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Schumpeter’s Gales Of Creative Destruction

on September 16th, 2008

The expression "creative destruction" derives from the Austrian economist Joseph Schumpeter’s book, Capitalism, Socialism and Democracy, published in 1942. He coined the phrase to describe the process of change that accompanies innovation. In the book Schumpeter commented that capitalism:

…incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in and what every capitalist concern has got to live in…

He goes on to say that:

Every piece of business strategy acquires its true significance only against the background of that process and within the situation created by it. It must be seen in its role in the perennial gale of creative destruction; it cannot be understood irrespective of it or, in fact, on the hypothesis that there is a perennial lull.

Schumpeter’s view on capitalism was that innovations by entrepreneurs are the force that sustains long-term economic growth, even as it destroys the value of established companies. If you look around it’s not hard to see evidence of this creative destruction; vinyl records were replaced by cassette tapes, which were in turn replaced, by CDs which in their turn are being replaced by MP3s which is leading to the destruction of the music industry as we know it and the emergence of a new style of music industry, one which is shaped by the low cost of worldwide digital distribution which has been facilitated by the Internet.

The current financial climate (credit crunch) will no doubt result in a considerable level of creative destruction within the banking industry as new processes are established to measure, manage and mitigate risk, new products are developed to share that risk and new areas of profitability sought.

So how does this affect you as someone looking for a business opportunity or a business idea? Well as note by a former US treasury secretary "the economy of the future is likely to be ‘Schumpeterian’", with creative destruction the norm and innovation the main driver of wealth. I’d agree with him and it seems we’re seeing this already.

Typically modern products are based on intellectual property – music, software, pharmaceuticals. These require an considerable up front investment to develop and market but very little to produce. They’re also often subject to network effects, which reward those that achieve critical mass by creating the blockbusters. Taken together, these factors – high cost to create, minimal cost to produce, and the winner-take-all environment – the result tends to be a natural monopoly, at least until the next innovation comes along and the cycle of creative destruction starts all over again.

Creative destruction can take on a number of forms:

  • New markets/products.
  • New equipment.
  • New sources of labour or raw materials.
  • New methods of organisation or management.
  • New methods of inventory management.
  • New methods of distribution.
  • New methods of communication.
  • New methods of advertising and marketing.
  • New financial instruments.
  • New political lobbing or new legal strategies.

Considering each can reveal new business opportunities, or new opportunities for existing businesses. It’s up to you as an entrepreneur to identify and execute them.

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  • 1

    I agree. These economic forces make our economies what they should be in the long run, though the short term pain we have to go through seems hardly worth it.

    We are struggling here in America, as well I believe you are in the UK. We will survive…

    …if the regulators let the market do its job.

    Thanks, Jason M. Blumer

    Thriveal on September 17th, 2008
  • 2

    From what I’ve read Schumpeter rather feared that regulation would harm capitalism.

    Something you’ve got to hope the regulators take into account…

    John on September 17th, 2008
  • 3

    Schumpeter’s creative destruction theory is a reality here in Kenya where I live.

    Where before companies were bloated, nowadays most of the enterprises are small and medium. Entrepreneurs have had to be innovative in how they ensure their business survival.

    For instance, if one walks around Nairobi’s central business district, you find many retail stalls instead of established shops. One thing these stalls have in common is that they either sell electronics or clothing , and are mainly managed by youth entrepreneurs.

    By starting small these enterprises have changed the way business is done in Kenya.

    Fiona Mati on September 22nd, 2008


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