Prior knowledge and the discovery of entrepreneurial opportunities

Purpose

There is an ongoing debate about whether investors should bet on the jockey or the horse, i.e., the founders’ abilities to succeed or the quality of the entrepreneurial opportunities pursued. There is no doubt, though, that high-quality opportunities are an important ingredient contributing to startup success, particularly when they revolve around technological innovations.

But, how do entrepreneurs discover opportunities? Scott Shane, in his 2000 article, “Prior knowledge and the discovery of entrepreneurial opportunities,” studies eight different companies that launched in an effort to exploit the 3DP™ process¹ in different ways. Shane’s research shows “entrepreneurs discover opportunities related to the information that they already possess” and those discoveries are immediate epiphanies—not the result of systematic search and evaluation.

Research

Conceptual model

Based on prior literature, particularly Austrian economic theory, the author develops the following conceptual model and propositions to test in his research study.

Information asymmetry leads to non-obvious opportunities

Entrepreneurs look for opportunities to bring into existence new goods and services and market them at a profit. But why do these opportunities exist at all, particularly if markets are efficient? The author believes opportunities exist because of the imbalance, or asymmetry, of information possessed by various entrepreneurs, investors, resource owners, and customers. This asymmetry of information leads to deals where both parties are guessing about the intentions of the other party and this leads to errors that misallocate resources away from their “best use.”

Then, entrepreneurs enter the picture by recognizing opportunities to better deploy resources. This recognition is not automatic, trivial or obvious. If it were, all entrepreneurs would recognize it and there would be no economic advantage to pursuing the opportunity as many entrepreneurs flooded into the market. Likewise, if resource owners understood the opportunity, they would set their price such that the entrepreneur would make little profit.

The author proposes that all individuals are not equally likely to recognize an entrepreneurial opportunity.

Immediate recognition trumps opportunity search

Prior academic theory presents two competing explanations for how entrepreneurs discover an opportunity has value: search and recognition. Search theory suggests people invest their time systematically looking for an opportunity and the successful ones have some superior traits such as processing ability, search technique, or scanning behavior.

The author argues that people do not discover opportunities through search but through an immediate recognition of value via information they happen to receive.

The author proposes that people will discover opportunities without active searching.

Prior knowledge fuels the discovery process

Why does one person instantly recognize an opportunity, but then cannot see another opportunity that seems obvious to someone else?

People possess different—often idiosyncratic and random—knowledge and experiences. As a result, at any given time, only a small subset of people will be open to discovering a particular opportunity because the opportunity relates to the life, career, or educational experiences of those people.

The author proposes that people’s prior knowledge about markets, how to serve a market, and customer problems within a market will influence their discovery.

Figure 1. Conceptual model (adapted from Shane 2000).

Research design

The article’s research is comprised of a study of eight entrepreneurial opportunities exploiting a single MIT invention, the three-dimensional (3DP™) printing process.

The study used a case study method where in-depth interviews were conducted with members of each entrepreneurial group and the collected interview data was then cross-referenced and corroborated through both database searches and archival records, such as business plans, press releases, contracts, etc.

Participant companies’ products and services ranged from devices for creating industrial molds, medical pills, ceramic filters, architectural models, artificial bones, and surgical models (e.g. artificial brains), to a chain of retail stores that would sell sculptures generated from customer photographs.

Eight entrepreneurial opportunities

Table 1

Summary

Entrepreneurs were not equally likely to recognize an opportunity

MIT’s 3DP™ process was widely discussed in both scientific conferences and the popular business press, including Fortune, the Financial Times, and the Economist. The MIT technology licensing office actively promoted the invention.

In spite of the public relations successes, only eight companies have been formed as of the writing of Shane’s article. Or, in other words, there have been only eight distinct opportunities discovered.

You couldn’t just look at the 3DP™ process and know that you could use it for medical purposes. To make use of 3DP™ process for drug delivery, you had to know something about what drugs and drug delivery systems are made from and how drug manufacture operates.

–Walter Flamenbaum (Therics)

Of the eight entrepreneurial groups, each only discovered one of the eight opportunities. Interestingly, none of the entrepreneurial groups even weighed “the relative advantages and disadvantages of using the technology to pursue different opportunities.”

Entrepreneurs discovered opportunities without actively searching for them

The eight entrepreneurs in the study “described a discovery process which involved recognition, rather than a search for information.” None of the entrepreneurs were searching for the opportunity when they discovered it.

When Mike Cima showed me MIT’s 3DP™ machine, I just thought that this would make great filters . . . . The point is, we never searched for this opportunity.

–Mike Parish (Specific Surface)

Each entrepreneur heard about the 3DP™ technology through a professional connection (not the university’s official channels) and immediately recognized an opportunity upon hearing about it.

I just saw immediately that there was an opportunity to make functional metal parts directly from a computer.

–Yehorem Uziel (SOLIGEN)

The entrepreneurs all indicated that they “simply recognized” their opportunities, as if by accident.

Entrepreneurs’ prior knowledge about markets, how to serve a market, and customer problems within a market influenced the entrepreneurial opportunities they discovered

The eight entrepreneurial groups used the 3DP™ process to address different markets, in different ways, while tackling different customer problems. “In each case, the selection of the market, the way to serve the market, and the solutions to the customer problems were influenced by the entrepreneur’s prior knowledge.”

[The person who discovered the opportunity] was an architect . . . . We focused . . . the architectural market because it was the only market we knew anything about.

–Andrew Kelly (3D Partners)

Whether it relates to identifying a market, serving a market, or solving a customer problem, “the discovery of entrepreneurial opportunities depends on prior knowledge.”

The Take-Away

The message from Shane’s research is clear: Prior knowledge leads to opportunity discovery.

Instead of pursuing the hot and trendy that’s flooding your social media or launching yourself into laborious quests in areas you are not already familiar, go back to what you know well to discover your entrepreneurial opportunity. Just as writers are told to write about what they know, budding entrepreneurs should first investigate opportunities in spaces with which they are familiar, where they know potential customers and where they’ve experienced, or at least observed, problems that need to be solved.

Part of my investment thesis as an angel investor includes finding startups whose founders have a deep understanding of an industry, customers, suppliers, problems, and existing solutions (or lack thereof). For instance, I don’t want to invest in a mechanical engineer who is trying to build a new social media platform. I want to back a mechanical engineer who is building an innovative physical product that solves a real problem of which they have first-hand knowledge.

The background you’ve developed, via training, education, life experience, and personal connections, makes you a unique entrepreneur. That luggage, your past, that you carry with you is your competitive advantage—but only if you engage it in your quest. If you ignore your past and chase an opportunity that isn’t cohesive with you and your luggage, you may still succeed, but you make your journey that much more difficult.

1. Three-dimensional printing was invented in 1989 by four MIT researchers. It is a process for making a physical component by creating successive layers of powder and binding material.