Are You an Entrepreneur?
Understanding the role and implications of entrepreneurship in value creation.
Who, exactly, is an entrepreneur? This question has been a topic of heated debates for many decades. The most brilliant minds in history have wracked their brains trying to define the entrepreneurial role in society. It was an economic, political and, of course, a social question. There are two prominently distinguishable camps in the definition and understanding of entrepreneurship.
The ‘Joseph Schumpeter’ camp
Joseph Schumpeter — a famous Austrian economist of the mid 20th century — defined entrepreneurs as a destructive force of creation, primarily assigning them a role of constant innovation. In Schumpeter’s view an entrepreneur carries out three functions that all deserve to be rewarded, but whose main distinction lies in their substitutability.
- Provision of capital, rewarded by the return on investment at market rates — this function can be taken over by financial markets;
- Managing of enterprise, rewarded through salary — this function can be carried out by a hired manager, meaning if the entrepreneur takes over this function, then he/she also deserves a normal salary;
- Innovation is the third feature — Schumpeter argues that entrepreneurs are the driving force behind technological change in the society and fulfil a crucial role by moving society to the next frontier. It is for this innovation that entrepreneurs deserve the return above the market rate on capital and in excess of salary for leading their enterprise, as long as those copying the idea don’t squeeze the profit margins and deprive the entrepreneur of the “monopolist” reward.
For Schumpeter this third characteristic is the one distinguishing an entrepreneur from all others.
The ‘Peter Drucker’ camp
The other camp may be represented by another prominent figure, management consultant Peter Drucker. For him entrepreneurs are not necessarily the agents of change, but those cleverly exploiting the change. Entrepreneurs don’t have to be inventors themselves; they might as well copy someone else’s idea and exploit it to the benefit of both society and themselves.
The implications…
Whereas the philosophical debate as to what to call those launching a business, as entertaining as it may sound, is of little practical value to us, there are several important implications that are very practical in nature.
First of all, if you as an entrepreneur also lead your enterprise, you must assign yourself a salary. Here there is nothing to debate or prove. It forms part of business expenses and by not doing so you unjustifiably overestimate your company’s profit. Full stop.
Secondly, copying as such may by all means be OK, but in order for it to provide adequate return, you should watch how your entering the market will impact the margins, both for you and already existing businesses. Opening an M-Pesa shop in a remote area not yet served will definitely bring value to customers and earn you a return. But opening a second one within 150m of your competitor will not suddenly double the number of M-Pesa users, but halve the revenues for both of you, possibly endangering the very existence of both businesses. Beware of this before plunging head over heels into a new business otherwise you risk oversaturating the market. Such senseless copying without an underlying market research usually results in cut-throat competition and endless price dumping. Blue Ocean theory was invented precisely to combat this notorious view that tackling competition consists solely in cutting prices. (Read more on how discounting and price wars can be dangerous for your business here)
Thirdly, speaking from the inventor side, whenever you come up with a ground-breaking idea, you should weigh the chances of how long you can hold the first-mover advantage, enjoy the monopolist profits and if you will have enough time to at least recover the initial investment. How expensive or difficult is it to replicate? How long will it take the competitors to do it? Can you erect entry barriers, for example by getting a patent for it? In unprotected industries it is up to participants to create those barriers. If not, how long can you keep the crucial ingredients of your success secret?
Inventing something doesn’t necessarily put you in a better position compared to others. It may actually be the reverse. You spent time and money on trial and error, came up with something new and innovative, just for the competitors to copy the best solution without having worn down their resources along the way. If your success is based solely on one, however brilliant, idea, it will most probably be very easy to copy. But if it is a combination of many small things, then the chances of keeping the advantage are higher. There is nothing special about making hamburgers, but McDonalds still holds the worldwide record because it managed to create structures and maintain the same quality standards all over the world. You may find better tasting burgers in every town, but you can expect the same quality in every McDonalds joint wherever you go. And that is difficult to replicate.
At the ISBI Entrepreneurship Program we help entrepreneurs understand their role in the value creation process and how to think critically about their strategies and impact. Join us.
