Exploration, exploitation and adaptive rationality: the neo-Schumpeterian perspective

Abstract

Resource allocation between exploration of emerging technological possibilities and exploitation of known technological possibilities involves a delicate trade-off. We develop a model to represent this trade-off under the time-pressing situation where the firm’s existing basis of survival is constantly challenged by competitors’ innovation and imitation. We examine how the employment of an adaptive rule improves a balance between the exploration and the exploitation. Simulation experiments show that an adaptively rational decision rule, or a step-by-step exploration of unknown opportunities based on feedback on returns, is more likely to increase firm survival under diverse conditions than an all-or-nothing approach regarding the unknown opportunities. Furthermore, our study suggests that the adaptively rational rule is self-protected from too much loss, while its potential pay-off can be unbounded above.