Tuesday, February 3, 2015

The Role of the Entrepreneur: Coordination and Innovation

Entrepreneurs guide production according to the needs of consumers. Remember that a good is a type of object whose definition is a subjective. The final consumer must expect that the good will improve his or her position enough that he or she actually purchases the good. The entrepreneur’s role is to provide that good to the consumer. Note the inherent difficulty in this role. Consumer demand is not inherently stable. Preferences are subject to fluctuations. Consumers can also be swayed by a competing products. Recently, producers of phones employing Android platforms have been facing steep competition from Apple. Many have switched to the iPhone6, and, as a result, Apple has reaped record profits. And let’s not forget about competitors that faded away long ago. Remember when Nokia was dominating the market for cell phones, only to have its gains swept away by smart phone providers? In serving consumer demands, entrepreneurs engage in a dynamic process of competition. Most entrepreneurs eventually fail!

Entrepreneurs are thus an integral part of a system of decentralized planning. In his economic treatise, The Theory of Social Economy, Gustav Cassel recognized this process of decentralized planning.

The difficulty of the problem lies precisely in the fact that the constantly varying demands of consumers, which cannot be determined in advance with any degree of certainty, must be satisfied, despite incessant changes in the methods and conditions of production. This work is actually done – naturally not perfectly – by a number of independent entrepreneurs, each of whom, on the whole, looks merely to his own interest.

This solution of the problem is possible because, whenever a want that can be paid for is left unsatisfied, or is not completely satisfied, or satisfied only at an abnormally high price – every time, that is, the problem of the economic direction of social production is not satisfactorily solved – an entrepreneur is encouraged by the prospect of earning a special profit to make a better provision for the want in question, and the productive process is thus steadily improved. The entrepreneurs intervenes, not only where something is to be done for the immediate satisfaction of consumers’ wants, but everywhere where the productive process, somewhere among the thousands of its component processes, exhibits a gap which leaves room for his enterprise. In this way, all these partial processes are united into a single productive process, embracing the entire satisfaction of wants in the exchange economy. (95)

In the process of providing goods, the entrepreneur is responsible for transforming and building portions of the structure of production. Imagine that entrepreneur as having the responsibility of ensuring that the nodes under his control are profitable. Profit signals to the entrepreneur that he improving the lot of consumers at the end of his supply chain. Loss suggests that the entrepreneur is failing. If the entrepreneur fails for too long, he will incur losses that force him to withdraw from the market.

While the primary job of the entrepreneur might be generally described as earning a profit, his role can be described more thoroughly. The job of the entrepreneur can be divided up into several categories. In one early formulation, Joseph Schumpeter (1928) describes the entrepreneur as innovator.

Successful innovation is, as said before, a task sui generis. It is a feat not of intellect, but of will. It is a special case of the social phenomenon of leadership. Its difficulty consisting in the resistances and uncertainties incident to doing what has not been done before, it is accessible for, and appeals to, only a distinct type which is rare. Whilst differences in aptitude for the routine work of ‘static’ management only results in differences of success in doing what every one does, differences in this particular aptitude result in only some being able to do this particular thing at all. To overcome these difficulties incident to change of practice is the function characteristic of the entrepreneur.

Although Schumpeter stresses the discontinuous nature of innovation and economic growth, innovation can be of any magnitude. Small improvements in existing technology surely counts as innovation just as much as more substantial changes – say the invention of the lightbulb or telephone or steam engine. With each innovation, improvements are made over exist technologies. This provides the entrepreneur an opportunity to earn a profit. For this to occur, consumers must also expect that the improvement will benefit them. Otherwise, the supposed improvement is not improvement at all. Thus, a role exists for advertising to bring in the consumer as a participant in the trial and error process.

Successful innovation allows the innovator to overtake old competitors. When Henry Ford increased the efficiency of production of motor vehicles, the days of the horse and buggy quickly came to an end. With the massive adoption of cell phones, land line connections have become much less important for consumers. Remember the rapid ascent and decline of VCRs of the course of a couple decades? (Maybe you don’t!) No firm can use a single invention to rule the market for an extended period of time without confronting competition.

Competition is key to the market process. It is inherent in any form of decentralized planning where agents and firms operate with legal equality. The world is filled with opportunities to improve the welfare of consumers. These opportunities are discovered, whether out of intention or by accident, by entrepreneurs and provided to the market by the will of the entrepreneur. In the next post, I will consider the role of tacit information, discovery, and difficulty in the process of entrepreneurial competition.