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Market Failure, Market Dynamics, and Entrepreneurial Innovation by

Environmental Ventures

Article · May 2011

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Market failure, market dynamics and entrepreneurial
innovation by environmental ventures

Elizabeth Garnsey, Nicola Dee and Simon Ford

Chapter 2 of Handbook of Research on Energy

Entrepreneurship
edited by Rolf Wüstenhagen and Robert Wuebker
published by Edward Elgar Published 2011

Summary of chapter
Recent contributions to understanding the role of enterprise in environmental
innovation have inferred that market failures are an unexpected source of
entrepreneurial opportunities for ventures with environmental innovations. This
inquiry used iterations between theory and evidence to explore this issue. The concept
of market failure is explained, and explored in relation to evidence on opportunities
targeted and constraints reported by UK environmental ventures including low carbon
energy innovators. In the development of these young firms, some instances of market
failures provided business opportunities, but other instances seriously impeded
attempts at environmental innovation. The concept of market failure could not
illuminate these differences. This suggested that the key question is how innovative
environmental enterprises have in practice overcome impediments associated with
market failure. This issue was explored through case studies. The logic of the inquiry
showed that it was innovative responses to market dynamics rather than the existence
of market failures that created business opportunities. The concept of market failure is
undermined by its theoretical assumptions and empirical limitations, which make it
redundant for policy purposes.

1
1. INTRODUCTION
Entrepreneurial innovation is now recognized as an engine of change in the economy.
Yet new entrant firms have made little innovative impact in utilities, construction,
transport and heavy industry sectors, the major contributors to carbon emissions. Nor
have larger companies in these sectors been able to innovate radically in the face of
pressures to maintain short term rates of return on capital.1 There is new interest from
investors2 and policy makers3 in environmental ventures as changes unfold in the
environmental arena. Academic work reflects awareness of these changes. For example
it has been argued that the prevalence of market failure provides a basis for viewing
high carbon sectors as fertile with opportunities for entrepreneurs (Dean and
McMullen 2002; Cohen and Winn 2007; Dean and McMullen 2007).

This attention to environmental ventures is promising and suggests a new research

agenda. But the neoclassical theory on which this recent work draws does not
distinguish between market failures that obstruct entrepreneurs and those that provide a
source of opportunity: both are attributed to the failure of perfect competition.

To understand whether and how market failure provides business opportunities from
environmental innovation, evidence is needed on the experience of enterprises
launching innovative environmental technologies. Evidence can help operationalise
constructs by showing what instances of market failures they encounter and how these
affect their prospects. To have an impact on carbon emissions and their mitigation, a
new company must not only commercialise environmental technology but grow the
business sufficiently to achieve market penetration. This study explores evidence from
a database of 73 UK environmental ventures, summarising the opportunities they
targeted and the constraints they reported. Illustrative data is provided on the
experience of energy innovators and that of SME innovators in other sectors of the
environmental goods and services industry. From this evidence we are able to trace the
impact of specific instances of market failures: many such instances were reported as
obstacles rather than opportunities. A key question is therefore how entrepreneurial
firms responded to instances of market failure. This question is explored from case
studies of innovative environmental enterprises, which throws further light on the
concept of market failure. We draw on literature in the field of entrepreneurial

2
innovation, as well as that on market failure, to guide the inquiry.

PRIOR WORK ON ENTREPRENEURIAL INNOVATION4

Early literature on innovation showed that entrepreneurial firms realize opportunities
by configuring their resources so as to match changing market needs (Penrose 1960;
Freeman 1982). Recent work on entrepreneurship has diverted attention from this
entrepreneurial matching process onto the entrepreneurial pursuit of opportunities,
which has been proposed by recent scholars as the defining feature of entrepreneurial
activity (Venkataraman 1997; Shane and Venkataraman 2000; Shane 2003).5 The
focus of recent entrepreneurship studies is the genesis of the business idea and its
translation into a business model that can attract investment. But the questions on
entrepreneurial innovation addressed here require a more Schumpeterian perspective
on how innovations are conceived, resourced, launched and diffused in distinctive
ways. This question requires a concept of the entrepreneurial process which
encompasses new business development.

1.1 The entrepreneurial means-ends calculus

Entrepreneurs are said not only to improve the means to achieving ends, but to think up
completely new means to achieve business ends (Kirzner 1973; Shane 2003). The
application of new ‘means-ends frameworks’ has been identified as distinctively
entrepreneurial behaviour (Shane and Venkataraman 2000; Shane 2003). In particular,
entrepreneurial alertness to opportunity is said to lead them to recognize the deficiency
of current price signals (Casson 1982; Kirzner 1973). Economists who have addressed
the role of entrepreneurs in the economy have focused on the improved resource
allocation which results from their putting resources to better use in this way. As
Casson explains, an entrepreneurial discovery occurs when someone makes the
conjecture that a set of resources is priced too low, given the likelihood that the output
from their combination could achieve a better price through a different allocation
(Casson 1982). A return to best use provides welfare benefits idealized in the Pareto
equilibrium (Dean and McMullen 2002).6 However there has been little use of
evidence to operationalise the concepts of the entrepreneurial means-ends framework
or market failure as business opportunity. In this study, we sought evidence that can

3
show whether (and how) the means and ends pursued by entrepreneurs makes it
possible for some of these to turn certain situations that can be characterised as market
failure into opportunities.

1.2 Market failure as a source of opportunity?

Welfare economics traditionally views malfunctioning markets (market failures) as a
barrier to entrepreneurial activity (Pigou 1932). When there are no incentives from
private returns, services may not be provided to protect public goods7 or render them
more useful (Samuelson 1954; Coase 1974; Jaffe, Newell et al. 2001). But market
failures have recently been identified as providing sources of opportunities for
entrepreneurs. Information asymmetries (Eckhardt and Shane 2003) and externalities
(Carlaw and Lipsey 2002) have been described as specific instances of market failure
that provide the entrepreneurial firm with opportunities. The same argument applies to
inefficient competitors and flawed pricing mechanisms (Cohen and Winn 2007).
Market failures have also been identified as creating opportunities because public
goods and monopoly power can be a stimulus to government intervention (Dean and
McMullen 2002, 2007).8 These authors have pointed to the various means by which
entrepreneurs can address market failure: the introduction of property rights, backing
new institutions, altering subsidies and stimulating anti-monopoly measures. All these
involve government intervention. The course of action identified by Dean and
McMullen (2007) for environmental entrepreneurs that does not require recourse to
government action is for them to remedy the imperfect information available to
suppliers, and/or customers.

The idea that entrepreneurial opportunities are opened by market failures has
interesting implications, but the conceptual apparatus of market failure creates
difficulties.9 Factors that bring about disparities between supply and demand and
prevent market clearing, whether those that stimulate or those that inhibit market
dynamics, are viewed as creating market failure in orthodox theory because perfect
competition would prevent these disparities. Metcalfe considers it curious terminology
to characterize the very conditions that generate change and innovation as market
failures (Metcalfe 1998; 2004). From an evolutionary perspective, changes that result
in demand outgrowing supply, and innovative supply available where a market does

4
not yet exist (which represent failures of perfect competition), are the very factors that
bring about market evolution; they are the basis of market dynamics.

The term market failure is used to refer to conditions that lead to potentially transient
discrepancies that can be remedied by entrepreneurial innovation. But it is also used to
refer to more entrenched and persistent failures of market functioning, as identified by
earlier economists (Pigou 1932). These include conditions in need of institutional
remediation as set out by Dean and McMullen (2002). Where supply-demand
disparities are attributed to market imperfections there is no clear basis for
distinguishing between market failures that obstruct entrepreneurs and those that
provide a source of opportunity.

To explore factors stemming from market failure that systematically impede business
development in entrepreneurial ventures, we turn now to evidence from a database and
survey. We then go on to examine evidence that informs us of the relationship between
market opportunities, market failure and entrepreneurial practices through case studies
of environmental enterprise.

2. EVIDENCE ON IMPEDIMENTS TO
ENVIRONMENTAL ENTERPRISE

METHODOLOGY

To explore the concept of market failure as a source of business opportunity for

environmental entrepreneurs, we sought evidence on opportunities pursued by
environmental enterprises, evidence on obstacles they encountered, and on how these
related to market failure. Our aim was to use evidence to explore and elucidate
concepts of market failure and entrepreneurial means and ends. As these had not been
operationalised, data testing was premature. Moreover, no formal hypotheses had been
offered by adherents of the thesis that market failure constitutes business opportunity.
We explored evidence from databases, surveys and business case histories. We had a
particular interest in enterprises launching renewable energy technologies but for
purposes of comparison, we included firms in other activities within the environmental

5
goods and services sector (as defined by the UK Department of Trade and Industry10).
We conducted an exploratory analysis of a DTI database on environmental enterprises
in the UK. We followed up a sample of these firms in a telephone survey in order to
find out what constraints were perceived by managers of these firms. Since we found
many instances of market failure cited as obstacles, a key question was how innovative
entrepreneurial firms have turned such obstacles into opportunities. To this end we
conducted case studies of 21 international firms with environmental innovations.

The Environmental Innovations Unit of the UK DTI compiled a cross-sectoral

database in 2005 of firms pursuing innovations in the environmental domain. This
database included 288 organisations with the aim of identifying a significant
proportion of the UK’s environmental organisations. From this government database
we derived a dataset of small and medium sized enterprises (SMEs). We removed
firms whose core business proved not to be based on environmental technologies, or
for which there was incomplete data.11 This resulted in a sample of 73 SMEs for which
we obtained further information from telephone interviews. Sectors of activity chosen
by these environmental SMEs provided evidence of opportunity recognition; these
were the sectoral markets in which they hoped to realise business opportunities.
The classification system used was that of the Joint Environmental Market Unit
(JEMU) of the UK DTI.12 The largest category, comprising 30 companies, was the
JEMU category Renewable and Low Carbon Energy; in this sector we distinguished
between stationary and transportation applications. Thus the market opportunities
targeted by the majority of SMEs in the database could be classed in five categories:
• Cleaner Technologies and Processes (largely pollution prevention products)
• Renewable and Low Carbon Energy – Stationary
• Renewable and Low Carbon Energy – Transport
• Recovery and Recycling
• Water and Wastewater Treatment
The telephone survey analysis of the sample dataset firms revealed perceived market
opportunities (from the description of barriers to commercial exploitation) and
business development obstacles self-reported by the respondents. This inquiry revealed
how serious were the various developmental difficulties experienced in young
environmental firms and pointed to contrasts between the sectors (Table 1).

6
Nine companies were selected from the 73 respondent firms, comprising a cross
section of environmental technology sectors. Follow-up research by questionnaire and
telephone interviews was conducted to gain more detailed findings than were available
in the survey on obstacles and opportunities. To see how market failures and other
challenges have been addressed by entrepreneurs, we turned to case studies. Issues of
theoretical interest that cannot readily be quantified can be illuminated by qualitative
evidence from case studies. These aim to present theoretically interesting, rather than
representative, evidence. For this purpose we carried out more detailed case studies of
eleven new entrants that had found innovative ways to get past difficulties of the kind
reported in the survey.13 These provided a more international perspective than the UK
survey, while the inclusion of some older companies offers a view of early challenges
of environmental ventures from a longer term perspective than do studies of recent
start ups.

2.1 Development and funding difficulties reported by surveyed firms

In the survey, firms were asked for their views on the obstacles they faced. “What is
the biggest barrier your firm faced in 2006?” The unprompted replies were coded and
categorised for this analysis into seven types of issue, summarised in Table 1.

Table 1. Dominant issue facing UK environmental enterprises developing and

commercialising environmental innovations, by sector (N=73)

Sector
Clean Renewable Renewable
tech- Recovery and Low and Low Waste
nologies and Carbon Carbon water
and Recycling Energy – Energy – treatment
processes Stationary Transport
Issue reported as % % % % %
obstacle
1. Contacts with
customers/partners 19.4 14.3 12 16.7 15
2. Funding for
certification 16.7 9.5 4 5.6 15
3. Funding for
commercialisation 11.1 9.5 12 16.7 10
4.
Funding for R&D 2.8 14.3 40 33.3 20
5.

7
 High capital costs 19.4 0 0 5.6 0
6.
Operating costs 5.6 4.8 4 0 0
7.
Proof of product 11.1 33.3 12 11.1 30
8. Lack of national
standards 0 4.8 0 5.6 0
9. Lack of public
procurement 11.1 4.8 4 0 0
10. Regulatory
uncertainty 2.8 4.8 12 5.6 10

Totals 100 (n-36) 100 (n-21) 100 (n-25) 100 (n-18) 100 (n-20)

From Table 1, we see that many firms reported a lack of finance for development but
others did not view this as a current obstacle. The sectoral differences may relate to
different stages of sector maturity, technology costs and stage of development of the
companies. Thus capital development costs had not yet been encountered by
renewables companies which were mainly engaged in R&D. But in sectors where new
companies are ready to compete with established industrial companies and need scale
economies to make their activities viable (pollution prevention technologies), obtaining
funds to cover capital costs was more frequently reported to be an obstacle. Among the
companies with cleaner technologies and processes, 20% reported that high capital
costs were a barrier, a problem reported by 5% of the companies with renewable and
low carbon technologies for transport, most of which were still mainly at the R&D
stage.
Other sources of finance included government grants which companies
reported as playing a critical role in the early development of their businesses. There
was difficulty accessing bank credit because banks expected revenue streams and
collateral. “We approached banks because we were looking to invest in capital equipment,
so they might have something to secure loan against. [We] also thought we might apply
for small firms loan guarantee, however banks won’t invest unless there is already an
income stream to repay their loan.” Companies that had obtained venture capital raised
concerns about equity dilution, early exit pressures and a loss of control by founders
over their companies. They viewed investors’ knowledge of environmental
technologies as deficient.14 As one answer put it: “To date difficulties centred on too
early stage, modest revenues and difficulty of some potential investors in supporting
technology they don’t understand.”

8
2.2 The problem of creating value recognised by customers
Barriers to market entry were also associated with R&D costs and delays (Table 1).
Many firms with new technologies in low carbon energy are developing products such
as fuel cells or urban wind machines. However most of these technologies are not yet
market-ready and require further R&D. In this study, 40% of such firms reported
difficulties funding R&D: 30% of renewables firms with transportation applications
reported problems of obtaining funding for R&D. Funding for commercialization of
their technology was experienced over and above the need for R&D funding, since
commercialization involves costly scaling up, and requires a different skill set from
design.

The market failure represented by information asymmetry operated in combination

with entry cost barriers. Information asymmetry prevailed when innovators were in
ignorance of customer needs and customers of technology potential. These small
companies needed to prove to customers that their product worked, through testing,
trials and endorsement, before they could attract customers. It was difficult to achieve
endorsed testing and certification because of cost and lack of testing equipment and
trial sites. These deficiencies in the value chain or business ecosystem denote varieties
of market failure since the market was not providing facilities for which there was
demand. The need to prove their product and pay to have it certified were the most
frequently cited causes of problems to the companies in this study. Renewable energy
companies cited this problem to a lesser extent. Most had products that were not yet
market ready. This may have limited their awareness of testing requirements in
technical assessment costs. There was greater awareness of the need for funding
among pollution prevention and waste and water treatment companies, where products
were nearer to market readiness.

A further barrier to entry was the innovators’ inability to meet existing technical and
building standards because the standards were not intended for their new designs. For
environmental ventures, attracting private finance and partners was difficult without
endorsed test data to demonstrate that their product was approaching certification.

Only six firms cited barriers to entry from the reluctance of public sector purchasers to

9
consider their products as an issue. But this is because the remaining companies in the
study did not view the public sector to be worth approaching as customers for SMEs in
the UK.

Information asymmetries underlie many of the barriers to market entry. For a new and
especially a discontinuous product, the innovator may have to prove to the sceptical
customer that this will be a source of value to them. One reply identified a barrier
specifically in: “The conservatism of the construction industry, leading to resistance to
change and a very long and tortuous process between product specification and actual
sales.” Until a demonstration product and trials are available it will be difficult to elicit
a customer response (Aldrich and Fiol 1994; Florin, Lubatkin et al. 2003). Recognition
of innovations by regulatory authorities or standards bodies lags behind innovations by
ventures. The innovating new firm that proves its ability to create value depends on
early-innovator customers (Rogers, 1995). The new firm may not achieve access to
such customers when oligopsonist retailers control the channels to market. These
market failures do not provide opportunities for entrepreneurs.

2.3 Market failures that impact on the appropriation of returns

Evidence from surveys of the kind cited above is still very limited. But undoubtedly,
realizing business opportunities requires scaling up to the minimum level of efficiency
required for profitability. Problems of scale up are commonly underrated for
innovations, even in large companies.15 Typically, only 0.05% of UK venture capital
investment in clean technology enterprises has been devoted to expansion (Library
House 2005).

The young firm that does achieve expansion of its revenues attracts attention from
imitators who may grind down the innovator's margins before start up and
development costs have been amortized, as Schumpeter anticipated (1928). Well
entrenched companies with traditional substitute technologies have often proved able
to lower their costs on the incumbent technology faster than the new company can
scale up its innovation. This is the reason for deficient markets for emerging
technologies. Investors are also deterred by the prospect that a new entrant investee
could not afford to fight off imitators, should companies with deep pockets infringe

10
their patents.16

Few of the companies in the study were yet profitable. Returns were still to come, but
so were expansion costs. The few environmental companies in this study citing
operational costs as a problem suggests that many of these companies were immature
operationally or intended to license their technology; alternatively they had not
factored in the operational costs of scaling up that lay ahead. New processes are
emerging, such as a new metal purification process offered by a university spin out
company, Metalysis. Such cases revealed both the potential for lowering costs and the
difficulty of cost reduction without prior expansion. Information asymmetry can be
remedied by learning-by-doing. But the ability to estimate scale-up costs for emerging
technologies depends on pilot projects providing learning-by-doing for the industry.
When short term market incentives limit the motivation to set up pilot projects for
emerging technologies this creates an obstacle to market evolution.

Implications of findings for market failure explanations of entrepreneurial

innovation
Many of the obstacles to enterprise identified in the survey can be categorised as
stemming from market failure (the absence of perfect competition together with
inappropriately regulated markets). This evidence supports the traditional welfare
economic view that market failure inhibits new entry (Pigou 1932) rather than
providing openings for new entrants (Dean and McMullen 2007). Obstacles of this
kind persist when conditions reinforce and maintain asynchronies of supply and
demand. That such obstacles are prevalent in conservative, carbon intensive sectors of
heavy industry, transport, construction energy and other utilities explains why
entrepreneurs have not played the role they have performed in other sectors.

However, some gaps between supply and demand provided opportunities for the
companies studied; the case profile evidence reveals how they were able to realize
these opportunities. It has been recognised since the time of Say (1803) that gaps
between supply and demand provide openings for entrepreneurs. This idea is overlaid
by the concept of market failure drawn from equilibrium economics, which sees such
discrepancies as the results of market imperfections. This use of the concept of market
failure obscures an important distinction between supply-demand discrepancies that

11
Case study Bio-fuels EnVal Apaclara Rural Solar Solar Cell Ballard Hyflux

reflect structural and institutional rigidities, and the way leads and lags in supply and
demand are features of the operation of market dynamics. In non-equilibrium
conditions, market dynamics include supply bottlenecks that invite breakthroughs and
demand delays that stimulate novel approaches. Such discrepancies between supply
and demand are critical mechanisms of market evolution.17 Changes in different
sectors are interlinked; thus advances in transport lead to demand for innovations in
communication, and greater ease of communication increases mobility and furthers the
demand for innovations in transport (Rosenberg 1994). Entrepreneurs excel at
detecting opportunities that unfold through market evolution (Nairn 2002). But they
cannot realign supply and demand where rigidities prevent innovation.

To trace the way unusually innovative ventures succeeded in providing new sources of
supply or altering demand, we turn from the survey to evidence from case histories that
can capture perceptions, responses and feedback processes in environmental ventures.

2.4 How environmental innovators realize opportunities for enterprise

While obstacles arising from market failures were revealed in the survey evidence,
case histories are needed to reveal ways in which entrepreneurs addressed constraints,
including market failures. Table 2 lists the experience of eight of our cases, each of
which is summarised in a brief case profile. These cases were selected not as
representative firms, but as exemplars of entrepreneurial innovation taking place in the
face of a variety of constraints emanating from market failure, including the shortage
of investment capital, deficient sources of new components in factor markets, barriers
to consumer access and discrimination against new firms by government procurement
managers.

Table 2. Entrepreneurial innovation among seven case study companies

12
Country UK UK UK Sri Lanka Switzerland Canada Singapore

Opportunity

Newly detected x x x x x x

Created x x x x x x

Reconfigured x x x x x x

Resources

Newly detected x x x x x

Created x x x x x x x

Reconfigured x x x x x x

Business model

Reconfigured x x x x x x

1. In our first example we profile entrepreneurs who reconfigure resources - usually

taking advantage of a change in regulations that altered cost structures. They developd
technologies that met customers’ needs and simultaneously addressed environmental
problems. These environmental entrepreneurs aimed to turn waste materials of little or
negative utility into a source of value. Their emerging high tech technologies held the
potential to contribute to a major shift in the current techno-regime.

The founder of Bio-fuels, Martin Brook, found an opportunity in the lack of market for oil wastes. The
UK government announced a reduction in fuel duty on bio-diesel in 2002, a change in fiscal policy that
provided the potential for bio-diesel to become cost competitive with fossil based fuels in the UK. This
was the trigger for Brook to see a business opportunity to address two environmental issues
simultaneously. He saw from the frequent presence of drain-clearing vans that waste oil was causing
18
expensive drainage problems at schools and elsewhere as it was not being disposed of correctly. Many
years before, he had remarked on the potential for use of vegetable oil as a fuel for vehicles in Africa.
The local school agreed to provide their waste oil to Brook since this removed a disposal problem and
other organisations followed suit. Brook commissioned development work from chemical engineers on a
device to improve the processing of vegetable oil for vehicle use. His initial idea was to run a fleet of
buses on tax-free bio-fuel, but he later reconfigured his plans to aim his business at national rather than
local markets.

13
There was no market for used-drinks cartons in Western Europe, where 650,000 tonnes of this waste
was disposed of in landfill sites. Composed of thin layers of a variety of plastics, paper and aluminium,
such Tetra Pak-style cartons are designed to preserve freshness but create difficulties for recycling. This
results in a loss of 40,000 tonnes of valuable aluminium per year. Councils were being penalised for
contributing to landfill. Moreover aluminium prices were rising. Together these conditions created new
opportunities for recycling. Chemical Engineering professors at the University of Cambridge have
patented and developed a continuous prototype based on microwave induced pyrolysis to recover this
aluminium and set up a new company, EnVal, to commercialize the technology. Success in a university
business plan competition in 2005 provided access to private investors who helped them commercialize
their recycling process to generate industrial grade aluminium.

Apaclara was founded to address deficiencies with supply of fresh waste. It aimed to use
nanotechnology to extract fresh water from seawater. Globally, over 1.1 billion people lack access to
sufficient drinking water, but desalination technologies are currently very costly. Apaclara’s technology
will decrease the costs of water purification using a process known as ‘forward osmosis’ (FO), which
holds the promise of lowering the energy requirements and costs for membrane seawater desalination,
along with increasing source water recovery. Initial economic models comparing traditional seawater
reverse osmosis and forward osmosis found the cost of water would be around 30% less for FO.
Apaclara’s innovative use of macromolecules generates osmotic pressure to drive a membrane
purification process, but the macromolecules can be separated using a field gradient to provide pure
water. The company is currently supported by development grant revenue and is working in partnership
with Cascade Designs of Seattle, Washington to develop a prototype unit. Apaclara will start generating
product revenue by licensing the use of its materials, but there is a longer term opportunity to develop
and manufacture high-performance systems based materials technology developed at Bath and Bristol
19
Universities. Apaclara is establishing an entry market in military and disaster relief activities.

2. If entrepreneurs who created new markets for waste illustrate the reconfiguration of
resources, entrepreneurs also altered their perception of opportunity in the light of
experience, thereby turning constraints to their advantage. This creative process is
revealed in case profiles of companies that discovered new opportunities arising from
the obstacles they faced.

Entrepreneurial engineers in Sri Lanka developed an experimental solar powered water pump for the
irrigation of agriculture land. When the prototypes were demonstrated to farmers, it emerged that the
pump’s capacity was too small for the farmers’ water requirements. But the farmers helped the
company’s founders identify their more pressing need: electricity for lighting and entertainment. The
founders reoriented the business and technology to develop rural solar home systems for Sri Lanka.
When civil unrest prevented the work of their sales and servicing staff, the company trained local village
youth who were paid on a commission basis. The diffused rural network created by Power and Sun’s

14
agents was to prove critical for the sales and maintenance of solar home systems in remote rural areas.
The company was acquired by Shell International in 1999.

In a Swiss solar cell company, the high cost of licensing a solar cell technology led the founders to use
their research network to find ways to negotiate a license on better terms. But difficulties with
development work on the solar cell shifted their business idea to providing materials and services to
other licensees rather than developing the technology themselves. As barriers to commercializing the
licensed technology became more widely recognized, their services became less attractive. However by
then the entrepreneurs had developed competencies which could be applied to other technologies and
markets. Overcoming a series of barriers led the entrepreneurs to build competencies which opened
opportunities for a new solar cell product in the high margin aerospace market.

Ballard Power was founded by the Canadian Geoffrey Ballard who wanted to contribute to a new
energy paradigm. One means of doing so was through advances in fuel cell technology, for which
defence funding was becoming available. However this involved a long term effort when the business
needed immediate revenues. These they obtained from their existing lithium batteries project, on which
they developed competences relevant to fuel cell technology. Over the next few years the founders
diverted funds from the revenue-earning lithium battery division of Ballard into fuel cell development.
When the lithium battery division required an infusion of capital to build manufacturing capabilities they
were able to attract a venture capitalist whose real interest was in fuel cells. He helped the team recruit
an experienced CEO and to transform their company from a contract research business into a world
leader in the fuel cell industry.

An entrepreneur in Singapore turned to international markets to overcome local barriers to entry (Lloyd-
Smith 2004). Olivia Lum, then a young graduate working at a multi-national company, decided to
address the growing global problem of a shortage of clean drinking water and at the same time remove
waste water from the environment. She set up Hydrochem in Singapore in 1989 with seed capital of
USD $12k, based on a new membrane technology to tackle and recover value from waste. But potential
customers in Singapore were not attracted by an innovation supplied by an unknown producer with no
track record. Olivia Lum turned to small firms in Malaysia and persuaded them that her company could
deliver the value they needed, based on the precision engineering of their technology and stringent
project management. Having built a reputation for reliability, the company was ready to penetrate a
larger market by 1993. Olivia Lum approached friends and raised USD $580k as development capital
for Hydrochem and an office in Shanghai. Their first customers in China were Singapore companies
setting up manufacturing facilities there, but they rapidly built up business with Chinese companies.
Within a decade, the company, renamed Hyflux, had been transformed from an unknown start-up to an
established name in Malaysia and China. Now an international company of repute, Hyflux was awarded
the tender to meet some 10% of Singapore’s water needs in 2003, a project valued at around US $200
million. The company was ready for entry into the Middle East market with a strategic alliance to build
a seawater desalination plant in Dubai.

15
Discussion
The case study evidence revealed environmental entrepreneurs facing market failures
that may be insuperable without the kinds of institutional and government backed
change identified by Dean and McMullen (2007 p.43). Entrepreneurs do engage in
lobbying to alter regulations that affect their viability or profitability and to help set up
appropriate regulatory or standards bodies, as illustrated by the case profiles of Solar
Systems, Viridian and Hyflux. But recourse to government support is not a remedy that
is distinctively entrepreneurial. Policy pressure can be exerted more easily by large
established companies. The voice of the small firm is seldom heard in time-consuming
government consultation processes.20 More specifically entrepreneurial is the way
these firms continually readjusted their means-ends calculus to identify new means and
new objectives (new resources and new opportunities), often by realigning their
emergent strategies as they learned more about the regulatory and business
environment.

3. IMPLICATIONS FOR THEORY

In the final part of the paper we re-examine the issue of market failure and the issue of
entrepreneurial ends and means. We show that both issues are related to supply-
demand discrepancies that provide opportunities for environmental innovation.

3.1 Ends and Means Reassessed

The case studies showed that the entrepreneurial means-ends framework is not limited
to reallocating resources by re-assessing price signals as assumed in economic theories
of the role of the entrepreneur (Casson 1982; Shane 2004). Instead, entrepreneurs
explore possibilities using a multi-dimensional calculus that extends into areas where
future value and prices are unpredictable. They identify potential uses of a neglected
resource which inform them of an opportunity, while detected opportunities help
entrepreneurs to recognize what could become a resource.21 This modus operandi

16
makes them receptive to serendipity and to exploiting the unexpected.22 By
reconfiguring their calculus of ends and means, entrepreneurs can reconceptualise
opportunities and the means needed to realize them.

Resource-constrained entrepreneurs are so often thwarted that the entrepreneurial

process must encompass iterative attempts at problem solving.23 When founder-
entrepreneurs cannot obtain the resources they need to implement their idea and
develop the business, they revise their business model, coming up with further new
ideas. This reconfiguration of ends and means to overcome obstacles is much less
likely to occur in established firms where planning and budgeting follow a
predetermined path and where adjustment to new circumstances take longer to effect.

Entrepreneurs’ continual reassessment of both means and ends may be an accelerated

version of rational decision making as embodied in recommendations to specify the
main goal to be achieved, identify and select appropriate means and pursue each of
these means as sub-goals to the predetermined end (Simon and March 1958). However
intuition and serendipity often play a larger part than rational planning in effecting the
experiments that give rise to entrepreneurial innovation.

Further evidence confirming the experimental modus operandi of entrepreneurs is

available from a variety of authors who have recognised the trial and error manner in
which entrepreneurs proceed (Nicholls-Nixon, Cooper et al. 2000). This mode of
operation has been termed strategic flexibility or improvisation (Bhidé 2000),
bricolage and entrepreneurial contingency (Garud and Karnoe 2003; Sarasvethy 2001).
The trial and error approaches of entrepreneurs involve them in continual interaction
with partners who provide resources at the time when they are needed – in return for a
future share in the appropriation of value to come. Through this mode of activity, the
new technology firm connects itself to complementary technological developments
from which it might be closed off by self-sufficiency.

Investors often attempt to turn entrepreneurial ventures into managed projects, and in
doing so restrain rash decisions. But controls of this kind may also reduce decision-
making flexibility and the responsiveness of the entrepreneurial firm to gaps in supply
and to shifts in market opportunity. Entrepreneurs who have decision making

17
autonomy can be continually alert to serendipities and involved in experiments with
new solutions whereby they match resources to emerging market needs (Hugo and
Garnsey 2004).

3.2 Opportunities arise from entrepreneurial responses to market

dynamics

Attention to supply and demand in dynamic interaction, and to rigidities that prevent
change, can offer a more holistic perspective on entrepreneurial innovation than can
the notion of market failure. Some have argued that environmental ventures can seize
opportunities to remedy market failure by lobbying government for the institutional
change needed to promote competitive markets (Dean and McMullen 2007). Yet
lobbying government is a remedy that is not distinctively entrepreneurial, and, indeed,
is particularly difficult for such firms to achieve given their limited resources. In
contrast, traditional welfare economics views market failures as obstacles to
entrepreneurial innovation (Jaffe, Newell et al. 2001). Neither approach identifies what
is distinctive about entrepreneurial innovation. Our case profiles show that this
involves responsiveness to market dynamics and the ability to shift markets by
introducing innovations that change the nature of supply and elicit new forms of
demand. Table 3 summarizes the differences between the neoclassical approach to
market failure and the evolutionary persective offered here.

18
Table 3. Neoclassical versus evolutionary perspectives

Evolutionary view of supply and

Neoclassical view of market failure
demand asynchronies

• The market allocates resources with
optimum efficiency
• The market is automatically self-
adjusting. Market power reflects
consumer preferences.
• No distinction offered between
market failures that inhibit innovation
and those that encourage innovation.
• Supply and demand are continually
moving out of synchrony through the
leads and lags that propel market
evolution.
• Asymmetries of market power are
path dependent and can prevent
innovations that readjust supply and
demand.

• Perfect competition prevents market • Asynchronies between supply and

failure arising from externalities, demand offer opportunities for
information asymmetries, entry innovation where selection forces are
barriers, etc favourable.

• Market failures can be addressed by • Selection forces of the economy

entrepreneurs, in particular by include market structure and power,
lobbying government to ensure financial conventions, institutions and
market competition. regulations. Policy inertia maintains
the current selection regime.

As an example of the limited perspective of the market failure thesis, externalities have
been viewed as obstacles to innovation. This is because investment in new entrants
may be deterred where investors do not gain exclusive returns from investment (Jaffe,
Newell et al 2001). Externalities are a form of market failure in equilibrium
economics: they represent costs incurred by, or benefits conferred on, parties other
than their originators. Under the conditions of perfect competition where market failure
would not occur, externalities would be avoided. However in this world of perfect
competition, the new knowledge created by technical entrepreneurs would not spill
over to the benefit of co-producers, suppliers, complementary producers and
distributors. In theory this would suit investors who want to capture exclusive returns.
But it would inhibit entrepreneurial innovation, which operates by building support
through “spillovers” – or benefits to a variety of parties beyond the firm itself. The
focus on individual firms and investors inherent in the concept of externalities as
market failure obscures how such open innovation processes operate.

The concept of market failure offers a limited perspective on returns when it is focused

19
on short term returns to a specific company and its investors. This view does not
recognize the way entrepreneurs operate as market-makers, their innovations altering
value chains, tapping into latent demand and changing flows of risk capital. The case
profiles showed how entrepreneurial companies with decision-making autonomy used
multiple means to match supply to effective and latent demand in new ways.

The argument that there are opportunities in market failure is undermined by its
underlying assumptions. If market failures were abolished, conditions of perfect
competition would be in place. Information would be symmetrical between buyers and
sellers, benefits would be internalised within the firm – but in consequence there would
be no opportunities for entrepreneurial innovation.

In neoclassical analysis of the market, preoccupation is with price and quantity of

output together with consumer preference in a static context. This overlooks the forces
of institutional and market power governing exchange and the transformative impact of
innovation. To recognize this is to shift focus from market failure as a set of discrete
obstacles to perfect competition onto the way supply and demand continually move in
and out of synchrony. Accordingly, asynchronies between supply and demand provide
opportunities for innovation, while asymmetrical market power and entrenched
structural and institutional barriers inhibit innovation.

Policy guidance is not provided by the idea that ‘market failure provides
entrepreneurial opportunities’ since this cannot distinguish between market failures
that encourage and those that inhibit innovation. For example monopoly pricing as a
market failure can be beaten by cost-reducing entrepreneurial innovations but
monopoly control of consumer outlets constitutes a barrier to entry that is difficult for
new firms to surmount. The focus should be on whether the market failure in question
allows or prevents market dynamics, for it is market dynamics that offer opportunities
for innovation, not market failure as such. But in consequence, the concept of market
failure may be redundant for policy purposes.

In brief, the equilibrium-based concept of market failure was used in this study as an
analytical starting point for examining opportunities and obstacles for environmental
entrepreneurs. Its limitations are tied to its equilibrium connotations. In contrast,

20
entrepreneurs can be seen to make a key contribution to market dynamics by shifting
the innovation landscape (Beinhocker 2005), e.g. by altering value chains and
activating latent consumer preferences. This is the perspective of evolutionary theory,
which seeks to understand the impact on innovation of selection forces (Metcalfe
1998). These are shaped not only by market competition, but also by path dependent
institutional and cultural conditions which policy inertia perpetuates.

There is scope for entrepreneurs to alter selection conditions, perhaps by lobbying

government, as Dean and McMullen advocate, but more profoundly, by altering the
arena of exchange. In the economy, selection is not a blind process. Economic actors –
here entrepreneurs – who understand and respond to the selection forces they currently
face, may alter the economy’s selection regime.24 Entrepreneurs with environmental
innovations that challenge the established carbon-intensive energy paradigm can only
alter market dynamics in favour of a less carbon-intensive economy once their
innovations reap economies of scale. This study has identified many obstacles to
innovative enterprises aiming to achieve this goal. They will prosper only in a
regulatory regime more favourable to their growth and innovative activity. This
requires institutional change ending the structural rigidities of the current selection
regime that promote carbon intensive activity.

21
Endnotes

1 This applies so long as returns from the current activity of established firms are high under current institutional arrangements and
their contribution to the social costs of carbon (Stern 2006) are low (Simms and Woodward 2006).
2 Investor interest in environmental enterprises in the US and the UK’s alternative market (Library House 2005) has resulted in
some very high market valuations in relation to level of business development.
3 The Asia-Pacific Partnership on Clean Development and Climate (AP6) has been promoted as a stimulus to innovative cleaner
technologies http://www.asiapacificpartnership.org/ Criticisms by environmentalists are summarized on
http://news.bbc.co.uk/1/hi/sci/tech/4602296.stm
4 We use terms as follows: entrepreneurial practices constitute entrepreneurship; enterprise is entrepreneurial activity; an
enterprise is the business founded by entrepreneurs; a venture is an immature business (usually pre-profit). Firm is the term for an
enterprise used in economics, company is used in legal language, business in ordinary usage. Terms are interchanged for stylistic
variety. An environmental enterprise refers to one that pursues business opportunities in addressing environmental problems.
Incremental innovation makes step changes within existing technological approaches, which may cumulatively be very significant.
Radical innovations involve discontinuities in technology and achieve depth of impact while generic technologies have breadth of
applications. See Maine and Garnsey 2006 for further definitions of types of innovation.
5 Venkataraman specified that entrepreneurship as a scholarly field “seeks to understand how opportunities to bring into existence
’future’ goods and services are discovered, created and exploited, by whom and with what consequences” (Venkataraman 1997,
p.120).
6 There are situations in which the only way to make one person better off is to make someone else worse off. In Pareto
equilibrium, this point has been reached on all dimensions of exchange.
7 By Samuelson’s (1954) definition, a public good is one “which all enjoy in common in the sense that each individual's
consumption of such a good leads to no subtractions from any other individual's consumption of that good.”
8 It is granted by these authors that theirs is neither an exhaustive nor a mutually exclusive list of market failures. Others include
spillovers (e.g. unpaid for facilities); poor service or monopoly pricing.
9 The term is at variance with ordinary usage in which a market failure refers to a firm as the unit of analysis rather than to the
market as unit of analysis. This contrast between lay usage and neoclassical terminology contributes to confusion in public
discussion of related issues.
10 DTI became BERR (Department for Business, Enterprise and Regulatory Reform) in June 2007, which has since merged with
the Department for Innovation, Universities and Skills (DIUS) to become the Department for Business, Innovation and Skills
(BIS) – July 2009.
11 The cases removed because of deficient data entry in the government survey were similar in size and age to those included,
resulting in a sample dataset not unrepresentative of the SMEs in the larger database.
12 This was the dominant classification scheme used at the time. JEMU has since been subsumed into other government activities.
13 Further information on the case studies is available in Dee, Ford and Garnsey (2006).
14 In support of this opinion, a recent U.K study reported that very few venture capital investors have repeat investments in clean
technology (Library House 2005). Investors may be deterred from repeat investments for a variety or reasons: investments may not
have performed as expected, investment opportunities may be lacking, investors may lack the experience to identify investment
opportunities, or the experience of investing may highlight the need for sector-specific competences to inform clean technology
investments. Investment in clean technology is still dwarfed by investment in other sectors despite recent investor interest. In 2007
energy technology investments formed 9.1% of total venture capital investments in U.S. based companies, compared to 5.9% in
2006 (Makower, Pernick et al. 2008).
15 Other examples of the costs of scale up are provided in Maine and Garnsey (2006) and in Lim, Garnsey and Gregory (2005).
16 The company from which Apaclara originated provides an example of this (see case studies).
17 Metcalfe finds it inappropriate that the term market failure is used to refer to the very features of dynamic markets that make
possible innovation and renewal (Metcalfe 2004).
18 Waste oil is classed as a hazardous waste and requires collection in specialist containers for controlled disposal. This is a paid
service which is rarely sought.
19 Information supplied by the CEO, Dr Eric Mayes.

22
20 See for example the dominance of large organizations and absence of SME perspectives in the consultation process undertaken
by the DTI over the European Emissions Trading Scheme, http://www.defra.gov.uk/news/2006/060515a.htm However the recent
UK Budget (2008) has recognised that government procurement could provide more opportunities for SMEs, as a result of
lobbying in favour of SMEs.
21 That entrepreneurs create opportunities as well as discovering them is recognised by writers on entrepreneurship who take a
Schumpeterian rather than a Kirznerian perspective (Ardichvili, Cardozo et al 2003).
22 This requires tolerance of ambiguity in committing to a line of action and yet shifting to another if the first proves fruitless.
Entrepreneurs are very diverse in personality, but need for achievement and tolerance of ambiguity are common traits (Bhidé
2000).
23 The analytic distinction between pre-venture (nascent enterprise) and post-venture activity in some of the entrepreneurship
literature (e.g. Reynolds and White 1997) does not accommodate the extent to which opportunities arise through efforts to resource
their exploitation.
24 The pharmaceuticals and telecommunications sectors, for example were rendered more favourable to entrepreneurial innovation
by institutional and regulatory change brought about in part through the proactive behaviour of entrepreneurial ventures.

23
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