What is the population ecology theory of entrepreneurship?
Hannan and Freeman’s (1977) population ecology theory hangs on the assumption that environments can only handle a fixed number of organizations of each type. After a certain point is reached, there are diminishing returns to density that eventually balance out through the mortality of organizations.
The theory is about the tension between the need to be considered as legitimate in order to compete, but also the need to be competitive. As more organizations enter the market, they become increasingly legitimate, but this leads to greater competition making survival more challenging. Thus, the early market is dominated by the need for legitimacy, while the later market is dominated by competitive forces of selection.
As environments change, often due to innovations introduced by organizations within them, mortality rates increase for organizations experiencing high levels of resistance to change. Inertial forces guarantee that most innovations will come from new entrants and not from incumbents resisting change. Organizational inertia is caused by a combination of internal (e.g., sunk costs, impaired managerial cognition, or organizational culture and history) and external restraints (e.g., government regulations, groupthink, or barriers to entry and exit).
Environmental niches are exploited by specialist organizations that risk adaptation to the requirements of a smaller number of customers. Generalist organizations span many niches, but they do so sub-optimally—catering to a subset of customers in each niche in return for diversified risk. The theory predicts mortality hazards based on the age of firms. New firms experience the liability of newness, where failure risks are high due to a lack of legitimacy. The liability of adolescence kicks in next, where firms gain stakeholder support to expand quickly, but they then reach resource constraints that raise their mortality risks. Finally, older firms face the liability of aging, where inertia kicks in making it difficult for firms to change in the face of environmental dynamism.