Category: Entrepreneurship

Behavioral Economics Does Not Undermine Capitalism

thinkingfastandslowBK2012-06-21.jpg

Source of book image: http://www.brainpickings.org/wp-content/uploads/2011/10/thinkingfastandslow.jpg

Daniel Kahneman first gained fame in economics through research with Tversky in which they showed that some of economists’ assumptions about human rationality do not always hold true.
Kahneman, whose discipline is psychology, went on to win the Nobel Prize in economics, sharing the prize with Vernon Smith. (Since the Prize is not normally awarded posthumously, Tversky was not a candidate.)
I have always thought that ultimately there should be only one unified science of human behavior—not claims that are “true” in economics and other claims that are “true” in psychology. (I even thought of minoring in psychology in college, before I realized that the price of minoring included taking time-intensive lab courses where you watched rats run through mazes.)
But I don’t think the implications of current work in behavioral economics are as clear as has often been asserted.
Some important results in economics do not depend on strong claims of rationality. For instance, the most important “law” in economics is the law of demand, and that law is due to human constraints more than to human rationality. Gary Becker, early in his career, wrote an interesting paper in which he showed that the law of demand could also be derived from habitual and random behavior. (I remember in conversation, George Stigler saying that he did not like this paper by Becker, because it did not hone closely to the rationality assumption that Stigler and Becker defended in their “De Gustibus” article.)
The latest book by Kahneman is rich and stimulating. It mainly consists of cataloging the names of, and evidence for, a host of biases and errors that humans make in thinking. But that does not mean we cannot choose to be more rational when it matters. Kahneman believes that there is a conscious System 2 that can over-ride the unconscious System 1. In fact, part of his motive for cataloging bias and irrationality is precisely so that we can be aware, and over-ride when it matters.
Sometimes it is claimed, as for instance in a Nova episode on PBS, that bias and irrationality were the main reasons for the financial crisis of 2008. I believe the more important causes were policy mistakes, like Clinton and Congress pressuring Fannie Mae and Freddie Mac to make home loans to those who did not have the resources to repay them; and past government bailouts encouraging finance firms to take greater risks. And the length and depth of the crisis were increased by government stimulus and bailout programs. If instead, long-term cuts had been made in taxes, entrepreneurs would have had more of the resources they need to create start-ups that would have stimulated growth and reduced unemployment.
More broadly, aspects of behavioral economics mentioned, but not emphasized, by Kahneman, can actually strengthen the underpinnings for the case in favor of entrepreneurial capitalism. Entrepreneurs may be more successful when they are allowed to make use of informal knowledge that would not be classified as “rational” in the usual sense. (I discuss this some in my forthcoming paper, “The Epistemology of Entrepreneurship.”)
Still, there are some useful and important examples and discussions in Kahneman’s book. In the next several weeks, I will be quoting some of these.

Book discussed:
Kahneman, Daniel. Thinking, Fast and Slow. New York: Farrar, Straus and Giroux, 2011.

The Becker article mentioned above is:
Becker, Gary S. “Irrational Behavior and Economic Theory.” Journal of Political Economy 70, no. 1 (Feb. 1962): 1-13.

The Stigler-Becker article mentioned above is:
Stigler, George J., and Gary S. Becker. “De Gustibus Non Est Disputandum.” American Economic Review 67, no. 2 (March 1977): 76-90.

Sam Walton Was “America’s Greatest Entrepreneur of the Twentieth Century”

(p. 194) Sam Walton is my pick for America’s greatest entrepreneur of the twentieth century.
He not only built the world’s largest retailing empire and the single most valuable company in America, he created the institution with the greatest muscle to do good today.

Source:
Wyly, Sam. 1,000 Dollars and an Idea: Entrepreneur to Billionaire. New York: Newmarket Press, 2008.

Ben Franklin Stores as Incubators of Retail Success

(p. 192) The chain was called Michaels. I’d never heard of it but, as George related its ancestry, I became more and more intrigued. You see, once upon a time it had been a Ben Franklin store, and therein lies a story.
Back in 1877, Edward and George Butler, brothers from Boston, came up with a new concept for retailing. Instead of setting up a specialty shop to sell one line of items–like shoes or dresses or kitchen supplies–they set up a store where they could sell all sorts of stuff. This was the very beginning of department stores, except that they weren’t yet called that. They were called variety stores, and they carried a large assortment of low-cost goods. Then the Butlers set up a “five-cent counter,” where everything cost a nickel. It worked in Boston, so they expanded westward and called it Ben Franklin Stores.
Three-quarters of a century later, in the days when America was just starting to move westward with the automobile, there were no shopping malls or big national retail chains. What you found in every town, especially in small-town America, was a variety store, like Ben Franklin’s. In Lake Providence, we had Morgan and Lindsey’s, where you could buy everything from paper napkins to thimbles, birthday cards, curtain hooks, and boxes of chocolates. The Butlers’ idea of a nickel counter became so popular and widespread that these places came to be nicknamed “five-and-dimes” or “five-and ten-cent” stores.
(p. 193) While some of them became the heart of Main Street America, others grew to become legendary department stores, like Macy’s in New York, Wanamaker’s in Philadelphia, and Lehman’s in Chicago. Still others merged into chains to compete with Ben Franklin Stores. That’s how JC Penney’s was born.

Source:
Wyly, Sam. 1,000 Dollars and an Idea: Entrepreneur to Billionaire. New York: Newmarket Press, 2008.

For Federal Regulators “It’s Easier Not to Approve than to Approve”

LauthXavierAquacultureScientist2012-06-04.jpg “Xavier Lauth, a scientist, working with zebra fish in a lab at the Center for Aquaculture Technologies.” Source of caption and photo: online version of the NYT article quoted and cited below.

(p. B1) SAN DIEGO — If Americans ever eat genetically engineered fast-growing salmon, it might be because of a Soviet biologist turned oligarch turned government minister turned fish farming entrepreneur.

That man, Kakha Bendukidze, holds the key to either extinction or survival for AquaBounty Technologies, the American company that is hoping for federal approval of a type of salmon that would be the first genetically engineered animal in the human food supply.
But 20 months since the Food and Drug Administration tentatively concluded that the fish would be safe to eat and for the environment, there has been no approval. And AquaBounty is running out of money.
Mr. Bendukidze, the former economics minister of Georgia and AquaBounty’s largest shareholder, says the company can stay afloat a while longer. But he is skeptical that genetically altered salmon will be approved in the United States in an election year, given the resistance from environmental and consumer groups.
“I understand politically that it’s easier not to approve than to approve,” Mr. Bendukidze said during a recent visit to a newly acquired laboratory in San Diego, where jars of tiny zebra fish for use in genetic engineering experiments are stacked on shelves. While many people would be annoyed by the approval, he said, “There will be no one except some scientists who will be annoyed if it is not approved.”
. . .
(p. B6) Mr. Bendukidze, 56, began his career as a molecular biologist in a research institute outside Moscow, working on genetically engineering viruses for vaccine use. He later started a company selling biology supplies. When parts of the Soviet economy were privatized, he earned a reputation as a corporate raider, building through acquisitions and leading United Heavy Machinery, a large maker of equipment for mining, oil drilling and power generation.
In 2004, Mr. Bendukidze returned to his native Georgia as economics minister under Mikheil Saakashvili, the newly elected president. With a free-market philosophy and a penchant for insulting those who disagreed with him, Mr. Bendukidze earned his share of enemies as he moved to deregulate and privatize the economy.
He still lives in Georgia and now spends his time as chairman of the Free University of Tbilisi, which he founded. He also set up Linnaeus Capital Partners to manage his money. It has increasingly focused on aquaculture, with stakes in companies in Greece, Israel and Britain, in addition to AquaBounty.

For the full story, see:
ANDREW POLLACK. “An Entrepreneur Bankrolls a Genetically Engineered Salmon.” The New York Times (Tues., May 22, 2012): B1 & B6.
(Note: ellipsis added.)
(Note: the online version of the article has the date May 21, 2012.)

BendukidzeKakhaEntrepreneur2012-06-04.jpg “Kakha Bendukidze acquired the lab after agreeing to give AquaBounty more cash.” Source of caption and photo: online version of the NYT article quoted and cited above.

Michael Milken Provided “Access to Capital for Growing Companies”

(p. 163) Although [high yield] . . . bonds eventually became known as a favored tool for leveraged–buyout specialists in the 1980s, Mike’s original goal was different. He wanted to provide access to capital for growing companies that needed financing to expand and create jobs. Most of these companies lacked the investment grade” bond ratings required before the big financial institutions would back them. Mike knew that non-investment-grade (a k a “junk”) companies create virtually all new jobs, and he believed that helping these companies grow strengthened the American economy and created good jobs for American workers.
It was by studying credit history at Berkeley in the 1960s that Mike developed his first great insight. He found that while there could be significant risk in any one high-yield bond, a carefully constructed portfolio of these assets produced a consistently better return over the long run than supposedly “safe” investment-grade debt. This was proved during the two decades of the 1970s and ’80s when returns on high-yield bonds topped all other asset classes. Mike saw a great opportunity when he realized that the perception of default risk far exceeded the reality. In fact, these bonds had a surprisingly low-risk profile when adjusted for the potential returns.
After twenty years of superior gains, the high-yield bond market finally fell in 1990. Actually, it didn’t fall–it was pushed by unwise government regulation that forced institutions to sell their bonds. The dip only lasted a year, however, with the market roaring back 46 percent in 1991.
Mike’s competitors–Goldman Sachs, Morgan Stanley, and Credit Suisse First Boston, the old oligopolies of the syndication (p. 164) business–labeled them “junk bonds” to disparage Mike’s brainchild. He was not a member of their white-shoe club and they were not going to take his act lying down.

Source:
Wyly, Sam. 1,000 Dollars and an Idea: Entrepreneur to Billionaire. New York: Newmarket Press, 2008.
(Note: bracketed words and ellipsis added.)

Entrepreneurs Should Seek Problems, Not Opportunities

McKelveyJimEntrepreneurBig2012-06-02.jpg “Jim McKelvey drew on experiences as a businessman and glassblower in his speech at Big Omaha 2012.” Source of caption and photo: online version of Macy Koch, “Jim McKelvey: “Just go ahead and build it”.” Silicon Prairie News. (Thursday May 10, 2012).

(p. 2D) The dynamics of the glass-blowing industry changed when a new, smaller version of the traditional glass-blowing furnace was developed. The economics of glass-blowing suddenly changed.

But as McKelvey’s glass-blowing skills grew and as he developed more products, including a patented glass water faucet, another barrier emerged: access to the financial system.
At one point, McKelvey was about to sell one of his faucets. The customer wanted to pay with an American Express credit card, but McKelvey couldn’t accept it without the requisite hardware. The sale fell through.
McKelvey then had a problem he needed to solve: Why wasn’t there a way to accept payments on a smartphone?
So he teamed up with Jack Dorsey, a co-founder of Twitter who worked with McKelvey at Mira, to start Square, which allows users to accept payments through their phones.
It was an idea that tackled a problem, McKelvey said, suggesting to attendees: “Go out there and seek problems. Don’t look for opportunities.”

For the full story, see:
Ross Boettcher. “Traveling the Road to Innovation; A former ‘Quitter’ and Others Offer tips at the Big Omaha Conference.” Omaha World-Herald (Fri., May 11, 2012): 1D & 2D.
(Note: the online version of the article has the title “Many roads to innovation at Big Omaha.”)

McKelveyJimEntrepreneur2012-06-01.jpg

“”Go out there and seek problems. Don’t look for opportunities.” Jim McKelvey, co-founder of Square.” Source of caption and photo: online version of the Omaha World-Herald article quoted and cited above.

In Antitrust, as in Medicine, First Do No Harm

(p. 94) Western Union’s lawyers carne up with a dusty old New York Stale law, dated 1905, that said no one could buy more than 10 percent of a telegraph company chartered in that state without the approval of Albany lawmakers. Hard to believe, but it was right there in black and white and there was no possibility of getting the New York State legislature to understand why it was vital to build digital highways.
Talk about unintended consequences!
(p. 95) Originally, the law was written to stop Western Union from monopolizing the telegram business, but the law backfired and was used by the monopolist for its own protection.

Source:
Wyly, Sam. 1,000 Dollars and an Idea: Entrepreneur to Billionaire. New York: Newmarket Press, 2008.

Lucasfilm Will Build Somewhere “That Sees Us as a Creative Asset, Not as an Evil Empire”

LucasValleyMarinCounty2012-05-30.jpg “Lucas Valley in Marin County, Calif., where residents’ objections led George Lucas to abandon a bid to expand operations at a new site near Skywalker Ranch.” Source of caption and photo: online version of the NYT article quoted and cited below.

(p. A13) SAN RAFAEL, Calif. — In 1978, a year after “Star Wars” was released, George Lucas began building his movie production company far from Hollywood, in the quiet hills and valley of Marin County here just north of San Francisco. Starting with Skywalker Ranch, the various pieces of Lucasfilm came together over the decades behind the large trees on his 6,100-acre property, invisible from the single two-lane road that snakes through the area.

And even as his fame grew, Mr. Lucas earned his neighbors’ respect through his discretion. Marin, one of America’s richest counties, liked it that way.
But after spending years and millions of dollars, Mr. Lucas abruptly canceled plans recently for the third, and most likely last, major expansion, citing community opposition. An emotional statement posted online said Lucasfilm would build instead in a place “that sees us as a creative asset, not as an evil empire.”
If the announcement took Marin by surprise, it was nothing compared with what came next. Mr. Lucas said he would sell the land to a developer to bring “low income housing” here.
. . .
Whatever Mr. Lucas’s intentions, his announcement has unsettled a county whose famously liberal politics often sits uncomfortably with the issue of low-cost housing and where battles have been fought over such construction before. His proposal has pitted neighbor against neighbor, who, after failed peacemaking efforts over local artisanal cheese and wine, traded accusations in the local newspaper.
The staunchest opponents of Lucasfilm’s expansion are now being accused of driving away the filmmaker and opening the door to a low-income housing development. That has created an atmosphere that one opponent, who asked not to be identified, saying she feared for her safety, described as “sheer terror” and likened to “Syria.”
Carl Fricke, a board member of the Lucas Valley Estates Homeowners Association, which represents houses nearest to the Lucas property, said: “We got letters saying, ‘You guys are going to get what you deserve. You’re going to bring drug dealers, all this crime and lowlife in here.’ “

For the full story, see:
NORIMITSU ONISHI. “A Pyrrhic Victory for Foes of a New Lucasfilm Project; In Lieu of digital Studio, Plan for Low-Income Homes.” The New York Times (Tues., May 22, 2012): A13 & A19.
(Note: ellipsis added.)
(Note: the online version of the story is dated May 21, 2012 and has the title “Lucas and Rich Neighbors Agree to Disagree: Part II.”)

LucasGeorge2012-05-30.jpg “Mr. Lucas said Marin needs affordable housing. A resident called his plan “class warfare.”” Source of caption and photo: online version of the NYT article quoted and cited above.

“Innovation” Should Be Reserved for Electricity, Printing Press, Telephone and iPhone

LightBulbInnovationGraphic2012-05-29.jpg Source of graphic: online version of the WSJ article quoted and cited below.

(p. B1) “Most companies say they’re innovative in the hope they can somehow con investors into thinking there is growth when there isn’t,” says Clayton Christensen, a professor at Harvard Business School and the author of the 1997 book, “The Innovator’s Dilemma.”
. . .
Scott Berkun, the author of the 2007 book “The Myths of Innovation,” which warns about the dilution of the word, says that what most people call an innovation is usually just a “very good product.”
He prefers to reserve the word for civilization-changing inventions like electricity, the printing press and the telephone–and, more recently, perhaps the iPhone.
. . .
Mr. Berkun tracks innovation’s popularity as a buzzword back to the 1990s, amid the dot-com bubble and the release of James M. Utterback’s “Mastering the Dynamics of Innovation” and Mr. Christensen’s “Dilemma.”
. . .
(p. B8) Mr. Christensen classifies innovations into three types: efficiency innovations, which produce the same product more cheaply, such as automating credit checks; sustaining innovations, which turn good products into better ones, such as the hybrid car; and disruptive innovations, which transform expensive, complex products into affordable, simple ones, such as the shift from mainframe to personal computers.
A company’s biggest potential for growth lies in disruptive innovation, he says, noting that the other types could just as well be called ordinary progress and normally don’t create more jobs or business.
But the disruptive innovations can take five to eight years to bear fruit, he says, so companies lose patience.
It is far easier, he adds, for companies to just say they’re innovating. “Everybody’s innovating, because any change is innovation.”

For the full story, see:
LESLIE KWOH. “You Call That Innovation? Companies Love to Say They Innovate, but the Term Has Begun to Lose Meaning.” The Wall Street Journal (Weds., May 23, 2012): B1 & B8.
(Note: ellipses added.)

“I Can’t Explain Strategy at the Same Time that I’m Inventing It”

(p. 75) I felt deceived. I felt betrayed. Their 51 percent control could be like working for IBM or Honeywell again. I felt a threat to the most important value I was seeking: independence. I had to ask myself “Do I say no? Or do I say yes and accept their contract, even though it isn’t what we shook hands on and it makes me uncomfortable?” “This was a major difficulty for me. The 51 percent issue is at the very core of what every entrepreneur is trying to do: control his own destiny.
We were talking about my company. I dreamed it up. I put it together and I was going to run it. I was not going to hand it over to some committee of lawyers and accountants. But neither could I let anger get hold of me.
I knew that “those whom the gods would destroy, they first make angry.” That said, not getting angry does not mean not being firm. So I firmly told Jerry, “I want to run this company. I don’t have time to sit around and explain to your staff what I’m doing. No offense, but they don’t know beans about what I’m (p. 76) trying to do, and neither do you, for that matter. I’ve got to be able to run this business. I can’t explain strategy at the same time that I’m inventing it.”

Source:
Wyly, Sam. 1,000 Dollars and an Idea: Entrepreneur to Billionaire. New York: Newmarket Press, 2008.