40. Peter Klein: 10 Fundamentals Of Economics On Which To Build A Successful Customer-First Business

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Our proposition is that the fundamentals of economics – a special humanistic, individualistic, entrepreneurial economics we call Austrian – can be the building blocks of a successful, growing, profitable business that understands and therefore delights its customers. Can you identify these fundamentals?

Key Takeaways And Actionable Insights

Menger Principles of Economics CoverProfessor Peter Klein teaches entrepreneurship based on fundamental Austrian principles from Carl Menger’s Principles Of Economics. His advice is unlike anything you’ll get from studying mainstream economics, or from business books and business school classes. In our podcast, Peter explains the fundamentals of economics under ten headings. We transform that economic knowledge into entrepreneurial guidance below and as a free PDF download.

Humanism: Business is about serving others, making their lives better. You can engage customers by understanding their hopes and dreams and their highest aspirations. Make humanism the foundation of your business strategy.

Individualism: To understand customers, you must approach them as individuals, not as “targets” or “segments” or “demographics”. Individualism is a methodology: identify one perfect customer and then try to add more that are closely similar.

Means and Ends: Customers choose products and services that they believe will serve them as means to achieve their preferred ends or goals. Use means-ends analysis to identify the pathways customers will follow to embrace your offering. Think of it as the customer’s journey through a valued experience that you can make possible for them. (Our free e-book, Understanding The Mind Of The Customer can help.)

Subjective Value: Value is an experience felt by the customer. It’s subjective and idiosyncratic, and can change with time and context and mood. Entrepreneurs must be empathic in diagnosing how customers experience value or its opposite, dissatisfaction, and humble in following changes in value perception that can occur quickly and without warning.

Customer Sovereignty: The customer is your boss, and determines what is valuable, what they will buy and refrain from buying, and which products, services and businesses will be successful. Changes in customer preferences can sometimes seem arbitrary and hard to follow; nevertheless, the entrepreneur’s job is to follow, respond, and ideally, imagine where the customer will go next in their search for betterment.

Uncertainty: The future can not be predicted. Extrapolated trends and predictive models can not deal with the changing preferences of customers over time. Even the customer is not sure what value they will experience when they use your product or service – it emerges from the interaction. Entrepreneurs understand this uncertainty and deal with it, by imagining what the future could be, based on their customer understanding, and adjusting to new information as it becomes available.

Deductive Method: Uncertainty sounds so intimidating. Austrian entrepreneurs use the deductive method to help steer them. Find some principles you know to be true – we know for example, that customers are always seeking betterment – and use those principles to reason your way to understanding complex phenomena. Your specialized knowledge of your chosen business specialty will give you solid grounding. By all means add test data and evaluation data and marketplace results data to your reasoning. But try to find the bedrock principles you can reason from.

The logic of cause and effect: All things are subject to the law of cause and effect. If you can identify the causal linkages, you will be firmly in command of your business. Write the story of the future evolution of your growth path in cause-and-effect language and match it to actual events as they unfold.

The role of time in production: Austrian economics has a unique sensitivity to time in the production process. Entrepreneurs must commit capital now to start production that will be completed in the future, without knowing the future nature of the market – what prices will prevail, what competitive firms will do, how the customer will be feeling about future conditions. Time is a danger to entrepreneurial success – so be as quick as possible, make fast decisions, shorten production cycles, and use time as a scarce resource.

The division of the production chain into higher and lower orders: The value of every link in the production chain reflects the revenue flow from customers to which it contributes. If preferences change, the value of upstream production resources changes. Wherever you operate, B2B or B2C, always keep an eye on end-customer behaviors and preferences. As a B2B supplier, you can be very useful to your business customers by alerting them to end-consumer changes.

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39 Rick Rule: Deep Understanding of Markets Opens a Pathway to Entrepreneurial Leadership

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Rick Rule is CEO at Sprott US Holdings. His lifetime focus on natural resources finance enabled him to carve a unique pathway to entrepreneurial success. Like many entrepreneurial journeys, Rick’s had some twists and turns. Here are some of the key stages.

Key Takeaways and Actionable Insights

Find out early what you love. Rick enjoyed the outdoors, nature and therefore natural resources, the associated science of efficient and effective use of natural resources, and finance. All of us have a combination of likes and preferences that may stimulate us but may not initially appear to present us with an entrepreneurial recipe. But as Curt Carlson explained in episode #34, combining knowledge from different people and fields can result in compounding insights.

Rick Rule's Entrepreneurial Leadership

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Combine Knowledge In New Ways. Rick combined natural resource science with principles of corporate finance, specifically debt and equity finance for extractive industries. As a result of the special properties of natural resource markets, and firms’ needs for customized financing, an opportunity niche emerged. Rick’s application of his special combination of knowledge placed him in a competitively advantaged position.

Learn By (Hard) Experience. Rick learned not to confuse a bull market with brains, as he puts it. He did business through a complete commodity market cycle in the 1970’s through the early 80’s, experiencing volatility and ups and downs first hand. Theory is no substitute for experience. Nevertheless, his knowledge of Austrian Business Cycle Theory, Austrian Price Theory (“the cure for high prices is high prices, and the cure for low prices is low prices”) granted him a superior perspective in interpreting market signals.

Develop Deep Market And Customer Understanding. In his focus market, Rick developed a business segmentation that focused on participant firms of a defined size (<$250MM market cap). He studied those customers and understood their circumstances. The consequence of limited information flow (data about these firms did not flow easily between conventional market analysts), was that the firms had limited access to capital. Rick was able to overcome these information gaps, making him a preferred supplier of scarce finance.

Identify A Need You Can Fill For Your Carefully Selected Audience In Your Carefully Selected Market Segment. The business model came together in a way that Rick describes as “lender of last resort to high-quality management teams in high-quality companies that were not popular” and were therefore capital constrained. In addition, Rick’s understanding of business cycles and commodity prices further strengthened his confidence in lending when others would not, the market rewards for which turned out to be high.

Combine Empathy, Trust and Courage. Rick confirmed the E4E emphasis on empathy as an important skill for entrepreneurs – primarily, in his case, empathy for the customers whom he financed. He sought to combine empathy with trust: in a market where information is scarce, it is imperative to have trust in the sources. “Without trust,” says Rick, “I have no information, and therefore I can not make decisions.” The third emotional attribute he identified is courage – the courage to have the conviction that your model indicating a future upcycle or price rise is well constructed, and not to second-guess it during the time that the trade is underwater.

We’ve summarized these journey milestones – and the Austrian foundations underlying them – in this free PDF download. 

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38. Per Bylund on The Laws Of Agile: A welcome step towards the Austrian vision, but not quite all the way there.

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The management methods and practices that have been gathered under the term Agile claim the status of a Copernican Revolution. Agile reverses the traditional view of business revolving around the firm, instead placing the customer at the center and viewing all other elements as revolving around the customer.

This is a welcome development – but just a step towards the Austrian vision of consumer sovereignty and the concept of value as created by the consumer, not the producer.

Key Takeaways And Actionable Insights

The management methods and practices that have been gathered under the term Agile claim the status of a Copernican Revolution. Agile reverses the traditional view of business revolving around the firm, instead placing the customer at the center and viewing all other elements as revolving around the customer.

This is a welcome development – but just a step towards the Austrian vision of consumer sovereignty and the concept of value as created by the consumer, not the producer.

We examined the three Laws Of Agile proposed by Stephen Denning in his book The Age Of Agile, and Per Bylund noted the elements that are useful for entrepreneurs, and the extra insights provided by Austrian Economics that can help entrepreneurs to perform at a higher level in facilitating value experiences for their customers and consumers.

The Law Of The Customer

  • Agile recognizes that the one valid definition of business purpose is to create a customer.
  • The customer – with mercurial thoughts and feelings – is at the center, and demands to be delighted.
  • What the firm thinks it produces is less important than what the customer thinks he / she is buying – what they consider “value”.
  • Everyone in the firm must view the world from the customer’s perspective, and share the goal of delighting the customer.
  • The firm must have accurate and thorough knowledge of the customer.
  • Continuous innovation is a requirement to delight customers.
  • The firm’s structure changes with the marketplace.
  • Speed of response becomes crucial and time is a strategic weapon.

Austrian Enhancements

  • The Austrian concept of Customer Sovereignty is even more powerful for entrepreneurs  – customers create firms, in the sense that customers decide what is produced by buying / not buying, and therefore which firms are successful.
  • Value is subjective – and so customer preferences can change rapidly and frequently.
  • Responsiveness is not enough – the goal is to imagine the customer’s future needs, and involve them in the production of future value.

The Law Of Network

  • Collaborative network of competence replaces hierarchy of authority.
  • The network has no leader, but it does have a shared, compelling goal.
  • The network is the sum of the small groups (rather than individuals) it contains.
  • Each group has an action orientation.
  • The network’s administrative framework stays in the background. No bureaucratic reporting.

Austrian Enhancements 

  • Agile is based on too narrow a view of the economic network. It’s still producer-centric.
  • The true network is the market – which includes customers (of which there are many more than firms, and who exert more economic influence than firms).
  • Networking the production side of the firm is an incomplete act.
  • A fully-functioning network includes customers and consumers with equally valid connections to the firm, not just collaborative production partners.

The Law Of Small Teams

  • Big and difficult problems are disaggregated into small batches and performed by small cross functional teams – scaling down the problem.
  • 7 +/- 2 is a good rule of thumb for team size.
  • Each team is autonomous, and works in small batches and short cycles.
  • Each team aims to get to “done” – it’s binary: either done or not done, never almost done.
  • No interruption.
  • Radical transparency.
  • Customer feedback each cycle.
  • Retrospective reviews.

Austrian Enhancements

  • A pure focus on short term execution can divert attention away from longer-term considerations – especially, imagining the future, which is the core component of entrepreneurship.
  • Focus on creating value for the future, while ensuring no loss of current reputation and relationship.
  • Administration – and therefore “bureaucracy” –  can’t be eliminated entirely without a reduction in customer value.
  • Required services can be a component of value creation – such as compliance, operations management, etc.

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Austrian Capital Theory Provides Principles Of Capital Allocation Every Entrepreneur Can Apply Right Now.

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Why do we make the case that Austrian Economics is the best resource an entrepreneur can use to grow their business? Because the principles of Austrian Economics are clear, precise and can be activated immediately in any business decision.

Here’s an example: how to allocate capital in your business. Most of the capital that’s free to allocate comes from your cash flow, and it might also come from investors and lenders. Whatever the source, you must allocate it to grow your revenue and profit. How do you make the decision? Here are five principles:

Zero-based capital allocation.

Austrian Capital Theory prizes responsiveness to market changes – your capital structure should reflect the preferences of your customers, and those preferences are in continuous change. Therefore, zero–base all your capital allocation decisions. Don’t allocate based on what you’ve done in the past. Allocate based on where revenues and profits can be generated in the future. Sometimes this is called agility. Whatever term you use, make sure you are not allocating capital today simply to continue or repeat what you’ve done in the past.

Fund strategies, not projects.

Austrian Capital Theory directs entrepreneurs to focus on long term value creation. This means funding strategies not projects. Identify strategies that will produce growth, and then make sure you allocate sufficient capital to foster that growth. Projects can be initiated once the strategy is determined and launched. If you fund projects, the economic calculation can always be gamed – creating a spreadsheet justification for any project.

Continuously assess which strategies are creating value, and fund them from strategies that are not.

Capital does not have to be rationed. It should be allocated to those strategies that create value and deliver growth. There is always a source – strategies that are not creating value. It’s simple portfolio management.

No tolerance for bad growth.

Customers determine which strategies are delivering value for them and therefore delivering growth for you. The customer decides what grows. They won’t tolerate any offering from you that falls below their value threshold. And you should not tolerate the continuation of any strategy that falls below your growth threshold.

Know the value of assets.

Austrian Capital Theory identifies the value of assets as the future revenue and profit streams they generate from customers. When that changes, the value of the asset changes, and economic calculation must adjust. You should be continuously asssessing the value of your assets with this calculation.

Here is an example of these principles of Austrian Economics being served up in business language, from Credit Suisse. The authors make it sound analytical and strategic, but really it’s the expression of established principles that every entrepreneur can apply.

https://research-doc.credit-suisse.com/docView?language=ENG&format=PDF&sourceid=em&document_id=1066007811&serialid=yKerDV9lV5lbOxhMTMaFhAZ9MZ8nzrqd4M0N8V3Gv9c%3d

Get insights like this every week from the Economics For Entrepreneurs podcast.

37. Curt Carlson’s Systematic, Repeatable Process to Generate Customer Value

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Is successful value creation through innovation the product of genius? Or of luck? No, it’s the product of a system, applied with discipline. Utilizing the system can result in repeated success in customer value generation.

Key Takeaways and Actionable Insights

Curt Carlson is the world’s leading expert practitioner. He is the founder and CEO of Practice Of Innovation, LLC, and was President Of SRI International, identified as the most successful innovation company in the world based on its development and introduction of globally important innovations like Siri for the iPhone4 and HDTV. Under Curt’s leadership, SRI grew 3.5X and created tens of billions of dollars of new customer value.

Curt believes any company can systematically generate new value for customers, and reap the rewards of the market for doing so, when they rigorously apply three fundamental rules.

  1. They have a simple value creation methodology that everyone in the company (and its collaborative partners) can describe, understand and apply every day in every job function. (Curt’s test: ask everyone in the company what the firm’s value creation method is: if they can’t describe it, there isn’t one.)
  2. They have metrics to define innovation work that is important rather than merely interesting. While subjective value is not quantifiable, there are proxies for measuring importance and market potential.
  3. They have a system for active learning. Innovation is a learning science, and active learning is a specific, high speed, high productivity version of learning, applying the best learning science principles.

In this week’s podcast, we focused especially on the simple, effective value creation methodology that Curt identifies by the initials N-A-B-C.

NABC Innovation Process

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N is the identification and quantification of the important customer need. In B2B businesses, it’s possible to monitor financial flows and identify needs based on quantifiable elements – cost savings, time savings, and measurable quality improvements. In consumer businesses, need identification is much harder, and quantification impossible except by proxy, since needs are subjective and individual. Importantly, they are also multi-dimensional, and need identification must encompass all the dimensions.

It’s important to deeply understand human wants, whether it’s for convenience, or higher order wants such as pride and identity. Surveys told Steve Jobs that consumers wanted a “new keyboard” for existing Nokia phones that were hard to use. Jobs’s intuition was that what they really longed for was convenience. The touchscreen on the iPhone provided convenience and opened a doorway to all kinds of additional services.

A is the Approach the entrepreneurial innovator takes to meet the customer need. The approach is the design of an experience that the customer will desire. The Approach mist embrace both the assembly of the right resources into a technical solution, and the business model so that the solution makes money. There’s an iterative back-and-forth between technical solution and business model that can continue for years. Nike’s technical solution for shoes is good but not unique; its business model for sponsoring athletes to inspire aspirational consumers who wanted to “be like Mike” (or today like LeBron) elevated their offering from product to experience.

B is Benefits Per Costs. Curt uses this construction to emphasize that there are large buckets of both benefits and of costs. Benefits include not just features and performance and appearance, but also the feelings produced by the experience. Costs are similarly multi-layered: not just dollars, but also the effort required to acquire the product, and perhaps to master its use, the opportunity cost of what is given up, durability, and more. The innovative entrepreneur must look at costs from all of these angles and calculate that the “benefits per costs” for customers are much better than alternatives.

Curt’s rule of thumb is 2X to 10X better. People measure perceived benefits in percentages. 10% better, 50% better, 100% better than the status quo or the alternatives. Transformational innovations are 2 – 10X better.

C is the competition and other alternatives – both today and in the future. What are all the other ways the customer can experience the benefit they seek? What are alternative ways for them to spend their money – perhaps on a different experience that’s not a direct substitute but on which they’ll spend instead of buying our solution. How does your innovation fit into their lives so compellingly as to become preferred over all these alternatives?

N-A-B-C is a simple framework, but it’s not easy to achieve results. It requires iteration at speed among many collaborators (including customers, and possibly investors), all with different and specific talents and tacit knowledge. No individual can command sufficient knowledge, so team learning – active, comparative learning, frequently updated – is critical to the outcome.

The result is transformational: for customers who experience new value, for the firms that facilitate it, and for the individuals who practice the discipline of innovation.

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Buy a copy of Curt Carlson’s book, Innovation: The Five Disciplines For Creating What Customers Want.

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36. Professor Arthur Diamond on Sustaining Innovative Dynamism

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This week, while keeping our eye on our highest value – entrepreneurial success – we raised our focus to the system level and the meta-ideas that sustain entrepreneurial effort and Austrian innovative dynamism.

Key Takeaways and Actionable Insights

Professor Arthur Diamond has written a wonderful book about nurturing the system in which we entrepreneurs operate. The subtitle of his book is Sustaining Innovative Dynamism. Like all great writers in the Austrian tradition, he recognizes and celebrates the contribution of the entrepreneur to society: to make others’ lives better.

In many ways, this is both an economic and an ethical stance. To quote Jesus Huerta De Soto (in a similarly titled essay, The Theory of Dynamic Efficiency):

….the most just society will be the society that most forcefully promotes the entrepreneurial creativity of all the human beings who compose it1.

But Professor Diamond is a little bit concerned that the environment for entrepreneurial dynamism is under assault in the US. It’s up to all of us to work hard to sustain the system. Professor Diamond lays out the threats under three headings.

Sustaining Innovative Dynamism Infographic

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Culture

The entrepreneurial culture would celebrate the contributions of its entrepreneurs to a better life for all: prosperity, comfort, efficiency, health, personal achievement, and the human augmentation that comes with technology. Our lives are not only more prosperous, but more productive and more enjoyable, longer and healthier, thanks to entrepreneurs.

Often when we do celebrate entrepreneurs, it’s one hand clapping. Bezos, Musk, Gates and Jobs and others are recognized, but also sometimes vilified, and often judged on whether they “give back” – as if there was some guilt about their incredible contributions to human well-being.

And, Professor Diamond points out, a truly entrepreneurial culture would celebrate the lives of meaning and purpose led by entrepreneurs on every scale, from small business to big business.

We can all participate by celebrating the heroic stories of the entrepreneurial life, telling them loud and often.

Institutions

Under this heading, Professor Diamond focuses on the law, private property and markets.

We can observe our legal institutions turning against entrepreneurs in the form of tort suits and punitive damages. Professor Diamond calls for reform to preclude unreasonable awards of damages, and points to examples where doing so has resulted in unleashing entrepreneurship (such as 7000 new doctor’s practices opened in Texas after a damages cap on malpractice cases was put in place).

Private property protection is fundamental to the economic freedom entrepreneurs exercise to bring the benefits of innovation to society. Government is always tempted to seize private property, and often succumbs to the temptation. We must publicize each instance and protest each time.

Markets are the institution that facilitate the entrepreneur’s presentation of new offerings, and the consumer’s freedom to choose from what’s on offer. We talked about matching venturesome consumers (early adopters) with venturesome entrepreneurs, and removing the barriers that often come between them (for example, in medical innovation markets).

Governance

At this point, Professor Diamond exhibits amplified animation, recognizing that government regulation is the greatest threat to entrepreneurship and innovative value creation on behalf of others. He’s angry. He discerns two types of anti-entrepreneur regulation. The first is regulation that is sourced in purportedly well-intentioned (but demonstrably wrong-headed) efforts to protect consumers or workers. Here, we must energetically point to the greater benefits that ensue from the exercise of economic freedom than from its constraint.

One particularly important example is medical innovation. Too often, the heroic efforts of medical entrepreneurs to alleviate pain and suffering are thwarted by FDA regulation.

The second kind of regulation is the overtly corrupt protection of industry incumbents and big business, lubricated by lobbying and political quid pro quos. Here, we must all be whistleblowers.

Key Takeaway

Maintain entrepreneurial energy at all times and spread it in all directions. Celebrate heroic stories at every scale. Educate the world on the ethical and moral superiority of the entrepreneurial society, as well as its prosperity and well-being. Denounce legal predators, regulation and protectionism. We must contribute to the development of the entrepreneurial culture, institutional framework and governance as much as we do to customer betterment.

Downloads & Extras

Sustaining Innovative Dynamism: Our E4E Knowledge Graphic

Entrepreneurial Stories For Young Socialists: Arthur Diamond tells Walt Disney’s story.

When New Yorkers Cheered The Wright Stuff: Arthur Diamond tells The Wright Brothers Story.

Openness To Creative Destruction: Sustaining Innovative Dynamism: Arthur Diamond’s book.

Visit Professor Diamond’s personal website and blog, and read his article on Innovation Unbound, which begins: Inventors and entrepreneurs are key drivers of innovations that result in improvement in human welfare.