Joseph Schumpeter formulated the Innovation Theory of Profits. According to this theory, the entrepreneur gets profits only by introduction of innovations. The primary responsibility of entrepreneur is to introduce innovations in the production process which may give rise to profits.
Changes relating to the production process and marketing are called innovations. Entrepreneur introduce innovations in order to increase the gap between cost of production and price and this will lead to more profits. Following are some of the innovations
1. Implementation or introduction of new techniques in the production process.
2. To improve managerial techniques.
3. To utilize new raw-materials in the production. process.
4. To bring out change in the quantity and quality of the product.
5. To introduce new methods in the marketing.
The above innovations keep the entrepreneurs in a better position than other entrepreneurs and fetch more profits. But the profits arise due to the innovations may not prevail in the long run. Whenever, entrepreneur introduces innovations, the other entrepreneurs will also try to introduce some more innovations in order to maintain abnormal profits even in the long run. There will be ups and downs in the profits of the entrepreneurs. According to Schumpeter, there will be a relation between changes in the economy and profits. In this aspect, there is close relation between J. B. Clark theory and Schumpeter’s theory.
Various changes are responsible for the formation of profits in the view of J. B. Clark. But only innovations are responsible for profits in the view of Schumpeter. According to Schumpeter risk-bearing is the responsibility of capitalist but not the entrepreneur. In this aspect Schumpeter’s theory is quite against to F. H. Knight theory.
Criticism of Innovation Theory of Profit:
Schumpeter theory is subjected to the criticism on the following grounds :
1. This theory concentrates only on innovations for occurring profits. But there are so many other factors which may also influence profits in addition to innovations. So this theory failed to provide a comprehensive explanation of profits.
2. According to this theory, capitalist is the risk bearer. But this is contrary to facts. It is the entrepreneur, not the capitalist, who takes risk.
3. This theory takes a very narrow view of the functions of the entrepreneur. The function of entrepreneur is not merely to introduce innovations, but he is equally responsible for the proper organization of business.