Category Archives: Entrepreneurship

Theory of Profit

Prof. Hawley, an American economist in 1907, propounded the risk-bearing theory of profit. Prof. Hawley remarks, “The profit of an undertaking, or residue of the product after the claims of land, labour and capital are satisfied, is not the reward of management or coordination but of the risk and responsibilities that the undertaker subjects himself to“.

So, according to this theory, profit is the reward for risk-taking in business. Every business involves some risk or other. Since the entrepreneur undertakes the risk, he is entitled to receive profit. If he does the reward, he will not be prepared to undertake the risks. Hence, higher the risk, the greater is the possibility of profit. This profit of the entrepreneur exceeds the ordinary return on capital. If it were less than the ordinary return on capital, the entrepreneur would not be prepared to undertake the risk.

Knight identifies entrepreneurship as:

  • Recipient of pure profit
  • Pure profit is bearing the cost of uncertainty
  • For which self-confidence is important

Criticisms of this theory

  1. No Direct relationship between Risk and Profit
  2. Reward for Risk avoidance
  3. Unforeseeable Risk

Prof. Knight asserted that the essential functions of an entrepreneur are to bear non insurable risks or uncertainties; he propounded what has come to be known as uncertainty bearing theory of profit.

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Importance of Business Plan

A business plan is not just a document; it is a white paper on your business. Every new business you one needs to start must begin with a business plan. If you look at most of the successful businesses today all had a very good business plan in place at the inception. One can say that business owners that develop and follow a business plan are more likely to succeed than business owners who do not have a business plan.

There are several reasons why Business Plan is important, some of them are:

Secure Financing for your business

So often it is observed that those people who have business ideas do not have enough capital to start their own business. They need to obtain financing from various financial institutions. Any financial institution would not lend money just because you have an idea; you need to present to them a business plan. A well-written business plan shows lenders and investors that you are serious about your business idea and have spent sufficient time in the planning process.

To plan for uncertain future

Planning is vital at any stage of the organization in any business. If you pen down your business plans you understand your business better and also specific courses of action can be taken to improve it. You can list down all the alternative solutions and ideas, in future these can be used in case of any eventuality.

Plan and Think about all aspect of Business

As mentioned earlier once you sit to draft a business plan, you start to think about each and every aspect of the business. This will help you think of business strategy, recognize limits and identify the problems that you might face.

Communicate Ideas of Others

When you sit to write your business plan you would have already thought what business you want to venture into. Once you begin to start to write toy will begin to believe that your business would succeed. Once you have entered your ideas and plan on paper it will also help you convince the readers. Once your ideas are communicated to the readers they will also gain confidence in your business plan and this can help you get quick financing and also winning the confidence of suppliers.

Tool for Managing the Business

Once the business is up and running you can use the plan to supplement your decision making and planning your future decisions. It can also be used to track whether your business is developing according to plan

Business Plan: Meaning and Purpose

A business plan is a written document that describes all the steps that you need to open and operate a successful business.

Writing a business plan is one of the most important and difficult task that each and every successful entrepreneur has to do. One you know what business you are going to start and have planned all the details, you need to pen these down. This will not only help you sell your idea to convince your investors but also help you visualize all the aspects of the business.

A good business plan must:

  • Describes what your business will produce, how you will produce it, and who will buy your product or service.
  • Explains who will run your business and who will supply it with goods
  • States how your business will win over customers from competitors and what your business will do to keep customers
  • Provides detailed financial information that shows how your business will succeed in earning a profit

The business plan serves three important purposes.

1. A business plan explains the idea behind your business and spells out how your product or service will be produced or sold. To convince investors that your business idea is solid, you will need a completely new product or service or one that is better or less expensive than products or services that already exist. You will need to identify who your target customer is and show how your company will be able to obtain and keep customers.

2. A business plan sets specific objectives and describes how your business expects to achieve them. A good business plan includes sales projections for the short term (the first year), the medium term (two to five years after startup), and the long term (five years in the future). It describes what products and services will be introduced over the next five years and sets forth future business plans, such as expansion of the business.

3. A business plan describes the backgrounds and experience of the people who will be running the business. Banks and other lenders make financing decisions based on how well they think a company can meet its objectives. If you provide information on the background and experience of the people who will be running your company, the bank or investor will be more likely to invest money in your business.

Theory of Achievement (N-Ach)

McClelland further described the profile of an entrepreneur as someone high in nAch (Achievement) and low in nP (Power), while good managers have high nPower and low nAch.

Over four decades of research into the characteristics of entrepreneurs has established that the essential need for achievement for entrepreneurship is learned at an early age. Persons with a high ‘need achievement’ have a general predisposition towards entrepreneurial activity.

McClelland identified 2 characteristics of Entrepreneurship.

1.       Doing things in a new and better way

2.       Decision making under uncertainty

NArch

Achievement orientation is defined as tendency to strive for success in situation involving an evaluation of one’s performance in relation to some standards of excellence.

Need for achievement is needed for successful entrepreneurs.

People with high achievement are not motivated by money alone. Money is just a measure of success for them. Highly successful entrepreneurs have high need for achievement. They do things that make them stand out and what to achieve things not done before.

They strive hard to achieve. Take failures as learning experience and bounce back

Dynamic entrepreneurship Theory

Dynamic Theory of entrepreneurship was advocated by Schumpeter, it considers entrepreneurship as a catalyst that disrupts the stationary flow of the economy and sustains process of development i.e. new combination.

The Theory of Economic Development, originally published in German in 1911, in which he endorsed entrepreneurship, was hardly ever mentioned. The theory was not widely accepted in 1930,s as dominance of sellers’ market. Theory was only mere fancy till 1990 when mega corporates failed due to over emphasis on operation which worked well in past.

Embarking upon new combinations of the factors of production – which he succinctly terms innovation – the entrepreneur activates the economy to a new level of development. The concept of innovation and its corollary development embraces five functions:

  1. Introducing new goods or a new quality of good
  2. Introducing new ways of producing goods
  3. Opening up new markets (usually overseas)
  4. Discovering new sources of supply of raw materials or partly-manufactured goods
  5. Re-organizing the structure of an industry (for example, by creating a monopoly or breaking up a monopoly situation)

Schumpeter represents a synthesis of different notions of entrepreneurship. His concept of innovation included elements of risk taking, superintendence and co-ordination. However, Schumpeter stressed the fact that these attributes unaccompanied by the ability to innovate would not be sufficient to account for entrepreneurship.

Schumpeter points out, “to produce means to combine materials and forces within our reach” and that the same materials may well be used in different ways. He describes these potential alternatives as new combinations and identifies the entrepreneur’s role as the discovery and commercialization of new combinations

Theory advocates the age of discontinuity and more on formulating the right questions and then the right answers for survival.

Leibenstein’s X-efficiency theory

X-inefficiency is the difference between efficient behavior of firms assumed or implied by economic theory and their observed behavior in practice. It occurs when technical-efficiency is not being achieved due to a lack of competitive pressure. The concepts of x-inefficiency were introduced by Harvey Leibenstein

The degree of efficiency maintained by individuals and firms under conditions of imperfect competition. According to the neoclassical theory of economics, under perfect competition individuals and firms must maximize efficiency in order to succeed and make a profit; those who do not will fail and be forced to exit the market. However, x-efficiency theory asserts that under conditions of less-than-perfect competition, inefficiency may persist.

Economic theory assumes that the management of firms act to maximize economic profits—which is accomplished by adjusting the inputs used or the output produced. In perfect competition, the free entry and exit of firms tends toward firms producing at the point where price equals long run average costs and long run average costs are minimized. Thus firms earn zero economic profits and consumers pay a price equal to the marginal cost of producing the good. This result defines economic efficiency or, more precisely, allocative economic efficiency.

X-inefficiency is not the only type of inefficiency in economics. X-inefficiency only looks at the outputs that are produced with given inputs. It doesn’t take account of whether the inputs are the best ones to be using, or whether the outputs are the best ones to be producing, which is referred to as allocative efficiency. For example, a firm that employs brain surgeons to dig ditches might still be x-efficient, even though reallocating the brain surgeons to curing the sick would be more efficient for society overall.

Leibenstein regards entrepreneurship as a creative response to X-efficiency. Other people’s lack of effort and the consequent inefficiency of the organizations that employ them, create opportunities for entrepreneurs. Entrepreneurial activities pose a competitive threat to inefficient organizations.

Leibenstein identifies two main roles for entrepreneurs. The first role is the ‘input completion’ involves making available inputs which improve efficiency of existing production methods or facilitates the introduction of new ones. It is normally effected by intermediation in factor markets, in particular the markets for venture capital and management skills. The role of entrepreneur is to improve the flow of information in these markets.

The second role ‘gap filling’ is closely related to arbitrage function emphasized by Kirzner. Leibenstein provides a very vivid description of gap filling, visualizing the economy as a net made up of nodes and pathways.

The nodes represent industries or households that receive inputs (or consumer goods) along the pathway and send outputs (final goods and inputs for the other commodities) to the other nodes. The perfect competition model would be represented by a net that is complete: one that has pathways that are well marked and well defined, one that has well-marked and well-defined nodes, and one in which each element (that is firm or household) of each node deals with every other node along the pathways on equal terms for the same commodity.

 

Schumpeter’s Theory on Entrepreneurship

The innovative theory is one of the most famous theories of entrepreneurship used all around the world.  The theory was advanced by one famous scholar, Schumpeter, in 1991.

Schumpeter believes that creativity or innovation is the key factor in any entrepreneur’s field of specialization.  He argued that knowledge can only go a long way in helping an entrepreneur to become successful. He believed development as consisting of a process which involved reformation on various equipment’s of productions, outputs, marketing and industrial organizations.

However, Schumpeter viewed innovation along with knowledge as the main catalysts of successful entrepreneurship. He believed that creativity was necessary if an entrepreneur was to accumulate a lot of profits in a heavily competitive market.

The concept of innovation and its corollary development embraces five functions:

  1. Introduction of a new good
  2. Introduction of a new method of production
  3. Opening of a new market
  4. Conquest of a new source of supply of raw materials and
  5. Carrying out of a new organization of any industry

Schumpeter represents a synthesis of different notions of entrepreneurship. His concept of innovation included elements of risk taking, superintendence and co-ordination.

According to Schumpeter

  • Development is not an automatic process, bur must be deliberately and actively promoted by some agency within the system. Schumpeter called the agent who initiates the above as entrepreneur
  • He is the agent who provides economic leadership that changes the initial conditions of the economy and causes discontinuous dynamic changes
  • By nature he is neither technician, nor a financier but he is considered an innovator
  • Entrepreneurship is not a profession or a permanent occupation and therefore, it cannot formulate a social class like capitalist
  • Psychological, entrepreneurs are not solely motivated by profit

Features of Schumpeter Theory

  • High degree of risk and uncertainty in Schumpeterian World
  • Highly motivated and talented individual
  • Profit is merely an part of objectives of entrepreneurs
  • Progress under capitalism is much slower than actually it is
  • It is leadership rather than ownership which matters.

Many business people support this theory, and hence its popularity over other theories of entrepreneurship.

 

Theories of Entrepreneurship

Define Entrepreneurship

Over 200 years of the study of entrepreneurship have provided many definitions of the word “entrepreneur.”

Indeed, the search for a best definition may have impeded the development of theory. The Schumpeter economic outcome-based concept that an entrepreneur creates value by carrying out new combinations causing discontinuity is embodied in many of the definitions offered within the last 50 years.

What is a Theory?

According to Oxford Dictionaryit is supposition or system of ideas explaining something, especially one based on general principles.

For one to become a successful businessman there is need for that person to know all about the theories of entrepreneurship.  However, entrepreneurship (though famous) is not a fully known field to many people.

There are quite a lot of theories on Entrepreneurship; we will look at some of those in the coming weeks.

I have listed most of them below, which I will be covering on this blog

  1. Schumpeter’s Theory
  2. Economic Theory of Entrepreneurship
  3. Leibenstein’s X-efficiency theory
  4. Dynamic entrepreneurship Theory
  5. Harvard School Theory
  6. Theory of Achievement (N-Ach)
  7. Theory of Profit
  8. Theory of Change
  9. Theory of Adjustment of Price
  10. Theory of Market Equilibrium
  11. Theory of Entrepreneurial Supply
  12. Theory of Personal Resourcefulness
  13. Theory of Cultural Values

 

Importance of Entrepreneurship in Developing Country

The entrepreneur who is a business leader looks for ideas and puts them into effect in fostering economic growth and development. Entrepreneurship is one of the most important input in the economic development of a country.

The nature of a developing economy is quite different from a developed economy. The developing economy can be an agricultural country moving towards the industrialization or it may be the one where in the industry may be in its infancy lacking advance technology.

The modern era is an era of changes. The whole world is becoming a village due to the industrial revolution and fast developing communication technology. The globalization of industry and commerce is bringing a vast change in various aspects of life.

Economic development of a country is the outcome of purposeful human activity. The modern era is an era of changes. The whole world is becoming a village due to the industrial revolution and fast developing communication technology. The globalization of industry and commerce is bringing a vast change in various aspects of life.

Economic development of a country is the outcome of purposeful human activity. Economic development is a highly dynamic process characterized by the pattern of demand shifts, new products are needed, appear for the production of goods within a country.

A developing country needs entrepreneurs who are competent to perceive new opportunities and are willing to incur the necessary risk in exploiting them. A developing economy is required to be brought out of the vicious circle of low income and poverty. Entrepreneur can break this vicious circle. Entrepreneurs and helping government can change a developing economy in developed economy.

Employment Generation

Entrepreneurs not only give employment to the entrepreneur but also a source of direct and indirect employment for many people in a country. Unemployment is a chronic problem in most of the developing and underdeveloped countries. Entrepreneurs play an effective role in reducing the problem of unemployment in the country which in turn clears the path towards economic development of the nation

 Entrepreneurial development is looked at as a vehicle for employment generation through promotion of small business. India, being far more developed and forward looking country than some of the third world countries, can provide lead to entrepreneurial development activities. However, India can benefit from the well- documented success experiences of developed countries like USA, Japan and UK in the field of employment generation and small business promotion.

Promotes Capital Formation

Entrepreneurs mobilize the idle funds which lead to capital formation. The funds which are used by entrepreneurs is a mix of their own and borrowed. This leads to creation of wealth which is very essential for development of an economy.

Small Business Plan Dynamism

Great dynamism is one of the qualities of the small and medium enterprises. This quality of dynamism originates in the inherent nature of the small business. The structure of small and medium enterprises is less complex than that of large enterprises and therefore facilitates quicker and smoother communication and decision- making. This allows for the greater flexibility and mobility of small business management. Also, small enterprises, more often make it possible for owners, who have a stronger entrepreneurial spirit than employed mangers, to undertake risk and challenges.

Balanced Economic Development

Small business promotion needs relatively low investment and therefore can be easily undertaken in rural and semi-urban areas. This in turn creates additional employment in these areas and prevents migration of people from rural to urban areas. Since majority of the people are living in the rural areas, therefore, more of our development efforts should be directed towards this sector. Small enterprises use local resources and are best suited to rural and underdeveloped sector

The growth of industries and business in these areas lead to a large number of public benefits like road transport, health, education, entertainment, etc… Setting up of more industries leads to more development of backward regions and thereby promotes balanced regional development.

Innovations in Enterprises

Business enterprises need to be innovative for survival and better performance. It is believed that smaller firms have a relatively higher necessity and capability to innovate. The smaller firms do not face the constraints imposed by large investment in existing technology. Thus they are both free and compelled to innovate.

Entrepreneurship development is accelerating the pace of small firm’s growth in India. An increased number of small firms are expected to result in more innovations and make the Indian industry compete in the international market.

Better standards of living

Entrepreneurs play a vital role in achieving a higher rate of economic growth. Entrepreneurs are able to produce goods at lower cost and supply quality goods at lower price to the community according to their requirements. When the price of the commodes decreases the consumers get the power to buy more goods for their satisfaction. In this way they can increase the standard of living of the people.

Self-Reliance

Entrepreneurs are the corner stores of national self-reliance. They help to manufacture indigenous substitutes to imported products which reduce the dependence on foreign countries. There is also a possibility of exporting goods and services to earn foreign exchange for the country. Hence, the import substitution and export promotion ensure economic independence and the country becomes self-reliance.

Facilitates Overall Development:

Entrepreneurs act as catalytic agent for change which results in chain reaction. Once an enterprise is established, the process of industrialization is set in motion. This unit will generate demand for various types of units required by it and there will be so many other units which require the output of this unit. This leads to overall development of an area due to increase in demand and setting up of more and more units. In this way, the entrepreneurs multiply their entrepreneurial activities, thus creating an environment of enthusiasm and conveying an impetus for overall development of the area

Emergence of Entrepreneurial Class [India Perspective]

During earlier times India’s prosperity attracted communities across boundaries

Strategies adopted by Mughals and Turkish

Turk Mughals settled down in India and shared the prosperity. . They bought currency with them and disrupted the barter system

Strategy of the British

Wanted to offload surplus supply due to Industrial Revolution in India to balance the demand and supply situation in U.K Managed to acquire power and became the ruler.

Banned manufacturing in India. Sent all raw materials (cotton, oilseeds etc…) to UK for conversion and value addition thus transferring wealth to UK

18th Century

Indian Industry remained nonstarter. Major thrust was on cash crops neglecting food grains resulting in severe famine. Indian Economy was dominated by British economy.

1920

World war prevented transfer of raw materials to Manchester. British decided to manufacture in India itself. This initiated the first Indian Industry – The Mumbai Textile Mills.

1930s to mid-1940s

Mahatma Gandhi directed his captains to set the basic infrastructure for Industrial and Economic development. These are the founder entrepreneurs of India. They developed various areas of basic infrastructure.

1.       JRD Tata –  Aviation, steel, railway, post & telegraph, power, roads, textile etc…

2.       G.D Birla – Textile, vehicles, power, cement, chemicals, heavy industries, aluminum, cement etc..

3.       S. L Kirloskar – Machine tools, farm equipment’s, pumps etc…

4.       Jamnalal Bajaj – Two wheelers, 3 wheelers etc…

Independence 1947

British went back leaving the business to their employees/agents/market intermediaries.

Late 1960s

Nationalization of banks and Insurance companies made available huge funds for SSI and entrepreneurial development. It made investment available to common man challenging business monopoly

1970s to mid-1985

Emergence of new generation entrepreneurs because of funds and supporting government policies. Technocrats, artisans, rural craftsman, educated, uneducated youngsters created the greatest ever SSI development.

Resulted in excellent interdependence of SSI ands organized sector creating highest ever growth rate of 8.9% and very high addition to GDP. Organized sector could expand, diversify without any direct investment and SSI could share the prosperity.

Mid 1980s

Indian industry remained protected by license raj, permits, quotas, monopolistic market resulting into losing export and entry of cheaper better goods in gray market(Germany & Japan) resulting in worse BOP Situation and industrial sickness. Closure of several industries in organized sector.

1990s

Liberalization sets reforms rolling by scrapping export regulations. DE licensing, making import and export simpler, direct FDI in all sectors, concessions for technical know-how and collaboration. Indian entrepreneurship started.

Mid 1990s

Third generation of entrepreneurs Rahul Baja, Mahindra, Ambani, Ratan Tata, Kumarmangalam Birla proved their competencies in managing various large companies

2000

Indian Entrepreneurship took great leap in the global market entering in to service Industry (IT, BPO, Bio Technology, hospitality etc)

India established leadership in several areas-

•        Bajaj-Largest manufacture of 2 wheelers

•        Ambuja cement-cheapest manufacturing of cement

Job market is changing; Companies are passing through highly unstable phase. It may call for drastic changes in their business form that will lead to change in the employee pool. Jobs and remuneration will be more result based. Those will demand high enterprising capabilities and entrepreneurship attitude.