Chapter 2:Theories of entrepreneurship

Objectives
• Describe the historical perspectives of entrepreneurship.
• Point out economical, sociological and psychological view on the emergence of
entrepreneurship.
• Understand various theories of entrepreneurship propounded by various eminent authors.
• Focus on various multitudes of factors which influence entrepreneurship.
• Study and analyze global impact of entrepreneurship.
• Explain and correlate various theories from your own point of view.
• Understand Entrepreneurship as multi dimensional concept
 Historical Perspectives on Entrepreneurship

The distinctive features of entrepreneurship over the years are:

• Innovation
• A Function of high achievement
• Organisation building
• Group level activities
• Managerial skills and leadership
• Gap filling activity
• Entrepreneurship – An emerging class.
 Different Opinion on Emergence of Entrepreneurship
Entrepreneurship is complex in its content, it is influenced by not only economical
aspects, but also by sociological, psychological, ethical, religious and cultural
values. There are different opinions on the emergence of entrepreneurship. These
opinions may be classified into three categories:
• Economist’s view
• Sociologist’s view
• Psychologist’s view
…….Continued
 Economist’s view
G.F. Papanek and J.R. Harris are the main advocates of this theory.
According to economists entrepreneurship and economic growth will take place in those situations
where particular economic conditions are most favourable.
Economic incentives are the main drive for the entrepreneurial activities. They firmly believe that
a well developed market and efficient economic policies foster entrepreneurship in a big way.
In the view of an economist, economic incentives are the main drive for the entrepreneurial
activities. In some cases, it not so evident, but the persons inner drives have always been
associated with economic gains. Therefore, these incentives and gains are regards as the sufficient
conditions for the emergence of industrial entrepreneurship. When an individual recognizes that
the market for a product or service is out of equilibrium, he may purchase or produce at the
prevailing price and sell to those who are prepared to but at the highest price. Lack of
entrepreneurship is due to various kinds of market imperfections and inefficient economic policies
 Sociologist’s View
Sociologists argue that entrepreneurship is most likely to emerge under a specific social culture.
According to them social sanctions, cultural values and role expectations are responsible for the
emergence of entrepreneurship. Social-cultural values channel economic action that gives birth to
entrepreneurship.
According to Weber religious beliefs produce intensive exertion in· occupational pursuits, the
systematic ordering of means to end, and the accumulation on assets. It is these beliefs, which
generate a drive for entrepreneurial growth.
Hoselitz suggests that culturally marginal groups promote entrepreneurship and economic
development. Such groups, because of their ambiguous position are peculiarly suited to make
creative adjustments and thereby develop genuine innovations.
Psychologist’s View

According to Psychologists, entrepreneurship is most likely to emerge when a society has

sufficient supply of individuals possessing particular psychological characteristics. The
main characteristics are:
• an institutional capacity to see things in new way (vision),
• energy of will and mind to overcome fixed habits of thought.
• an urge to do something.
• to fulfil a dream.
• The capacity to withstand social opposition.
• the high need for achievement.
 Psychologist’s View
Different people have stressed on the psychological aspects as contributing to entrepreneurial
success are Joseph Schumpeter, McClelland, Hagen and Kunkal. The main focus of these theories
is as follows:
Schumpeter believes that entrepreneurs are primarily motivated by an atavistic will to power, will
to find a private kingdom or will to conquer.
According to McClelland it is the high need for achievement which drives people towards
entrepreneurial activities. This achievement motive is inculcated through child rearing practices,
which stress standards of excellence, material warmth, self-reliance training. Individuals with high
achievement motive tend to take keen interest in situations of high rest, desire for responsibility
and a desire for a concrete measure of task performance.
Hagen considers withdrawal of status respect as the trigger mechanism for changes is personality
formation. Status withdrawal is the perception on the part of the members of some social group
that their purposes and values on life are not respected by groups in the society whom they respect
Hagen identifies four types of events that coven produce status withdrawal
 Theories of Entrepreneurship
There are different theories of entrepreneurship propounded by the different eminent
social thinkers:
1. Innovation Theory of Schumpeter
2. Need for Achievement Theory of McClelland
3. Leibenstein’s X-efficiency Theory
4. Risk Bearing Theory of knight.
5. Max Weber’s Theory of Entrepreneurial Growth
6. Hagen’s Theory of Entrepreneurship
7. Thomas Cochran’s Theory of Cultural Values
8. Theory of Change in Group Level Pattern
9. Economic Theory of Entrepreneurship
10. Exposure Theory of Entrepreneurship.
11. Political System Theory for Entrepreneurial Growth.
 Innovation Theory of Schumpeter

According to Schumpeter entrepreneurship is the catalyst that disrupts the stationary

circular flow of the economy and thereby initiates and sustains the process of development.
Embarking upon ‘new combinations’ of the factors of production - which he succinctly
terms, innovation.
Schumpeter introduced a concept of innovation as key factor in entrepreneurship in
addition to assuming risks and organizing factors of production.
Schumpeter defines entrepreneurship as “a creative activity”. An innovator who brings new
products or services into economy is given the status of an entrepreneur. He regards
innovation as a tool of entrepreneur.
Note: The entrepreneur activates the economy to a new level of development.
 Continued
The concept of innovation and its corollary development embraces five functions:
• The introduction of a new product with which consumers are not yet familiar or introduction of a
new quality of an existing product
• 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
• 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.
• Conquest of a new source of supply of raw material.
• The carrying out of the new organization of any industry.
• Expansion of goods, products.
• Productivity of factors of production such as finance, labour, material.
• Innovation in production such as, technology, process changes and increase in human resource
productivity.
• Innovation in marketing area such as the composition of the market, size of the market and new
markets.
Continued
 Continued
According to Schumpeter, the entrepreneur is the prime mover in economic development; his
function is 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 whereas 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.
Note: 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.
 Limitation of the Innovation Theory of Schumpeter
It can be noted that this theory’s main figure, the “innovating entrepreneur” has played an
important role in the rise of modem capitalism.
The entrepreneur has been the prime mover - for economic development process.
This theory seems one-sided as it puts too much emphasis on innovative functions thus ignoring
the risk taking and organizing aspects of entrepreneurship.
An entrepreneur has not only to innovate but also assemble the resources and put them to
optimum use. While stressing upon the innovative function of the entrepreneur, Schumpeter
ignored the risk-taking function, which is equally important. When an entrepreneur develops a
new combination of factors of production, there is enough risk involved.
 Need for Achievement Theory of McClelland

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. He
further explains that it is the need for achievement (N-Ach), the sense of doing and getting things
done, that promote entrepreneurship.
Individuals with high achievement orientation are not influenced by considerations of money or
any other external incentives. 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.
According to him, N-Ach is a relatively stable personality characteristic rooted in experiences in
middle childhood through family socialization and child-learning practices which stress standards
of excellence, material warmth, self-reliance training.
 Continued

According to him a person acquires three types of needs as a result of one’s life experience. These
three needs are:
• Need for Achievement. A drive to excel, advance and grow.
• Need for Power. A drive to dominate or influence others and situations.
• Need for Affiliation. A drive for friendly and close inter-personal relationships.
 Major components to the N-ach trait

• Responsibility for problem solving,

• Setting goals,
• Reaching goals through one’s own effort,
• The need for and use of feedback,
• A preference for moderate levels of risk-taking.
Characteristics of a high achiever (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.

Note: The individual with high levels of need achievement is a potential entrepreneur
Leibenstein’s X-Efficiency Theory
Basically, X-efficiency is the degree of inefficiency in the use of resources within the firm:
it measures the extent to which the firm fails to realize its productive potential.
According to Leibenstein, when an input is not used effectively the difference between the
actual output and the maximum output attributable to that input is a measure of the degree
of X-efficiency.
Leibenstein identifies two main roles for the entrepreneur:
(i) A gap filler. If not all factors of production are marketed or if there are imperfections
in markets, the entrepreneur has to fill the gaps in the market .
(ii) An input completer. This involves making available inputs that improve the efficiency
of existing production methods or facilitate the introduction of new ones.
Note: X-efficiency arises either because the firm’s resources are used in the wrong way or
because they are wasted, that is, not used at all.
…..Continued
 ……Continued
The theory concludes that an entrepreneur has to act as gap filler and an input completer
if there are imperfections in markets.
According to him there are two types of entrepreneurship.
(i) Routine entrepreneurship – This type of entrepreneurship deals with normal
business functions like coordinating the business activities.
(ii) Innovative entrepreneurship – This is where an entrepreneur is innovative in his
approach. It includes the activities necessary to create an enterprise where not all the
markets are well-established or clearly defined.
 Risk Bearing Theory of Knight
A key element of entrepreneurship is risk bearing.
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.

More Risk More Gain: The degree of risk varies in different industries. Entrepreneurs undertake
different degrees of risk according to their ability and inclination. The risk theory proposes that
the more risky the nature of business, the greater must be the profit earned by it.

Profit as Reward and Cost: Profit is the reward of entrepreneur for assuming risks. Hence, it is
also treated as a part of the normal cost of production.
 ……Continued

Entrepreneur’s Income is Uncertain: He identifies uncertainty with a situation where the

probabilities of alterative outcomes cannot be determined either by a priori reasoning or by
statistical inference. This theory summarizes that profit is the reward of an entrepreneur
effort which arises for bearing non insurable risks and uncertainties and the amount of profit
earned depends upon the degree of uncertainty bearing. Knight argues that business
enterprises the level of uncertainty can be reduced through ‘consolidation’. Consolidation is
to uncertainty is what insurance is to risk; it is a method of reducing total uncertainty by
pooling individual instance. The elasticity of the supply of self confidence is the single most
important determinant of the level of profit and the number of entrepreneurs.
 Max Weber’s Theory of Entrepreneurial Growth

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.
Max Weber refer to them as a ‘spirit of capitalism’ and ‘adventurous spirit’. The spirit of
capitalism will be generated when mental attitude in the society is favourable 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.
Max Weber’s Theory
 Assumptions of Max Weber’s Theory

• There is a single system of Hindu value,

• The Indian community internalised those values and translated them to day-to-day
behavior.
• These values remained immune to and insulated against external pressures and change.
The rapid growth of entrepreneurship in India since independence proves that Hinduism
is not averse to the spirit of capitalism and to adventurous spirit.
Note: But it has been criticised by subsequent researchers. The theory is based on the
invalid assumptions,
 Hagen’s Theory of Entrepreneurship
Hagen has attributed the withdrawal of status respect of a group to genesis of entrepreneurship.
Hagen considers the withdrawal of status, of respect, as the trigger mechanism for changes in
personality formation. Status withdrawal occurs when members of some social group perceive
that their purposes and values in life are not respected by the groups in the society they respect,
and whose esteem they value.
Types of events which can produce status withdrawal:
• Displacement of a traditional elite group from its previous status by another traditional supply
physical force.
• Denigration of valued symbols through some change in the attitude of the superior group.
• Inconsistency of status symbols with a changing’ distribution of economic power.
• Non-acceptance of expected status on migration to a new society.
…….Continued
Hagen further postulates that withdrawal of status respect would give to four possible reactions
and create four different personality types:
• Retreatist: Entrepreneur who continues to work in society but remains indifferent to his work
or status.
• Ritualist: One who works as per the norms in the society hut with no hope of improvement in
the working conditions or his status.
• Reformist: One who is a rebellion and tries to bring in new ways of working and new society.
• Innovator: An entrepreneur who is creative and try to achieve his goals set by himself.
Note: According to Hagen (1962), the creativity of a disadvantaged minority group is the main
source of entrepreneurship. He developed this thesis from the case of the samurai community of
Japan. Traditionally, this community had enjoyed a high status of which it was deprived later. To
regain this lost prestige, it became more active and vigorous and gave rise to many entrepreneurs.
Thomas Cochran’s Theory of Cultural Values

The key proportions in Thomas Cochran’s theory are cultural values, role expectations and social
sanctions.
According to him, the entrepreneur represents society’s model personality. His performance is
influenced by the factors of his own attitudes towards his occupation, the role expectations held
by sanctioning groups, and the operational requirements of the job. The determinants for the first
two factors are the society’s values. Changes over time in such variables as population,
technology, and institutional drift will impinge on the role structure by creating new operational
needs. In most countries, entrepreneurs have emerged from a particular socio-economic class.
The Protestant ethic of the West is said to have contributed to the emergence of a new class of
industrialists. It can be noted that various communities and castes like samurai in Japan, family
pattern in France, Yoruba in Nigeria, Kikuya in Kenya, Christians in Lebanon, Halai Memon
industrialists in Pakistan, Parsees, Marwaries and Gujaratis in India have been the sources of
entrepreneurship
 Theory of Change in Group Level Pattern:
Young defines entrepreneurs as that the entrepreneur characteristics are found in small groups
wherein individuals develop as entrepreneurs.
Young’s theory is a theory of change based on society’s incorporation of reactive subgroups. A
group becomes reactive when the following three conditions coincide:
• When denied of access to important social networks
• When a group experiences low ‘status recognition; and
• When the group has better institutional resources than other groups in the society at the same
level.
Young arrived at the group level pattern behavior entrepreneurs based on his studies known as
Thematic Appreciation Test (TAT) on groups of entrepreneurs. The test revealed’ the tendency to
describe the situation as a problem to be solved, an awareness of pragmatic effort required,
confidence in their own ability to solve the problem and a tendency to take the viewpoint of each
individual in turn and analyse the situation as he might see it before suggesting an outcome.
Economic Theory of Entrepreneurship
The main advocates of this theory were Papanek and Harris.
According to them they believe that entrepreneurship and economic growth will take place in
those circumstances where particular economic conditions are in favour of the business
environment.
They further state that economic incentives are the main forces for entrepreneurial activities in
any country. There are a lot of economic factors which promote or demote entrepreneurship in a
country and these factors include:
• The availability of bank credit
• High capital formation with a good flow of savings and investments
• Supply for loanable funds with a lower rate of interest.
• Increased demand for consumer goods ad services
• Availability of productive resources.
• Efficient economic policies like fiscal ad monetary policies
• Communication and transportation facilities
 Exposure Theory of Entrepreneurship

This theory states that it is the exposure to new ideas and opportunities towards creativity
and innovation which leads to creation of a new venture.
It is also the differential responses of the social groups to opportunities provided by the
commitment of the political system to industrialization that has led the process of
entrepreneurial spread.
There is adequate empirical evidence to prove its validity. ‘Tripathi has observed that
exposure to new ideas and values were the common factor between Parsi and Hindu
entrepreneurs, which led them to entrepreneurship. Education has played very significant
role in exposing the Indian entrepreneurs to Western ideas leading them to
entrepreneurship.
…….Continued
 Political System Theory of Entrepreneurial Growth:
The commitment of political system can contribute significantly towards entrepreneurial
development.
Political system can create adequate infrastructure, favourable laws, favourable taxation system
and procedures, provide incentives and subsides, security to entrepreneurs, create promoting
policies and can encourage people towards entrepreneurship.
 socia1, economic, political and cultural factors that stimulate
entrepreneurial activity

• An increasing focus on capital formation.

• The ability to transform scientific and technical developments through new institutional
development.
• The supportive government programmes.
• Availability of required training and inputs.
• A collaborative relationship between business and research and their direct attempts to transfer
technology to the market place will be an opportunity for entrepreneurs who commercialise their
ideas
• Finally, an endeavour to create an environment conducive to innovation will provide a much-
needed stimulant to entrepreneura1 activities.