thinking entrepreneur. Kirzner’s capital theory seemed to provide a useful means of integrating the theory of the entrepreneur with transaction cost theories of the firm and resource-based approaches to competitive advantage, bodies of literature that had developed largely in isolation, despite much overlap in approach and subject matter. Developing and extending Kirzner’s capital theory led to the Festschrift chapter and two follow-up papers (Foss et al., 2007; Foss, Foss, and Klein, 2007) and, a few years later, to Foss’s and my 2012 book Organizing Entrepreneurial Judgment: A New Approach to the Firm (Cambridge University Press).
My 2008 SEJ article, “Opportunity Discovery, Entrepreneurial Action, and Economic Organization,” outlines what has come to be called the “judgment-based approach” to entrepreneurship which emphasizes action under Knightian uncertainty, rather than the discovery of preexisting profit opportunities, as the core entrepreneurial function. This paper received the SEJ Best Paper Prize in 2018 and has stimulated new research on uncertainty, resource assembly, and governance—issues central to strategic entrepreneurship.
The term judgment comes from Knight, who described judgment as decision-making under uncertainty that cannot be modeled or parameterized as a set of formal decision rules. Judgment is midway between the “rational decision-making” of neoclassical economics models and blind luck or random guessing. We sometimes call it intuition, gut feeling, or understanding. In a world of Knightian uncertainty, and heterogeneous capital resources with attributes that are subjectively perceived and unknowable ex ante, some agency must bear the responsibility of owning, controlling, deploying, and redeploying these resources in the service of consumer wants. That, in my formulation, is the role of the entrepreneur. The entrepreneur’s job is to combine and recombine heterogeneous capital resources in pursuit of profit (and the avoidance of loss). When the entrepreneur is successful in acquiring resources at prices below their realized marginal revenue products—i.e., when the entrepreneur exercises good judgment—she earns an economic profit. When her judgments are poor, she earns an economic loss. Competition among entrepreneurs (and those who provide financial capital to entrepreneurs) tends to steer ownership and control of productive resources toward those entrepreneurs with better judgment.
The judgment-based approach plays a distinct role in the current conversation and controversy about the nature of entrepreneurship research. The once-dominant opportunity-discovery perspective has come under fire from a variety of perspectives. Alvarez and Barney (2007) kicked off a lively debate by challenging the ontological status of entrepreneurial opportunities, arguing that opportunities are best understood as created, subjectively, rather than existing outside of entrepreneurial action. The judgment-based view goes a step further, arguing that the construct of opportunity itself is unnecessary at best, misleading at worst (Foss and Klein, 2020). Entrepreneurial action is seen as beginning with the entrepreneur’s interpretation of current (objective) conditions, his beliefs about possible future states of the world (e.g., a profitable product or venture), and his expectations and confidence in his ability to bring about that possible future. The entrepreneur then acts (or doesn’t act), with success or failure determined ex post, largely by objective factors.
In this formulation, there is simply no need for the opportunity construct. The discovery view mistakenly implies that opportunities exist independent of human belief and action. The creation view rightly emphasizes human belief and action, but implies that profit opportunities, once the entrepreneur has conceived or established them, somehow come into being. I see entrepreneurship is a creative process but say that what entrepreneurs create (or attempt to create) are not opportunities, but new firms, new products, or new markets. When they are successful, their efforts may be recast after the fact in opportunity language. But little or no additional insight is produced by doing so (Foss and Klein, 2016). Moreover, it is extremely awkward to describe entrepreneurial failure—financial loss, bankruptcy, or other forms of unintentional exit—in opportunity language.
I see much of my recent work as an attempt to convince entrepreneurship scholars to make action, not opportunities, the unit of analysis for entrepreneurship research, teaching, and outreach. An action-theoretic perspective helps us (and our students and consulting clients) to re-member that action always takes place under conditions of uncertainty (even for mundane activities in established industries!). The language of opportunity may also encourage overconfidence, by mistakenly conveying the idea that the results of entrepreneurial action exist ex ante, before profits and losses are realized, either because these results were there waiting to be discovered, or because the entrepreneur created them through an act of will.I am happy that the 2008 paper has achieved some influence and glad that it appeared in SEJ, as a complement to related approaches that tie entrepreneurship to ownership, resources, and strategy.