Uncertainty-bearing theory of entrepreneurship

Frank Hyneman Knight, an American economist at the University of Chicago, developed the uncertainty-bearing theory in the 1920s to explain the phenomenon of entrepreneurship. The roaring 20s brought with them renewed attention to the people and processes that served to bring innovations to market with increasing intensity.

The uncertainty-bearing theory views entrepreneurs as bearers of uncertainty. Knight distinguished between risk that can be modeled probabilistically, from uncertainty, for which the probabilities are unknowable. For instance, uncertainty surrounds the implementation of new strategies, the development of new products or markets, or the consequences of acquiring a competitor may have unknowable probabilities.

According to the theory, bearing business uncertainty creates profit and the more uncertainty taken on, the more profit to be gained. The theory places great emphasis on the entrepreneur’s ability to make decisions under uncertainty. The uncertainly perspective suggests that entrepreneurs who are willing to take on great uncertainty may deserve windfall profits the rare times they do succeed--it is a normal cost of doing business or cost of production. Entrepreneurs take on uncertainty according to their inclinations and abilities—the greater their self-confidence, the more they can take on.

The theory also suggests that uncertainty can be reduced through pooling it among several entrepreneurs. Broadly pooling uncertainty may be especially important when pursuing windfall profits because the reward will be large enough to compensate several participants. Pooling may be less important for smaller payoff opportunities because they may not supply enough reward to make sharing worthwhile.

Uncertainly causes a kind of cognitive load that is not worth the trouble unless the payoff is very large. For instance, Andy Grove described smaller business opportunities as distractions because compared to the size of the core business, their potential was tiny, but the cognitive costs to the organization (in this case, Intel) were great. He advocated for periodic vectoring, which served to cull many of the projects that strayed from very large payoffs.

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Other Economic Theories of Entrepreneurship:

Sources:

Knight, F. H. (2012). Risk, uncertainty and profit. Courier Corporation.

Burgelman, R. A., and Grove, A. S. (2007). Let chaos reign, then rein in chaos—repeatedly: Managing strategic dynamics for corporate longevity. Strategic management journal28(10), 965-979.
 

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