Entrepreneurship for All, big and small

With the rhetorical overuse of terms like “let the market decide” being used in campaigns and debates I think it would be beneficial to define what real markets look like and when market forces work. Markets are neither magic nor wise. It is a term that describes the cumulative effect of a number of individual decisions made by real individuals.

I currently live in Cleveland where the economy is particularly bad but there is a very real market. The West Side Market has been a place where indicidual vendors come to compete for market share to a very real and identifiable “addressable market.” namely the very real humans that present themselves, cash in hand.

This market has worked very well for a long time because consumers can go there, review a range of choices for the goods they would like to purchase and make individual and relatively well-informed decisions as to which vendor they will use and what price they will pay.

This all works because the consumer who benefits from the purchase has informed choices.  It is very nearly the perfect theoretical market:

• Choice with frictionless switching
• Visibility of options
• Understanding of value by the consumers
• Feedback from consumers, usually in the form of switching

Lots of consumer goods end up having to make their way in a market with all these attributes, but most “markets” are not so well-formed and lack one or more of these criteria.  There is no “healthcare market” per se because almost no consumer has frictionless choice, visibility of options, understanding of value or any meaningful feedback except perhaps for lawsuits.  0 for 4.

As entrepreneurs, we often try to play against markets to gain at least initial advantage.  We do this because efficient markets drive down price and when you are starting up this is, obviously, undesirable. Once again, we can point to the  healthcare system as an example of what happens when there aren’t sufficient market attributes in place: prices rise uncontrolled.

Being first-to-market with anything can eliminate a couple of those attributes or at least mute them a bit.  Use this advantage to get to a place where you have what you need to compete in a more mature market (like efficient processes, optimized supply chains, or a ton of brand loyalty) – or even better, cannibalize your own market regularly and at a time of your own choosing.

The last bit that I’ll relate here is that markets have, historically, limited how fast things can increase in value.  If something is increasing in value for an extended period of time at better than 15%, you probably have a bubble caused by an inefficient market.

For the last thirty years, the economy has been slowly taken over by pirates, thieves, and terrorists.

The economy – even before we called it that – always had a diverse set of participants. There have always been those who gathered raw materials, those who manufactured things from raw materials, those who traded in things of value and those who financed parts of the process. There have also always been those who made their living by disrupting this otherwise harmonious flow of value, namely: pirates, thieves and terrorists.

Value and Wealth must stay connected

If we go back a few generations – three for me – all these roles were what we would now call vertically integrated. The Quaker farmers of my ancestry were soloists in the world  of commerce, as most people were back then. They gathered, built, and traded and maintained a keen sense of the market value of things because they lived and died by it. When things are on this simple level you can depend on “market forces” to keep the market players in line. Another way of describing those market forces is to say that wealth (things that represent economic possibilities like having 1 dollar in your pocket or owning something you can sell or use) must move somewhat proportionally to value. If you make something more valuable you see more return.  Defining value can be squishy and fluid – you know this if you are underwater on your mortgage. Lots of factors effect value. During a drought a gallon of water can fetch a better price than during a flood.  The newest iPod that retails for $249 is worth lots more than a new, still in the original packaging iPod that retailed at $249 two years ago. Under the right circumstances you might say “My kingdom for a horse.”The point is that a healthy capitalist economy requires that value and currency flow roughly together.  When they don’t, bad things happen.

If you are a farmer who has just sold your crop at a market, but get robbed on the way home, you no longer have the capital to grow the next crop.  That farmer suffers most, but everyone else does too. Suddenly there is less of that crop in the market place next year.  Costs rise for those who use the crop so funds must be diverted from other things or they buy less of it. If these buyers were making something to sell with that crop they are either making less of that thing, need to charge more for their product, or take less of a profit – the profit that they would use to invest in replacing tools or buying supplies. The ripples flow endlessly.

This is why human societies established law enforcement. Someone needs to stand in the way of these troublemakers or the whole thing falls apart because no one can predict what anything will really be worth.

For me, the economic troublemakers come in three basic flavors: pirates, thieves, and terrorists

Pirates

Pirates, by my definition, are those who absorb value from the flow of value. They position themselves in the path of delivery, real or virtual, and take whatever crosses their path. They obtain wealth from value transitioning from one entity to another. They tend to be indiscriminate of what types of wealth they take. This is a crime of structural opportunity. The ocean is vast, hard to patrol, and there are lots of places to run after the crime.

Thieves

Thieves target specific things that they want to have and take them by whatever means.Thieves obtain wealth from things that are supposed to be someplace in particular. Thieves take things out of cars, houses, and, increasingly often, the public coffers.  If you were to, say, contract with government, caretakers of the public coffers, to provide a service and that service fails to provide any value, then it is thievery.

Terrorists

Terrorists destroy value. Usually they are a proxy for someone else who sees some tangential gain from the destruction. Destroying someone’s business so yours will have less competition – that is an act of terrorism.

How they took over

If capitalism were a religion, piracy, thievery, and acts of terrorism would be sins. Unfortunately, we have confused capitalism and sinful capitalism. We have come to accept immoral activity that generates profit as acceptable, if not laudable, behavior. The truth is, however, that our willingness to accept these behaviors and not make them illegal or regulate against them, have created a randomness to the economy – rewarding all the wrong people far too often.

Pirates, Thieves and Terrorists have always existed in the economy but today they take new forms. In a large, complex, and mostly electronic economy there are lots of places to hide.  If there is no law enforcement in place, pirating or thievery start to look pretty enticing. Particularly pirating, is much easier than trying to create value on your own.

Unfortunately, these forces of economic destruction have grown so large that we have forgotten that they are dark forces instead of the norm.  Market forces cannot impact complex transactions.  The feedback loop that keeps markets efficient doesn’t exist when the buyers and sellers don’t have any access to understanding their choices or feeling the impact of their decisions. We need other players in the market – regulators of some form – to be the arbiters of safe value.

One way to keep from making the basic mistakes that kill most start-ups is to remain engaged with mentors. Notice the s on the end.  A proper mentor can offer a couple of things:

• Expertise in things you are less knowledgeable in (see the Golden Boy sin)
• Perspective on short-term problems: It’s nice to have someone who is not embroiled in whatever you are facing to help you
• Long term dedication to your strategy
• Grown-up logic

There are many versions of the old adage, “When the economy catches a cold, the poor have pneumonia.”

Who is spending and who is hurting?

A poll on LinkedIn asking about business spending patterns shows a wide range of responses to how much the economic downturn is effecting spending patterns (self-reported) of businesses.  At last look, 100% of those in large enterprises reported that the economy had no effect on their spending, while 76% of those in small businesses report that they are scaling back or operating on necessities.

I hate to be grumpy about this, but I have to make these two points:

1. An awful lot of money was pumped into the economy – guess where it went. Large enterprise, though it is easy to write just one large check rather than thousands of small ones, do not represent either most of the spending or most of the jobs in the economy.
2. The small businesses are the ones that innovate, create substantial new value, and are most at risk of failure.

Healthcare socialism would benefit small business substantially. Bail-out socialism helps only those at the top.

This is another handy chart form McKinsey. It is very easy to feel like all you can do is cut costs right now, but the truth is, this is a great time to go after new customers if you have some resources.