122. Andrew Frazier on Running Your Business

/0 Comments/in /by

There’s a middle class of businesses that are the backbone of the economy. Professor Saras Sarasvathy coined that term, and we’re pleased to adopt it.

These businesses sit between the big corporations of the major stock indexes and the VC-funded gazelles and unicorns of Silicon Valley and Silicon Hills. The watchwords for these backbone businesses are duration and durability. They last and prosper because they are well-run, following the entrepreneurial method.

Entrepreneurship is usually portrayed from the perspective of ends: identifying unmet customer needs, creating new and innovative solutions, taking them to market, making a success.

That’s all true. However, there is another perspective that comes from actually running a business, ensuring that operations are smooth and efficient, monitoring daily cash flows and monthly P&Ls, and managing people’s performance.

Often, running a business requires an intensified focus on means. Cash flow, operations, employee performance — these are means, and running a business is a science of managing means. Business advisor Andrew Frazier helped us focus on means in this week’s Economics For Business podcast.

Key Takeaways & Actionable Insights

Knowledge is an entrepreneurs most important means. Accumulate it purposefully (but not by losing money).

The more you know, the more you grow. That’s a mantra from Andrew Frazier. He advises thoughtful accumulation of knowledge. One way to learn is to lose money — you learn what doesn’t work, and what not to do. Avoid this form of learning by purposive knowledge gathering. This includes truly knowing your purpose — at least part of which is to build the business resiliency that delivers durability and duration.

Knowing your numbers is a critical component of durability and duration, and of shepherding your means.

In his advisory and consulting roles, Andrew encounters many business owners who don’t know their own numbers intimately — their daily cash inflows and outflows, the precise identification of fixed and variable expenses, the condition of the P&L and the balance sheet. Some, he says, fear the numbers. They delegate accounting to an outside service, or even to an internal “back room” employee. Don’t delegate “knowing your numbers” to anyone. Be on top of them every day. They tell you your means.

Sales and marketing are the most important means of lasting business growth, and not necessarily expensive.

There is no business without the sales and marketing activities that identify the right customer niche and tell your story to those customers in a credible, warm and persuasive fashion. Many business owners and entrepreneurs see sales and marketing as an expense to be incurred only if there is cash leftover from other variable and fixed costs that take precedence. This is wrong-way thinking. Sales and marketing are job #1.

Hiring employees is the biggest change you will make to your business and to your role in it.

You want to hire employees for the growth of your business. As you do so, you are changing your business. You change its structure: it now needs organizational design. You change your role: you are now a leader. You change the business’s operational flow because it now needs detailed processes and systems. You change the culture: it becomes more indeterminate and therefore requires more of your attention. You stop working in your business and start working on it.

Duration and durability require sacrifices from you.

One aspect of the entrepreneurial ethic is personal sacrifice today for market reward in the future. Sacrifice is part of your means. You’ll work harder and longer hours. Your business and social and family lives will become inextricably intertwined. Your business will become your identity. Realize this and embrace it.

A lasting business requires an exit plan.

A business that prospers over an extended period needs an exit plan for its owner or founding entrepreneur. This can range from an IPO or sale to an acquirer to leaving it to your kids or turning it over to employees. Whatever the case, the owner needs to plan ahead for exit, almost from the beginning. For example, if you have a professional services business, what will make it saleable when you want to exit? Is there asset value over and above revenue flow? Will customers stay after you leave? Are your kids even interested?

Additional Resource

“Running Your Business” (PDF): Download PDF

Visit Andrew Frazier’s Website: RunningYourSmallBusinessLikeAPro.com

Running Your Small Business Like A Pro by Andrew Frazier: Buy It On Amazon

“The Masterpreneur Playbook Summary” (PDF): Download PDF

The Austrian Business Model (video): https://e4epod.com/model

Start Your Own Entrepreneurial Journey

Ready to put Austrian Economics knowledge from the podcast to work for your business? Start your own entrepreneurial journey.

Enjoying The Podcast? Review, Subscribe & Listen On Your Favorite Platform:

Apple Podcasts, Google Play, Stitcher, Spotify

Value Mapping: New Thinking About Business Model Innovation.

/0 Comments/in /by

Only recently have business thinkers come to identify business models as a locus of innovation. In past eras, a business model was synonymous with monetization: how businesses generated revenue from customers. The concept of a business model came from the logic of goods and services: design and sell what the customer wants to buy.

Today, such a direct route to revenue is less assured. Famously, Google offers the world a search engine which is much used and generates no direct revenue. Revenue comes from advertising, which is an indirect property of search, and wasn’t even included in Google’s original proposition..

Today, as entirely new fields of business begin to open up, such as the unprecedented scope of service systems enabled by the connected devices and information streams of the Internet Of Things, a new breed of business models is about to emerge. How will businesses think about designing them?

The breakthrough paper by Professors Per Bylund and Mark Packard, Subjective Value In Entrepreneurship, gives the answer: business models will be designed through a subjectivist lens.

What exactly is entailed in subjectivist design? First comes the understanding and deep internalization of the concept of subjective value. Value is a feeling that comes from experience. For the consumer or customer, value is a learning process with clearly identifiable stages. Customers first encounter a value proposition from a potential provider of service, and must decide whether or not the proposition suggests a possibility of a valuable experience. If not, they’ll ignore it. If yes, they’ll go on to make a relative assessment of the potential value compared to available alternatives. Those alternatives may be similar services with a different mix of attributes, including price. Or the alternative might be an offering in an entirely different commercial space, in the case where the customer feels that, from a total expenditure perspective, they can only make one purchase and not two. Or the alternative might be doing nothing, and keeping money in the wallet for some future buying occasion.

If the purchase does take place, the value process is still nowhere near complete. It continues for several more stages. The buyer consumes the product or service (perhaps once or perhaps on several occasions or over time), noticing a usage experience as they do so. After the fact, they evaluate the experience, compared to what they anticipated and compared to what they perceive may be an alternative future or replacement experience. The customer now has new experiential knowledge to use the next time a value proposition is made to them.

The important mindset change for business model designers is to fully understand that all value is subjective. They are designing an experience for another mind, that of the customer. The method to use is Value Mapping.

Value mapping is the route to sound business models because it reflects the customer’s value learning process. There are 4 phases of value mapping for business model innovation, and together they compose the design of a desirable experience for the customer.

Value Conceptualization

Value Facilitation

Value Experience Monitoring

Value Agility and Adaptiveness

Value Conceptualization

What new experiences are possible for the customer? Which of them are more desirable? How can we know, given that customers have never experienced them before? Value conceptualization is the empathic phase of business model design. The customer, at every point in time, is in a mindset that can be described in the phrase, “Things could be better if…..” They are not necessarily precise in this expression of dissatisfaction. And they can’t tell the business model designer exactly what new and better experience they are seeking. They’ll know it when they feel it. Therefore, the first lines drawn on the value map are imaginary lines. The business model designer uses imagination – tries to imagine what positive emotions of satisfaction the customer might feel in the future if their wishful thinking for things to be better were fulfilled. Designers must place themselves inside the mental model of the customer, see things and feel experiences as customers might see and feel them, and then run a new experience “script” through that mental model, and project what the resultant feeling might be. That takes a lot of imagination.

The imagination may even be expanded further, to begin framing new experiences for employees who might work on the new initiative, and for partners who might join a future value network. Perhaps there is potential new value for the community in which a new venture is to be embedded, and perhaps also for the environment. The aim at this first stage is to map as big a value pool as possible.

Since it’s unlikely that the designer will get it exactly right, it’s necessary to develop many imagined experiences and find ways for customers to give input as to whether the design is going in the right direction and nearing some kind of level of evaluation where the customer gives a “Yes” to the question of whether they perceive any value potential at all. At this point, the designer has made it to the first threshold.

Value Facilitation

To reach the next threshold, the business model designer must identify all the resources, functions and capabilities necessary to bring the potential value experience to the point at which the customer can purchase. This is a reverse design process. The designer imagines the experience the customer will have in great detail, then works backward to identify every detail of what it will take to deliver it. This requires systems thinking. What is the system, in all its detail, that is required for perfect experience delivery? Not just the final product or final service, but the assembly of all components and elements, a supply chain, a network of partners, a back room, a service capability, a sales and marketing capacity. Every item at every stage must be designed and assembled so that the value proposition can be delivered without fault on every occasion.

It’s a kind of value engineering. All the necessary parts must be in place, connected in the right way, all fully functioning and enabling all other parts, sub-systems and the system as a whole to function perfectly to bring potential value to the customer without any barriers or undue work required on their part.

Value Exchange

At this point, the customer buys or does not buy. The act of exchange – the customer exchanging money and other resources such as time – is often seen as the moment of value creation. If the revenue flows, it’s an indication of value realized. But this is wrong. Think back to the Google search service example. The exchange takes place when the customer types into the search bar, expressing the belief that a knowledge gap they feel can be filled by the service. When they receive a response and feel that their expectation was fulfilled, that is when value is created. No money changes hands. Nor is it merely a time-shifting of a revenue commitment, such as when a customer visits a doctor for a health consultation, knowing that there will be a bill for somebody to pay in the future as part of the health care payment system.

The exchange, whether accompanied by payment or not, is the pivot from the first half of the value map, conceptualization and facilitation, to the second half of the map.

Value Experience and Value Monitoring

The customer now has ownership or control of the value proposition – the product, service or relationship from which they feel they will gain a valuable experience. The actual value comes in consumption, but it’s not value-in-use but value-in-experience. It’s a 2-step process on the customer’s part: consume then evaluate. Use the product or service, note the real-time experience and then stand back and appraise that experience. Did it feel as satisfying as expected, or as desired? How did it measure up to other comparable experiences? How does it stack up against future experiences promised by competitors?

The service provider’s role at this stage is monitoring, and, if possible, measuring. In the value facilitation phase, the provider did everything possible to get to the point of exchange, and put the service in the customer’s hands. Now it is time to observe. In some cases, there might be the opportunity to interact, if the customer calls a service center or uses a service chatbot, but these interactions are more accurately part of the customer’s consumption than their value experience. They become part of the experience later.

The provider’s business model design should include the capacity for experience monitoring. This could be ethnographic observation. It could be real-time analysis of web usage patterns from which judgments of experiential feelings can be made (an abandoned shopping cart, for example, might be indicative of frustration with the checkout process). We are promised sentiment analysis in the future: real-time measurement of how the customer feels during consumption, via mood sensors or other devices. This will be a great development for business model designers, making the value monitoring phase speedier and better informed.

And if the Phase 1 value map identified potential new value for employers, partners, communities and the environment, the business model must also build-in monitoring and measurement for these value holders, so that the keeping of any value promises made to them can be ratified.

Value Agility

The complete value cycle takes time to unfold, and the world is changing as it does. The customer is acquiring new knowledge, both from the current exchange and experience, and from multiple other experiences occurring in the same time frame, both of their own and those of others whom they can observe. Prices are changing, the competition is changing, and service options and possibilities are changing. The service system is in continuous flux and change.

That’s why this phase of the business model is referred to as value agility. The service provider is receiving feedback from customers, new information from the marketplace and competitors, suggestions from employees, and new environmental data. In response, they are developing new ideas for improved value propositions, and news of these improvements needs to reach customers before they defect or identify better alternatives. The business model designer must build in this agility and flexibility. Nothing in the capital stack or the corporate procedures or systems or in business model execution can be so fixed as to prevent agility or even slow it down.

How does a business model designer build-in agility? It requires an appreciation of capital flexibility, of capital as a process rather than as a balance sheet entry. It requires organizational empowerment, so that the first receivers of input from customers are empowered to put it to work in those parts of the organizational structure that can make most use of it. It requires an embrace of change as the operating norm rather than as a complication to be resisted.

The Value Cycle

The four stages of the value cycle – conceptualizing, facilitating, monitoring experience and agility in response to feedback – are brought together in contemporary business model design. Revenue and profit emerge for the participants and partners in the value network, but they are not measures of business model effectiveness. That role belongs to value.

121. Bill Sanders: How Creative Conflict Expands the Value Pie

/0 Comments/in /by

Value facilitation is a creative act of imagination, design, assembly, communication, and agile responsiveness. Our Economics For Business model applies these actions in the pursuit of new economic value. Bill Sanders, an expert in contract negotiation in business, applies them in dealmaking and business relationship management. His book, Creative Conflict: A Practical Guide For Business Negotiators, provides a highly actionable model for value facilitation in contract negotiations.

Download The Episode Resource The Negotiation Value Mapping Checklist (PDF) – Download

Key Takeaways and Actionable Insights

Business negotiations are searches for shared value.

Both parties in any negotiation are seeking value, and specifically subjective value. Each sees the eventual agreement on contract terms as a source of future value. Contract negotiation has often traditionally been viewed as a struggle for one side to capture the most value at the expense of the other.

But value facilitators view it differently. They first try to identify the total amount of value in a potential agreement, before thinking about the division of value.

Divergent thinking is a source of value.

In his book, Sanders refers to Creative Conflict as a positive, to be embraced. There’s no predetermined solution, and no absolutely perfect price. There are many possible solutions, and good negotiators are able and willing to continue exploring the ambiguity, and welcoming contending ideas. They are open to uncertainty. It may lead to a solution that neither party might have seen on its own.

Value potential can be mapped in preparation for negotiation.

Sanders introduces the concept of value mapping. Economists are somewhat familiar with this approach at the market level, but perhaps not at the level of individual exchange. Value mapping in contract negotiation is the mental connection of one side’s assets to the other side’s needs. The value map would include a list of concessions desired from the other side (with a subjective estimate of their importance) and a list of what can be given up by your side to generate more value for the other party. In some cases, the values can be quantified.

When presented, these lists become a value proposition for the shared outcome of the negotiation. Sanders provides a value mapping checklist as a tool to help negotiators think about all the assets they might have to bring to the negotiation, and all the areas where concessions might be sought in return.

Value mapping points to the productive end of the negotiation continuum.

Bill Sanders presents types of negotiations on a continuum. On the left-hand end is bargaining, the traditional zero-sum exercise to capture value, a purely distributive process. At the midpoint is creative dealmaking, where value mapping is applied to surface extra value so that both sides feel they gain more than they relinquish. On the right-hand end is relationship building, where the two parties enter into a partnership in which each works hard for the other party to succeed. The spectrum is one of ascending creativity from left to right.

Austrian economics has a big role to play.

Many of the techniques Sanders proffers in Creative Conflict are firmly based in Austrian economics, as he himself emphasizes. Some of the relevant concepts are:

Subjective Value: Each party experiences value in their own mind, and anticipates future value in the form of expectations, based on their own evaluative criteria. While subjective value can’t be quantified, the concept of an expanding pool of value can be considered by both sides, each from their own unique perspective.

Empathy: The tool for understanding the other party’s mental model for evaluation is empathy, the exercise of which we often stress as the entrepreneur’s primary value facilitation skill. This is as true in contract negotiation as in any other exchange.

Trust: Negotiation takes time and requires the declaration of parties’ wants and needs, preferences, capabilities and capacities, and the full functioning of the goods and services being traded. Trust is the required underpinning for these declarations.

Distributed knowledge: There are always things that the seller knows that the buyer doesn’t, and vice-versa. This is the normal (non-equilibrium) position, to be recognized and welcomed.

Uncertainty: Uncertainty is the quintessential condition of entrepreneurship. The future is unknowable. Sanders recommends the full recognition of uncertainty and indeterminism in contract negotiations. Explore possibilities rather than imposing mandatory conditions.

Heterogeneity: Negotiators are different, firms are different and have different priorities, every deal is different. There is no standard way of business negotiations. Sanders does not try to lay down “rules”.

Real time: Time is the context in which change takes place. Every advance in time brings new knowledge and more change. Since negotiation takes time, it must be flexible enough to accommodate change and avoid rigidity.

Processual perspective: The market is a process, value is a process and negotiation is a process. Austrian economics recognizes the role and influence of time — time as the context of change — at a high level of impact. Contract negotiators take the same perspective, using the time taken for the process to unfold as a means of facilitating greater value whenever possible.

Additional Resources

E4B Tool: The Negotiation Value Mapping Checklist (PDF): Download PDF

E4B Knowledge Map: The Negotiating Continuum (PDF): Download PDF

Bill’s Book Creative Conflict: A Practical Guide For Business Negotiators: Buy on Amazon

The Austrian Business Model (video): https://e4epod.com/model

Start Your Own Entrepreneurial Journey

Ready to put Austrian Economics knowledge from the podcast to work for your business? Start your own entrepreneurial journey.

Enjoying The Podcast? Review, Subscribe & Listen On Your Favorite Platform:

Apple Podcasts, Google Play, Stitcher, Spotify

Now Is A Good Time To Discard The Concepts Of Strategy, Planning And Strategic Planning.

/0 Comments/in /by

Business schools have been peddling strategic planning for 60 years or more. (Harvard Business School was founded in 1908, so the concept may even go back to that time.) A good deal of the conceptual ideas are said to have been borrowed from military planning. This origin story is illustrated in terminology such as “the battle for dominance” in markets or industries, or “defending market share”, or in language concerning “missions”, and ideas about a company’s strategic weapons or strategic arsenal.

More significantly, the concepts of strategic planning reflect the old-fashioned economics of equilibrium, of market structure and industry boundaries. It’s an approach based on statics and balance. Firms are advised to position themselves within a market map or industry map, often depicted as a box, and to mark out territory for which to fight over with similarly equipped rivals. They are advised how to fend off attacking forces.

It’s all sounds very World War One: massed armies facing off across a flat battlefield, guns drawn and cannons loaded and at the ready. Generals at the apex of the pyramidal hierarchy of command issuing orders to the lower-level officers and the troops.

Business is nothing like this, of course. Economists, led by those of the Austrian school, now recognize that the economy and the economic environment in which businesses operate is ever-changing, roiling and swirling in dynamic re-orientation and re-adjustment. The economy is an ecosystem of entrepreneurial projects, and, as a result of the trillions upon trillions of exchanges and interactions, adaptations and adjustments that take place at increasing speed across an expanding geographic playing field, there is no predictability to the outcomes and no possibility of control of the ongoing processes.

Strategy and planning are misguided attempts at prediction and control. There is great hubris involved: that accomplished strategists deploying advanced mathematics and sophisticated intellectual tools can overcome the uncertainties that baffle and defy lesser minds. Business schools that promise to coach managers in this alchemy can charge very high fees for the chimera of certainty. But their promise is empty. It can’t be kept.

What’s the alternative to strategic planning?

What’s the alternative? As always, there is a combination answer from the identification of the applicable theory, and its implementation in practice.

First, business practitioners must clear their minds of the memes of prediction and control over future outcomes. To do so, they can study and master complexity theory. This body of analysis has established that the outcomes of economic systems are emergent – unpredictable, even random. Or, as the mathematicians and computational modelers put it, non-linear. They are not the result of the interplay of variables in an equation. The key to understanding complex systems is to analyze them at the level of the individual – such as a single consumer – and their interactions with other individuals. The smallest geographies, most local neighborhoods and individual units provide the relevant measurements and data. This is the opposite approach to the grand sweep of global or market strategies and resource planning.

The second step in the escape from the tyranny of planning is to adopt the mindset of ignorance: to be open to the reality of not knowing and not being able to predict. The management method to employ is “explore and expand”. Because the most successful initiatives can not be identified in advance in the ever-changing marketplace, businesses act to ensure they have a sufficient number of exploratory initiatives to search for routes to growth and customer satisfaction. Those explorations that demonstrate promise can be expanded via more investment to more geography, wider reach, and greater impact. Agile businesses keep a continuously updated portfolio of initiatives that are exploratory and capable of expansion, and the composition of the portfolio represents the business’s health. A business is an ecosystem of experiments and initiatives and projects, all at different stages of maturity and development. The capacity to add new projects while growing or maintaining those that have proven their worth in the marketplace is the indicator of a vibrant business model.

Jeff Bezos calls it “wandering”:

 wandering in business is not efficient … but it’s also not random. It’s guided — by hunch, gut, intuition, curiosity, and powered by a deep conviction that the prize for customers is big enough that it’s worth being a little messy and tangential to find our way there. Wandering is an essential counterbalance to efficiency. You need to employ both. The outsized discoveries — the “non-linear” ones — are highly likely to require wandering.

https://www.fool.com/investing/2019/04/11/jeff-bezos-explains-why-wandering-is-key-to-amazon.aspx

Historically, strategy has been a time-consuming act of comparative statics based on data, trying to identify a future state of a business and how to attain it from a starting point in the past or present. Planning has been a static act of resource allocation, in which business units and divisions compete for budgets and then defend them aggressively against change.

Both of these activities are detrimental to business success, which requires adaptiveness to continually changing market feedback and changing circumstances. Adopting the explore-and-expand mindset can be both freeing in the creation of more options for business action, and accelerating in bringing new growth pathways to the fore.

120. Mark Schaefer on Cumulative Advantage

/0 Comments/in /by

Economists recognize the phenomenon of increasing returns. Knowledge markets such as those for software, operating systems and platforms, tend to tilt in favor of a product or service or brand that gets ahead, even to the point of lock-in. There is a growing body of theory — often under the heading of complexity theory, and supported by computational simulation — underpinning the concept of increasing returns.

Mark Schaefer is an expert at bringing economic theories of this kind into vibrant contemporary life. He coined the term Cumulative Advantage and wants all entrepreneurs to know how to harness it.

First of all, it’s not new. It’s in the Bible: For whoever has will be given more. Sociologist Robert K. Merton therefore called it The Matthew Effect.

How can entrepreneurs and their firms take advantage of increasing returns to achieve cumulative advantage? Consistent with the processual approach to value of Austrian economics, Mark has a five-step process.

Key Takeaways & Actionable Insights

Identify an initial advantage.

How do entrepreneurs identify a small initial advantage that sets momentum in motion? There are unlimited sources within complex economic systems. Mark tells us to look for collisions of events, ideas, people and circumstances from which entrepreneurs can derive their unique advantage. He calls them “click moments”. They are happy, random, emergent phenomena. He gives the example of Bill Bowerman’s experiment with latex in a waffle iron to create a new type of running shoe — the click moment for Nike.

Importantly, these random outcomes are spurred by action — acting on curiosity, and pursuing an energetic quest to establish how ideas and imagination can be exploited to solve customers’ problems.

Discover a seam of timely opportunity.

Mark rejects the concepts of strategy and planning. Business success can’t result from 50-page documents and elaborate spreadsheets. Momentum is a consequence of action. Entrepreneurs replace strategy with their own subjectively defined opportunity to exploit speed, time and space. A seam is a fracture in the status quo through which the entrepreneur sprints. Relentless searching for an open seam is the core activity of entrepreneurship. Seams are always opening as a result of the continuing, ongoing change of business and the economy, best understood through the dynamic lens provided by Austrian economics. Often the timing of the opening is the key factor in the success of an entrepreneurial initiative. Timing cannot be predicted, and so continuous experimentation is the best approach, to create the maximum possibility for “click moments”.

Create significant awareness through a “sonic boom” of social proof.

Once a business has entered a seam, it’s the occasion to search for amplification. Mark Schaefer proposes the leverage available through influence and influencers, those who can provide social proof to a broader audience that a new entrepreneurial offering is sufficiently worthy to command widespread demand. The customer is the marketer in this construct of social proof — which is a development, of course, of the Austrian theory of consumer sovereignty. People believe each other more than they believe advertising, promotion or PR.

Gain access to a higher orbit by reaching out and up to powerful partners and allies.

Once awareness and social proof of the entrepreneurial offering begin to build, the next process step is to seek partners and allies who can provide access to higher-level resources: powerful connections, better channels, financial capital, value-multiplying alliances. Network theory applies: denser and more active connections through bigger and more strategic network nodes can result in accelerated business expansion.

Maybe it’s distribution in Walmart or Target, or endorsement by a celebrity athlete, or presence on a FinTech trading platform, or access to new resources. Reaching up is an exercise in finding partners to expand an entrepreneur’s market potential.

Build momentum through constancy of purpose.

Ultimately, says Mark, the killer app is constancy of purpose. Discipline, resilience, purpose and persistence accompany entrepreneurs on the path to achievement. There’s flexibility and adaptiveness and agility of course, and these can bring changes in direction, but the goal and the purpose always retain their primary role in the narrative of success.

Additional Resources

Cumulative Advantage — The Theory of Increasing Returns (PDF): Download PDF

Cumulative Advantage: How to Build Momentum for your Ideas, Business and Life Against All Odds by Mark Schaefer: Buy the Book

Mark Schaefer’s Website: BusinessGrow.com

BSquared Media: BSquared.media

The Austrian Business Model (video): https://e4epod.com/model

Start Your Own Entrepreneurial Journey

Ready to put Austrian Economics knowledge from the podcast to work for your business? Start your own entrepreneurial journey.

Enjoying The Podcast? Review, Subscribe & Listen On Your Favorite Platform:

Apple Podcasts, Google Play, Stitcher, Spotify

119. Peter Klein on Cronyism, Capitalism, and the Entrepreneurial Pathway

/0 Comments/in /by

We often hear that capitalism is under fire: in contemporary politics, in journalism, in popular discourse, and even in some business schools and among some management scholars and their students. But the criticism, upon examination, is not about capitalism but cronyism. The two are entirely separate systems, and the corruption and corporate political activities of cronyism are not exhibited in capitalism, and will never appear if we can adhere to capitalism’s purest form, entrepreneurship.

Defining Capitalism

Capitalism is a system in which factors of production are privately owned, resources are allocated through markets, i.e., voluntary co-operation among individuals, and individuals and groups are free to engage in economic activity without centralized control or interference from the state.

Capitalism includes the monetary system that enables entrepreneurs to engage in economic calculation, and the institutions that support property rights, and the rule of law. There are high levels of individual freedom of people to form groups and act without state coercion or compulsion.

Defining Cronyism

Cronyism is a system in which the state takes charge of, or has a high degree of influence in, allocating resources to firms, and some firms derive advantages over other firms based on their relationship with and influence with government officials, rather than their ability to satisfy customer wants via superior capabilities. The supporting ideology favors high levels of state interference in the allocation of economic resources, with institutions and practices favoring the manipulation of public policy as a strategy for increasing profits.

The benefits of capitalism and the vices of cronyism

The advocacy for capitalism in the paper we discuss with Professor Klein in this episode of the Economics For Business podcast (“Capitalism, Cronyism, And Management Scholarship: A Call For Clarity”: Mises.org/E4B_119_Paper) is not pure theory, but rather the greater benefits for everyone in society that result from capitalism compared to alternative systems.

Current critics vent their dissatisfaction with some aspects of the status quo, such as issues related to the natural environment or reactions to measurements of income inequality. It is not only an illogical leap to believe that taking decision authority away from private individuals and firms and giving it to government will result in greater benefits for society. It is also moving the system towards cronyism, so that unscrupulous people, whether they be executives, investors, labor unions, politicians or government bureaucrats can benefit themselves at society’s expense.

The nuances of cronyism and the maleficent influence of size

Bribery, blackmail, extortion and other forms of criminality are widely deemed inappropriate. The problem of cronyism lies in practices that are legal and encouraged by the intelligentsia and business school academics as sources of commercial advantage via the manipulation of the political system. These include activities such as lobbying, political contributions, or awarding board seats to retired government officials.

Peter Klein noted that there was a time when Microsoft, as an up-and-coming high growth tech company, did not even have a Washington DC office. Politicians couldn’t help them and didn’t understand their business. But the politicians reminded Microsoft who was really in charge, via an expensive, threatening and long drawn out anti-trust suit. Now Microsoft and the rest of the mature high tech industry have extensive Washington DC offices and very large lobbying budgets. Levels of cronyism parallel the scale of the modern corporation.

The costs of cronyism

The costs of cronyism are both direct and indirect. The direct costs are misallocation of resources and the production of goods and services that the free market would not want but politicians favor. The skills of executives and managers are applied to the influencing of government officials rather than to seeking the rewards of the marketplace via consumer acceptance and consumer value. Firms develop in much different ways than they would under capitalism.

Some of the misallocation of resources are most highly visible in the build-up of bureaucracy in corporations. Bureaucrats are not strategic decision makers and not producers of goods and services. They are devoted to compliance, government relations, and working with regulators and lawyers. Their salaries and office space and equipment are all misallocations of resources.

An indirect cost of cronyism is the undermining of institutions. A well-functioning market has institutions for integrity of contracts, resolving disputes, and protecting private property. The institutions are neutral: they enforce general rules that apply to all. The effect of cronyism — its whole point, in effect — is to override general rules in favor of privileging those in power over those who lack power. Confidence in institutions consequently erodes.

Business schools and management scholars are part of the problem

Trendy developments in management practice such as stakeholder capitalism, ESG (Environmental, Social, and Governance considerations for investment) and DEI (Diversity, Equity, and Inclusion requirements) are forms of cronyism, diverting business activities away from meeting the wants of customers in voluntary free-market exchanges to aligning with government directives, some current and some anticipated.

Business schools have been party to encouraging this non-market behavior, and to developing the associated indexes and scales and processes, all of which are murky and ambiguous, as well as very costly to implement. Executives welcome the ambiguity that makes accountability more difficult.

Business schools and universities are, in fact, vulnerable to the practices and measures they have encouraged, and their staffs are now bloated with middle managers, administrators and compliance departments. It’s all highly costly and a waste of resources.

Corporations exhibit similarly destructive economic behavior with their “woke” advertising campaigns and corporate training programs. Gramsci’s long march through the institutions seems to have reached the corporate HR departments who are the source of much of this uneconomic, anti-capitalist behavior.

Entrepreneurship is the pathway to lead us out of the cronyist morass

The budding entrepreneurial movement is the way out of cronyism and corporatism. Entrepreneurial businesses focused on consumers and customers, on innovation and betterment, and on producing ever-improving goods and services, have no time for cronyism. They are not looking for political protection.

Newer firms, newer business models, and those harnessing newer technologies are less invested in lobbying and corporate political activity. They don’t have the time or the resources for it, and slow and sclerotically reactive government can only get in the way.

Entrepreneurial innovation can trigger the separation of business from government and reverse the processes of cronyism, encouraging an open, dynamic, vibrant economy in which firms of all sizes engage in the full-time pursuit of innovation and new economic value, and devote no resources to lobbying or government relations.

Additional Resources

“Capitalism, Cronyism, And Management Scholarship: A Call For Clarity” (forthcoming in Academy Of Management Perspectives) by Peter Klein, Michael Holmes, Nicolai Foss, Siri Terjesen, and Justin Pepe (PDF): Download PDF

The Austrian Business Model (video): https://e4epod.com/model

Start Your Own Entrepreneurial Journey

Ready to put Austrian Economics knowledge from the podcast to work for your business? Start your own entrepreneurial journey.

Enjoying The Podcast? Review, Subscribe & Listen On Your Favorite Platform:

Apple Podcasts, Google Play, Stitcher, Spotify