THEORIES OF ENTREPRENEURSHIP

Innovation Theory of Schumpeter

Author- Joseph Alois Schumpeter, one of the greatest economists
• According to Schumpeter, entrepreneurs take the stationary economy to a new
level of development by adding innovation and creativity of their own.
Schumpeter also stated that entrepreneurs bring innovation in two ways
namely:
• By reducing the cost of production
• By increasing the demand for certain products
Under this theory, an entrepreneur could earn economic profits by introducing
successful innovations.
In other words, innovation theory of profit posits that the main function of an
entrepreneur is to introduce innovations and the profit in the form of reward
is given for his performance.
Schumpeter defines entrepreneurship as “a creative activity”. The
entrepreneur is viewed as the ‘engine of growth’
• The concept of innovation and its corollary development embraces five
functions:
i. The introduction of a new product with which consumers are not yet
familiar or introduction of a new quality of an existing product,
ii. The introduction of new method of production that is not yet tested
by experience in the branch of manufacture concerned, which need by
no means be founded upon a discovery scientifically new and can also
exist in a new way of handling a commodity commercially,
iii. The opening of new market that is a market on to which the particular
branch of manufacturer of the country in question has not previously
entered, whether or not this market has existed before,
iv. Conquest of a new source of supply of raw material and
v. The carrying out of the new organization of any industry.
• According to Schumpeter, innovation refers to any new policy that an
entrepreneur undertakes to reduce the overall cost of production or
increase the demand for his products.
• Thus, innovation can be classified into two categories;
1. The first category includes all those activities which reduce the overall cost
of production such as the introduction of a new method or technique of
production, the introduction of new machinery, innovative methods of
organizing the industry, etc.
2. The second category of innovation includes all such activities which
increase the demand for a product, such as the introduction of a
new commodity or new quality goods, the emergence or opening
of a new market, finding new sources of raw material, a new
variety or a design of the product, etc.
• The innovation theory of profit posits that the entrepreneur gains
profit if his innovation is successful either in reducing the overall
cost of production or increasing the demand for his product.
• Schumpeter is the first major theorist to put the human agent at
the centre of the process of economic development. He is very
explicit about the economic function of the entrepreneur.
• The entrepreneur is the prime mover in economic development; his
function, to innovate or carry out new combinations.
• Schumpeter makes a distinction between an innovator and an
inventor. An inventor discovers new methods and new materials.
On the contrary, an innovator is one who utilizes or applies
inventions and discoveries in order to make new combinations. An
inventor is concerned with his technical work of invention whereas
an entrepreneur converts the technical work into economic
performance. An innovator is more than an inventor because he
does not only originate as the inventor does but goes much farther
in exploiting the invention commercially.
• Often, the profits earned are for a shorter duration as the competitors
imitate the innovation, thereby ceasing the innovation to be new or
novice.
• Earlier, the entrepreneur was enjoying a monopoly position in the
market as innovation was confined to himself and was earning larger
profits.
• But after some time, with the others imitating the innovation, the
profits start to disappear.
• An entrepreneur can earn larger profits for a longer duration if the law
allows him to patent his innovation.
• Such as a design of a product is patented to discourage others to imitate
it.
• Over the time, the supply of factors remaining the same, the factor prices
tend to rise as a result of which the cost of production also increases.
• On the other hand, with the firms adopting innovations the supply of
goods and services increases and their prices fall.
• Thus, on one hand the output per unit cost increases while on the other
hand the per unit revenue decreases.
 CRITICISM OF INNOVATION THEORY
• The innovation theory of profits has been criticized on the following
grounds;
1. It ignores the element of uncertainty.
2. In addition to innovations, there are many other factors which
give rise to profits.
3. In modern enterprises, it is the entrepreneur who bears the risk,
not the capitalist as Professor Schumpeter believes.
4. The innovation theory does not take into consideration the
element of uncertainty as an important factor giving rise to
profits. As pointed by Prof. Knight the main emphasis should
be placed on uncertainty and not on innovation because even
in absence of innovations, the entrepreneur would be able
to earn profits if he can predict the future with a fair degree
of certainty in so far as the changes in the demand and
supply conditions are concerned.
5. Besides innovations, there are several other factors which
give rise to profits, for e.g.- existence of monopoly, chance
profits etc.
6. The theory also does not consider profits as the reward for risk taking.
According to Prof. Schumpeter, "The entrepreneur is never the risk
bearer. The one who gives credit (loan) comes to grief if the
undertaking fails." This, however, is not correct, for we know that in the
modern industrial organization, it is the entrepreneur and not the
capitalist who bears the entire risk of business.
7. Lastly, it has also been said that the function of the entrepreneur is not
only to introduce innovations but also to organize the business in the
most efficient manner by coordinating the activities of the various
factors of production. As such, profits are not exclusively due to
innovations but also due to the superior organizational ability of the
entrepreneur.
Need for Achievement Theory of McClelland/
McCLELLAND’S PSYCHOLOGICAL THEORY
• According to McClelland the characteristics of entrepreneur has two
features - first doing things in a new and better way and second
decision making under uncertainty.
• McClelland emphasizes achievement orientation as most important
factor for entrepreneurs. Individuals with high achievement
orientation are not influenced by considerations of money or any
other external incentives.
• Profit and incentives are merely yardsticks of measurement of success
of entrepreneurs with high achievement orientation. People with high
achievement are not influenced by money rewards as compared to
people with low achievement.
• The latter types are prepared to work harder for money or such other
external incentives. On the contrary, profit is merely a measure of
success and competency for people with high achievement need.
• Professor David McClelland, in his book The Achieving Society, has
propounded a theory based on his research that entrepreneurship
ultimately depends on motivation.
• It is the need for achievement (N-Ach), the sense of doing and getting
things done, that promote entrepreneurship.
• According to him, N-Ach is a relatively stable personality characteristic
rooted in experiences in middle childhood through family socialisation
and child-learning practices which stress standards of excellence,
material warmth, self-reliance training and low father dominance.
• According to him a person acquires three types of needs as a result of one’s life
experience. These three needs are:
i. Need for Achievement. A drive to excel, advance and grow.
ii. Need for Power. A drive to dominate or influence others and situations.
iii. Need for Affiliation. A drive for friendly and close inter-personal relationships.
• McClelland found that certain societies tended to produce a large percentage of
people with high achievement. He pointed out that individuals, indeed whole
societies that possess N-ach will have higher levels of economic well-being than
those that do not.
• McClelland’s work indicated that there are five major components to the N-ach
trait:
(a) responsibility for problem solving,
(b) setting goals,
(c) reaching goals through one’s own effort,
(d) the need for and use of feedback, and
(e) a preference for moderate levels of risk-taking.
• The individual with high levels of need achievement is a potential
entrepreneur. The specific characteristics of a high achiever
(entrepreneur) can be summarized as follows:
(i) They set moderate realistic and attainable goals for them.
(ii) They take calculated risks.
(iii) They prefer situations wherein they can take personal
responsibility for solving problems.
(iv) They need concrete feedback on how well they are doing.
(v) Their need for achievement exist not merely for the sake of
economic rewards or social recognition rather personal
accomplishment is intrinsically more satisfying to them
• According to McClelland, motivation, abilities and congenial
environment, all combine to promote entrepreneurship.
• Since entrepreneurial motivation and abilities are long run sociological
issues; he opined it is better to make political, Social and economic
environments congenial for the growth of entrepreneurship in
underdeveloped and developing countries.
 MAX WEBER’S THEORY OF ENTREPRENEURIAL GROWTH
OR MAX WEBER’S THEORY OF SOCIAL CHANGE

• Max Weber in his theory says religion has a large impact on entrepreneurial
development.
• According to Weber, some religions have basic beliefs to earn and acquire
money and some have less of it.
• He calls them a ‘spirit of capitalism’ and ‘adventurous spirit’.
• The spirit of capitalism will be generated when mental attitude in the society
is favorable to capitalism.
• According to Max Weber, driving entrepreneurial energies are
generated by the adoption of exogenously-supplied religious beliefs.
• It is these beliefs which produce intensive exertion in occupational
pursuits, the systematic ordering of means to ends, and the
accumulation of assets.
• His theory suggests the belief systems of Hinduism, Buddhism ad Islam
do not encourage entrepreneurship. His stand has been challenged by
many sociologists.
 Criticisms of the Theory
• It is unrealistic and invalid assumptions
• It has been found empirically invalid
• Many sociologist criticized Max weber on his view by saying that the
rapid expansion of entrepreneurship in India in the post independence
period disproves that Hinduism is averse to the spirit of capitalism and
to adventurous spirit
• The view on protestant ethics were also not completely correct
• Capitalism has flourished in regions where protestant ethics is not
present.
The Uncertainty (Risk) Bearing Theory of
Knight
A key element of entrepreneurship is risk bearing. Prof. Knight and
John Staurt Mill saw risk-bearing as the important function of
entrepreneurs. Some important features of this theory are as follows:
Risk creates Profit: According to the risk-bearing theory, the
entrepreneur earns profits because he undertakes risks. (non insurable
risk and uncertainties)
More Risk More Gain: The degree of risk varies in different industries.
Entrepreneurs undertake different degrees of risk according to their
ability ad inclination. The risk theory proposes that the more risky the
nature of business, the greater must be the profit earned by it.
• The certain risk that are measurable and the probability of such risk
can be statistically estimated and hence risk can be insured.
• The certain risk that are not measurable and the probability of such
risk cannot be statistically estimated and hence risk can be non
insured like change in prices , demand & supply
• Uncertainty-bearing is one of the most vital functions in a dynamic
economy
• The existence of uncertainty tends to raise the minimum supply price.
Silent points of theory
• According to the theory, the entrepreneur earns pure profits for
bearing the uncertainty.
• The probability of uncertainty or non-insurable risks cannot be
statistically estimated.
• Entrepreneurs undertake risks of varying degrees according to their
ability ad inclination. The theory suggests that the more risky the
nature of enterprise, the higher level of profit earned by the
entrepreneurs.
• Profit is the reward of the entrepreneur for bearing uncertainties and
risks. Hence, it should be a part of the normal cost
• The reward of the entrepreneur is uncertain entrepreneur
guarantees Interest to lender of capital, land etc
• The level of uncertainty in business can be reduced by applying the
techniques of consolidation. The total level of uncertainty can be
reduced by pooling individual instances
 Criticisms
F.H. Knight's theory is one of the most sophisticated theories to explain supply of
entrepreneurship based on profit. But, the theory suffers from certain drawbacks as
pointed by the critics.
• The role of an entrepreneur has not been elaborately provided by the theory. The
entrepreneur's activity has been restricted to uncertainty bearing. Modern business
activities are different. Often, there is a dichotomy between ownership and
management. These factors have not been taken into consideration.
• The uncertainty-bearing theory discussed the concept of profit in a vague way. The
exact estimation of profit for the entrepreneur has not been provided in the theory.
• Profit as a residual income of the entrepreneur has been criticized.
• Critics feel that uncertainty-bearing should not be treated like other factors of
production like land, labour and capital. It is a psychological concept and should be
treated in a different manner.
 X-EFFICIENCY THEORY
AUTHOR- Harvey Leibenstein American economist
The author developed X-efficiency theory in the 1960s. He views
entrepreneurs as gap-fillers and input complementors.
Many firms face the problem of inefficient utilization of various inputs or
resources.
Innovative Entrepreneurs come forward to check inefficiencies in the
utilization of resources through novel ways.
According to Harvey Leibenstein the most significant feature of
entrepreneurship is GAP FILLING.
It is the job of the entrepreneur to fill the gap or correct the deficiencies
which always exist in the knowledge about production function, i.e.
utilization of various resources.

An entrepreneur has to marshal all inputs to achieve efficiency and

economy.
 TRAIT THEORY OF ENTREPREUNERSHIP

Author- F A Walker
The trait, theory holds that entrepreneurship developed because the
individuals called entrepreneur possessed certain specific traits or
characteristics or competencies which made them capable of
generating new ideas and creating a new venture.
An entrepreneur is a pioneer, a leader and a captain of the firm.
The Profit an entrepreneur gets depends on his efficiency and super
talents.
To be successful, as an entrepreneur, an individual must possess certain
traits or characteristics of personality like creativity, innovative skills, self
confidence, risk taking, imagination, Perseverance, foreseeability, etc.
 Hoselitz Sociological Theory
Hoselitz (1964) argued that entrepreneurship can develop in a society
when its culture permits a variety of choices and where social
processes are not rigid and in a situation which encourages
development of personalities interested in enterprise.
Such groups are ambiguous and make creative judgments and genuine
innovations.
History reveals that leading entrepreneurs have emerged from a
particular socio-economic classes such as Marwaris and Parsees in India
Hagen (1968) conducted a study of origin and background of
entrepreneurs in several countries. He found that entrepreneurs have
emerged from certain specified communities and castes. He also said
entrepreneurship arises because of social changes. Social changes may
cause loss in status of certain groups.
 KUNKEL THEORY OF SOCIAL BEHAVIOUR

According to Kunkel, Individuals perform various activities of which

some are accepted by the society while others are not.
The accepted are rewarded. The rewards act as reinforcing stimulus
increasing the probability of repeating that behaviour pattern. This
pattern of social behaviour is entrepreneurial behaviour.
The supply of entrepreneurship depends upon four structures found in a society.
That are as follows:
(i) Limitation Structure – The society limits specific activities and this limitation
structure affects all the members (including entrepreneurs) of a society.
(ii) Demand Structure- Material rewards are necessary to lay the foundation for
future social gains. Moreover, behaviour of people can be made entrepreneurial
by manipulating certain selected components of the demand structure.
(iii) Opportunity Structure – It consists of the availability of capital, management
and technological skills, information concerning production methods, labour and
markets.
(iv) Labour Structure – It is concerned with the supply of competent and willing
labour. The supply of labour is governed by several factors such as available
alternative means of livelihood, traditionalism and expectations of life.
CRITICAL EVALUATION:
The theory assumes the ideal structures for the supply of entrepreneurs.
But, generally, there is discrepancy between objectives, structures and
the actual incidence of entrepreneurs. It is due to the fact that there are
inadequate or incorrect perceptions attached with these perceptions. In
practice, entrepreneurship is also governed by the specific combinations
of circumstances which are generally not available in the environment.
 ECONOMIC THEORY OF ENTREPRENEURSHIP
• Many economists revealed that entrepreneurship and economic
growth will take place in those circumstances where particular
economic conditions are in favor of the business environment.
• The main advocates of this theory were G.F. Papanek (1962) and J.R.
Harris(1970).
• According to them, economic incentives/economic factors are the
main forces for entrepreneurial activities in any country.
• This theory holds that when economic conditions are favorable,
then entrepreneurship develops at a faster rate and come forward
to establish new ventures and bring resources, labor, materials and
other assets and put them together to increase their wealth.
• There are a lot of economic factors which promote or demote
entrepreneurship in a country. These factors are –
(a) The availability of bank credit .
(b) High capital formation with a good flow of savings and investments.
(c) Supply for funds(loan) with a lower rate of interest.
(d) Increased demand for consumer goods ad services
(e) Availability of productive resources.
(f) Efficient economic policies like fiscal ad monetary policies.
(g) Communication and transportation facilities