From Arms to Trees: Opportunity Costs and Path Dependence and the Exploration-Exploitation Tradeoff

Abstract

The literature on the exploration-exploitation tradeoff has anchored on the n-armed bandit problem as its canonical formal representation. This structure, however, omits a fundamental property of evolutionary dynamics. Contrary to a bandit formulation, foregoing an opportunity may negate the possibility of engaging in that opportunity in the future, not just modifying the beliefs about the attractiveness of engaging in that opportunity. Thus, the bandit structure only incorporates path dependence with respect to beliefs and not with regard to capabilities as our usual conceptions of dynamics of learning and capabilities would suggest. Furthermore, the consideration of opportunity cost is rather static and does not address the dynamic unfolding of opportunity structures. The nature of path dependence and opportunity costs are used to frame many of our existing conceptualizations of search processes and firm dynamics, including bandit models, real options, pivoting, the “secretary problem,” and “island” models of firm diversification. The discussion points to the need to develop canonical models of what evolutionary biologists’ term phylogenetic trees and opens up a set of new questions, such as what is the degree of parallelism of trajectories that is possible within an organization, what is the fecundity of different trajectories in terms of likelihood of branching possibilities arising, and how are these latent branching opportunities accessed?