The question “why are some entrepreneurs more innovative than others” implicitly assumes that entrepreneurs differ in terms of the degree and type of novelty they introduce to the economy. This simple starting point is consistent with current thinking about entrepreneurship and is likely to be a basis for consensus (Aldrich 1999; Cliff et al. 2006; Davidsson 2005; Low and Abrahamson 1997; Shane 2000).Footnote 1 However, asking this question also implies that innovation cannot generally be the defining element of entrepreneurship. For the purpose of this study, instead of defining entrepreneurship on the basis of innovation, I define it as the introduction of new economic activity (Herbert Simon in Sarasvathy 1999; Davidsson 2005). This includes both the introduction of innovation to the marketplace, as well as entering as a new imitative competitor. In particular, the analysis focuses on nascent entrepreneurs who initiate serious activities that are intended to culminate in a viable business start-up (Aldrich 1999).
Innovation is a subjective concept and whether some activity qualifies as innovative or not depends on the perspective of the observer. Obviously, the criteria for innovation become stricter when one zooms out from a micro to a macro perspective and the “right perspective” is in essence determined by the question one is asking. From an economic point of view, a product, service or production process does not need to be new to the world to have economic impact. Instead, it is sufficient if the innovation is new to the market under scrutiny. This market perspective is also the relevant perspective for the individual deciding about whether to start a business and which opportunity to pursue: When making judgments about the expected payoffs of the venture, the individual only needs to be concerned about the competitive factors that directly affect her. For example, someone trying to start a Turkmenian restaurant in Kansas City only needs to be concerned about the expected competition from other restaurants in Kansas City and the needs and wants of customers in that region, whereas it is totally irrelevant for her expected payoff and her start-up decision how many restaurants there are in Turkmenistan and if Turkmenian food is new to people in other parts of the world.
Building upon this market-based perspective and the work of Picot et al. (1989) and Aldrich (1999), imitative nascent entrepreneurs can be defined as individuals trying to start a business in an established population whose routines, competencies, and offers vary only minimally, if at all, from those of existing organizations. They bring little or no incremental knowledge to the populations they enter and organize their activities in the same way as their predecessors. Innovative nascent entrepreneurs, by contrast, attempt to start firms whose routines, competencies or offers vary significantly from those of existing organizations in the particular market they enter. In the above example, the entrepreneur trying to start a Turkmenian restaurant in Kansas City would most probably qualify as innovative, whereas the same business idea in Turkmenistan would classify as imitative.
To discover the relevant factors that influence the distribution of innovative versus imitative business ideas, the specific properties that characterize and distinguish innovative and imitative business opportunities need to be considered. By definition, innovation requires novelty. Hence, innovative ideas are characterized by limited available information about the behavior of customers, potential competitors, or “how to make things work” in the first place. The innovator needs the courage to “conquer unknown territory”. Consequently, innovation involves Knightian uncertainty (Knight 1921) and risk for the potential entrepreneur.Footnote 2 In contrast, purely imitative business ideas take place in established markets. Performance of competitors and behavior of customers can be observed. Imitation can be triggered by an entrepreneur who observes the data and discovers that a profit opportunity has not been realized yet by other market participants due to asymmetric information or simply pure ignorance. At the extreme, this may imply risk free arbitrage (Kirzner 1973). However, imitative business ventures may also exhibit some degrees of financial and technological risk as well as uncertainty about the reaction of competitors to market entry—theses factors are obviously also relevant for innovative ventures. But the key distinction is that imitative business ideas lack the additional uncertainty and risk of novelty and discovery.
A judgment and decision making framework
Given this basic distinction between innovation and imitation, the answer to the question “Why are some entrepreneurs more innovative than others” basically boils down to two sub questions: (1) Why are some individuals more likely than others to choose alternatives with more risky and uncertain outcomes? (2) Where do these more risky and uncertain decision alternatives come from?Footnote 3
Schade and Koellinger (2007) suggested that a judgment and decision making framework can be used to answer the first sub question. Such a framework assumes different decision alternatives as externally given and analyzes factors that influence the individual choice for one over the other alternative(s). In principal, an individual can decompose the given alternatives of action into their components before making a decision. Only four types of information are needed (Connolly et al. 2000):
What are my possible courses of action? (Alternatives)
What are the events that might follow from those actions? (Outcomes)
What is the likelihood of each event? (Risk)
What is the value of each event to me? (Individual utility)
Given this information, a rational and individually optimal decision could be made. Of course, the main difficulty is that outcomes and probabilities are usually not directly observable. Instead, the decision maker needs to exercise judgments about cues perceived in the environment (such as the news, stock market movements or casual conversations with friends) to form an opinion or belief about expected outcomes and probabilities (such as what is the probability that my business idea will earn me a sufficient income). In practice, individuals vary significantly in their ability to perform sound judgments and in general, this process is often subject to a variety of systematic biases which lead to suboptimal judgments and decisions (Schade and Koellinger 2007).
When making a decision pro or contra to a risky or even an uncertainty course of action, such as starting a business or deciding about an innovative versus an imitative business idea, numerous factors are relevant. This includes, for example, preferences and opportunity costs (Hamilton and Harper 1994; Gifford 1992), the availability of financial resources (Evans and Leighton 1989), the individual tolerance for uncertainty (Knight 1921), as well as person- and situation-specific differences in subjective evaluations of how attractive alternative courses of action are (Schade and Koellinger 2007).
In particular, the basic distinction that innovation is inherently more risky and uncertain than imitation immediately leads to the presumption that innovative entrepreneurs should be more prone to accept risk and uncertainty than imitative entrepreneurs. Thus, hypothesis 1:
Innovative entrepreneurs are prone to accept higher levels of risk and uncertainty than imitative entrepreneurs.
Furthermore, the literature on descriptive decision making has shown that people’s propensity to engage in risky or uncertain activities varies relative to individually given (monetary) reference points. Thus, most individuals do not have stable risk and uncertainty preferences. Instead, their preferences vary depending on the circumstances they are in. The typical empirical patterns described by prospect theory for risky choices (Kahneman and Tversky 1979) also seem to apply to uncertain outcomes (Kilka and Weber 2001). Thus, an aversion to high risk and uncertainty is usually observed among individuals that are in a gain position relative to their individual reference point, whereas individuals in a loss position actually seek high risk and uncertainty. Applying this behavioral pattern to business start-up decisions would suggest that very innovative business ideas with high risk and uncertainty should be more likely to be pursued by individuals who have “nothing to lose”. This would include people with an income that is below average and unemployed individuals, leading to hypotheses 2 and 3:
Unemployed individuals are more likely to start innovative rather than imitative businesses.
Individuals with below average income are more likely to start innovative rather than imitative businesses.
In general, when exercising judgments about probabilities and outcomes, people often use simple heuristics (Gigerenzer and Todd 1999; Goldstein and Gigerenzer 2002) or intuitive optimization rules (Lévesque and Schade 2005) to guide their choices in situations that are characterized by risk and uncertainty. This can lead to decisions that are not necessarily optimal from a normative perspective (Kahneman and Tversky 1979; Fox and Tversky 1995; Thaler et al. 1997). In particular, innovative business ideas require people to make decisions based on very little evidence. Making decisions based on little evidence requires high levels of self-confidence. In fact, it is a characteristic of overconfident people (Shane 2003; Bernardo and Welch 2001; Cooper et al. 1995). Overconfidence is greatest for difficult tasks, for forecasts with low predictability, and for activities that lack fast and clear feedback (Fischhoff et al. 1977; Lichtenstein et al. 1982; Yates 1990; Griffin and Tversky 1992), all of which are particularly relevant for innovative business ideas. This suggests that innovative entrepreneurs should exhibit a higher level of confidence than imitative entrepreneurs, although this higher level of confidence might not be justified by their objective skills, abilities, and probabilities of success. This leads to hypothesis 4:
Individuals with a higher level of self-confidence are more likely to exploit innovative rather than imitative business opportunities.
At the macro level, prevailing wage levels, employment opportunities, taxes, business regulation, and unemployment benefits might influence the opportunity costs and expected returns to starting a business (Amit et al. 1995, van Stel et al. 2006, Acs et al. 2005). Furthermore, “soft” factors such as the social acceptance of entrepreneurship and potential failure might also be relevant. To the extent that these macro level factors are different across countries and fluctuate over time, e.g., in correspondence with the business cycle, we can expect that the distribution of innovative and imitative business opportunities pursued by nascent entrepreneurs will vary across countries and over time.
Where do business alternatives come from?
While the judgment and decision making framework helps us to analyze individual behavior when different alternative courses of action are given, it remains silent about where these decision alternatives or potential business opportunities come from. There are two possible answers to this question: Either, business opportunities objectively exist in the environment and just need to be perceived and recognized as such (Kirzner 1973), or they are created by the decision maker (Sarasvathy 2001; Schumpeter 1934). In reality, the perception of business opportunities might actually require both individual access to existing information in the environment and individual creativity. In addition, these two different sources of business opportunities require us to consider environmental and individual factors to explain the prevalence of innovative entrepreneurship.
Furthermore, it is important to recall that the degree of innovativeness of a business idea is a matter of perspective. From a market perspective, an individual does not necessarily need to be highly creative to come up with a business idea that is new to the market. Instead, whether individual creativity is required for innovation depends on the market environment: If markets are characterized by symmetric information and optimal individual behavior, creativity is a necessary condition for innovation because any improvement of the status quo will require the generation of new knowledge which can only be the result of individual creativity. However, if markets are characterized by information asymmetries or sub-optimal behavior of market participants, individual creativity is neither a necessary nor a sufficient condition for innovation: Individual creativity is not necessary because the recognition of and the optimal response to existing information can result in a means-ends framework that is new to the market. Individual creativity is also not a sufficient condition for innovation because the lack of relevant information might cause individuals to “re-invent the wheel” over and over again.
Summarizing the above arguments, it can be expected that the ability of an individual to perceive an innovative business idea is a function of the environment in which the individual is located and individual factors that influence creativity and the likelihood to perceive relevant information from the environment.Footnote 4
Factors influencing individual creativity and entrepreneurial alertness
The ability to invent and the ability to conceive new business opportunities will not necessarily coincide in one person. In fact, many inventors do not actively seek to patent or commercialize their work. Many of the most well-known inventors, however, were both inventive and entrepreneurial (Khan and Sokoloff 1993). Individual characteristics that are systematically associated with creativity and inventiveness are high intelligence, the ability to and the interest in abstract and theoretical thinking, and an unusual curiosity and enthusiasm for problems and general solutions (Root-Bernstein 1989). The ability to invent and to recognize innovative business opportunities obviously also requires mastery of the basic tools and operations in the field of invention, which suggests that systematic training and previous experience in a particular field are relevant (Shane 2000). However, there is evidence suggesting that previous knowledge and experience is a double-edged sword. For example, Shepherd et al. (2003) show that the decisions of venture capitalists first become better with increasing experience. Beyond a specific point, however, further gains in experience are associated with reductions in reliability and performance. Numerous others studies have also shown that individuals may also be too well trained or too experienced in a particular field to be truly inventive (Burnet 1968; Cliff et al. 2006; Delmar and Shane 2006). Indeed, highly inventive individuals often do not specialize in one particular field, they tend to be generalists and pursue two or three fields simultaneously, permitting them to cross boundaries and bring different perspectives to each (Root-Bernstein 1989).
More likely than not, these highly intelligent and curious individuals will seek higher education. To the extent that higher educational attainment is correlated with the above-mentioned characteristics such as intelligence, abstract thinking, curiosity, and a strong interest to find general solutions to problems, we can expect that higher educational attainment is associated with creativity but also with a higher probability to perceive innovative business ideas that are grounded on the inventions of others. Thus, hypothesis 5:
Individuals with high educational attainment are more likely to start innovative rather than imitative businesses.
Other individual-specific factors could also influence the individual likelihood to perceive innovative rather than imitative business ideas. Baron (2006), for example, points out that one reason why specific persons (and not others) perceive an innovative business opportunity could be that they possess an appropriate cognitive framework to recognize patterns in seemingly unrelated changes or events. In a similar spirit, Sarasvathy (2001) explains that the creation of radically innovative firms, in an industry that does not yet exist, calls for different strategies than those used for penetrating a predefined and well-structured market. Instead of selecting the optimal means to create a particular pre-defined effect (causation), such radical innovation may require to take a set of means as given and focus on selecting between possible effects that can be created with that set of means (effectuation). Thus, according to Sarasvathy’s effectuation theory, radical innovations are more likely to be the product of experimentation and chance than the product of strategic planning and optimization.
Factors influencing the existence of objective opportunities
In addition to creativity, which may enable individuals to come up with their own innovative business ideas, the discussion above also emphasized that opportunities for innovative entrepreneurial activity can objectively exist in the outside world.Footnote 5 Examples for such objective opportunities are the invention of new technologies that can be marketed or used to improve production processes, such as the Internet or genetically modified seeds.
The objective existence of business opportunities in general, whether they are innovative or imitative, is influenced by environmental factors such as changes in technology, politics, regulation, demographics or other trends in society, such as changes in culture, fashion, or urbanization (Shane and Venkataraman 2000; Eckhardt and Shane 2003; Shane 2003). These factors vary across countries and industries and significant changes in one or more of these factors are likely to generate opportunities for entrepreneurship (Eckhardt 2003; Shane 2003). Acs et al. (2005) emphasize that the creation of innovative business opportunities is the result of the creation of new knowledge. The creation of new knowledge is endogenous in economic systems via R&D investments of firms that try to improve their performance. Yet, all or parts of the new knowledge generated via R&D may also be used by other firms or entrepreneurs because the returns to R&D investments can usually not be perfectly appropriated (Geroski 1995). In addition, universities, research laboratories, and independent researchers can generate new knowledge. The new knowledge and the technological opportunities generated by R&D are likely to stimulate innovative entrepreneurship (Shane 2001; Acs et al. 2005). Hence, countries with high levels of R&D activity should generate more opportunities for innovation and should, accordingly, exhibit higher prevalence rates of innovative entrepreneurs, ceteris paribus.Footnote 6
In addition, the education system contributes towards the generation and the diffusion of new knowledge in a society. Especially higher education serves the purpose of teaching students the state of the art in science and technology and training them to recognize, analyze and solve complex problems, which eventually leads to the creation of new knowledge. Thus, the prevalence of a highly developed education system should also positively influence the objective availability of innovative entrepreneurial opportunities in a country. Thus, hypothesis 6:
Countries with highly developed education systems exhibit a higher share of innovative rather than purely imitative nascent entrepreneurs.
Countries also vary in their level of economic development and technology usage. Technical inefficiencies together with market inefficiencies are possible reasons for countries falling below the worldwide PPF, which is an economic concept to describe the maximum feasible combination of goods and services an economy can produce, given the current state of technology and the availability of scarce production factors (Kumar and Russell 2002). A greater distance to the frontier suggests that a country does not make efficient use of its production factors and the available technologies. On the one hand, this inefficient use of technologies and production factors should create opportunities for entrepreneurship that would diffuse new technologies, knowledge and best practices to less developed countries. On a global scale, this type of entrepreneurship would be considered imitative. From a market-specific perspective, however, such behavior counts as innovative, because it introduces products, service or production techniques that are new to the local market. On the other hand, existing market inefficiencies also provide opportunities for imitative new businesses. As long as markets are not in equilibrium, a simple imitation of the behavior of other market participants can still yield a profit. On the contrary, closeness of a country to the worldwide PPF implies relatively little room for imitation because any point at the PPF is characterized by an efficient use of available resources and the current state of technology. Hence, it can be expected that there are more opportunities for imitative entrepreneurship in countries that are operating below the worldwide PPF, while the scope for imitative entrepreneurship is limited in highly developed countries. This leads to hypothesis 7:
Highly developed countries exhibit a higher share of innovative nascent entrepreneurs, while developing countries exhibit a higher share of purely imitative nascent entrepreneurs.
To summarize, the individual probability to exploit an innovative rather than imitative business idea is a function of various factors that influence the objective existence and distribution of business opportunities in the environment, individual creativity and the alertness to business opportunities, all of which are related to the question “where do business opportunities come from”. In addition, individual preferences, opportunity costs, cognitive styles and the use of particular decision heuristics influence the probability that someone who perceived an innovative business idea actually decides to exploit it.