A podcast based on the winning principle that entrepreneurs need only know the laws of economics plus the minds of customers. After that, apply your imagination.

25. Peter Klein on Organizational Designs

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Austrian economics has valuable and important things to say about organizing entrepreneurial firms.

Organization can make a crucial difference to entrepreneurial success. Ideas alone are not enough – execution is needed and the details of execution are important. The entrepreneur must design an organization for detailed, effective and efficient execution. Some entrepreneurs shy away, thinking it drudgery. That’s a mistake.

Key Takeaways and Actionable Insights

Organization is never static, but always dynamic. It’s not a structure, it’s a process. It’s your business model. It’s the collaboration that achieves the desired return on the entrepreneur’s imagination.

Austrian economics doesn’t prescribe a fixed way to “do” organization (unlike the rules- and framework-based approaches of consultants and organization gurus). It provides the right way to think about organization.

Organizational Designs

Organizational design starts with the entrepreneur’s ends in mind.

The purpose of the organization is to create customer value. Everything about the entrepreneurial firm is customer value, and so organization must be all about customer value. Elevate those elements that deliver customer value, and eliminate those that don’t. Everything that is not customer value, or gets in the way of creating customer value, or diverts resources from customer value, is waste and inefficiency.

Start with the best combination you can – in the current moment – of people and resources and capabilities to create the most customer value possible.

Delegate as much entrepreneurial judgement as you can – to people with the same customer value-creation focus as you, but greater expertise and knowledge in specific areas of the business.

Hire good people (or engage good contractors and vendors) who have the right skills and experience for a specific task or field, and then give them as much authority as possible. Don’t worry about over-delegating. Rather, worry about retaining too much control and becoming a limiting factor. Employees may find better ways to utilize an asset or expand a capability than you could have done in their place. They may show more ingenuity. Make sure your organization is consistent with the most productive use of available resources. It’s becoming more and more inefficient over time to exercise authority through control mechanisms. You can’t afford the transaction costs. By delegating, you lower your monitoring and management costs.

The owner-entrepreneur’s role is to design the rules of the game: making specifying decisions and determining how performance will be evaluated.

You retain ownership control by making what Peter Klein calls specifying decisions up-front: how you are going to run the business, tight or loose; defining in advance what discretion employees have, so that they don’t have to ask about every decision.

The second tool of control is defining the measurements of success and holding your team members to your metrics.

Outsource as much as possible.

The entrepreneur defines what resources and functions are crucial and proprietary to the business of customer value creation, and keeps control over them. Everything else can be outsourced – items like payroll services, accounting, transportation, legal, anything that constitutes overhead, and any tasks that are routinized. Just make sure there is no possible damage to the customer experience.

Employment contracts and compensation systems are tools of entrepreneurial control.

The specifying decisions can often be captured in the employment contract, where decision rights can be traded for benefits, and incentives can be defined to motivate the right levels of performance and the right feelings of participation and motivation. Go-getters and exceptionally creative people can be turned into “proxy-entrepreneurs”, exercising entrepreneurial judgement that is derived from the owner’s original judgment. There are no hard and fast rules about this trade-off, and it’s often a matter of gut feel. The savvy entrepreneur constructs a mental model of how the organization operates when it’s “just right” and makes adjustments when it’s not.

How you finance your business has major implications for your governance of your own company.

Venture capitalists want a major say, often a board seat and supervision of critical decisions. Lenders may have covenants that affect your governance decisions, and most definitely affect reporting. Friends and family will want to look over your shoulder, at minimum. When you are planning your financing, be sure to think about how it will affect your organization, and whether you want to accept the inevitable constraints.

In all cases, be ready to make adjustments to your organization design, your specifying decisions, your resources, and your metrics.

The entire point of flexible, dynamic organization is to facilitate change and adjustment on the fly. Plan to monitor continuously, and make changes whenever indicated. Never get locked in to a poorly functioning organization: change it.

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24. Dr. Smita Bakshi: An engineer, passionate about her mission, makes an impact by combining what the world needs and what the world will pay for.

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What is the nature of the journey from growing up in India and Africa, to an education in America and the successful founding, growing and managing a high-impact ed-tech business that helps instructors teach and students learn computer science?

The answer is: it’s not direct, and it’s not planned from start to finish.

It’s powered by individual drive, assembling knowledge, collaborating with a changing circle of smart and accomplished people, identifying the right pain point to address, and eventually finding – and then keeping – your focus.

Key Takeaways and Actionable Insights

The journey starts with individual drive: to better your own circumstances and those of your family. 

You are not necessarily called to change the world or start a brilliant new company. You find your drive at an early age to do better, move forward, expand your opportunity and improve life for you and your family. Perhaps there is some hardship in your early experience that provides greater determination and zeal. Channel it well.

Don’t necessarily expect a direct path. Keep moving forward, accumulate knowledge and experiences, and gradually start to narrow your preferences.  

Dr. Smita Bakshi identified engineering as her pathway. Her undergraduate degree was gained in India, and her Master’s and Doctor’s in the USA. Then she taught. Then she took an MBA. Then she worked for a small company in an engineering role, then a large one. There was diverse knowledge around engineering and its application in business and commerce. She established what she was good at.

Finding out what the world needs is a process of experimentation and discovery. It’s not always clear, and sometimes the people with the need can’t articulate it. 

Dr. Bakshi realized that her passion could not be fulfilled working on server configuration software, because, important though it undoubtedly is, it was too far removed from observable human impact. She made human impact her passion and began to experiment and investigate – in finance, healthcare and education. The idea was not necessarily to start and own a business, but to find the right place and the right way to make an impact.

There are two challenges in finding out what the world needs. The first is articulation: the customer can’t translate their felt unease into an articulated need. No-one “needed’ Uber to fix the problems of the taxi industry. All the taxi user knew was that they were unhappy with the existing experience. In what way? In many, many ways. Uncertainty of getting a ride when wanted; uncertainty of the quality; uncertainty of the costs. It takes entrepreneurial skill to articulate a solution and a business model.

The second challenge is scale. Is the need big enough to support a business? Answering that question also requires entrepreneurial imagination.

A mission emerges when you can identify a pain point within your circle of human impact that’s big enough and important enough to generate significant revenues.  

Dr. Bakshi started a consulting business helping start-ups to fashion business plans for their ideas and technologies. She rapidly found that it’s easy to identify pain points – engineering-speak for market needs or problems-to-be-solved – but that many of them are not significant enough to generate a business. A pain point is only half of a value proposition. Customers can live with pain points that don’t cripple them. It’s important to find the ones that they can’t live with. She advised all of her consulting clients that their ideas would not translate into effective business plans.

Having identified a significant pain point, with a potential for real human impact via a new solution, the next step is product-market fit. Imperfect is OK at the outset, improving steadily over time. 

Product-market fit is Silicon Valley-speak for the solution to the two challenges of articulation and scale: a set of features and benefits that truly meets the market’s need, and delivers an experience that matches the expectations that a sufficient customers have in their mind when they buy the product, and for which they will pay.

Dr. Bakshi found an unarticulated need in Higher Education for teaching Computer Science (CS). The inputs were part data (more than 50% of students abandon their CS course in Year 1 because the struggle to learn is too difficult) and part sentiment (instructor unease not only at this student struggle, but also at the instructor struggle of teaching with tools that were a poor fit to the task – text books – and the imbalance of administration (especially grading) versus teaching.

The answer was an educational technology solution – a web application instead of a text book, facilitating learning in as interactive a manner as possible, with limited text, interactive, animation, built in labs (tests for students to see if they can write short pieces of code), and auto grading. The brand name was Zybooks.

Importantly, the pilot looked nothing like the Zybooks product today. Once the product was in the market and began to generate feedback, there was a process of continuous updating, improvement and adding features. The MVP (minimum viable product) model worked for Zybooks because the first experience, though imperfect, was a sufficient improvement over the status quo of CS textbooks.

The harder part of success is adoption, rather than product design and launch. Even though the market has confirmed the need, that doesn’t mean adoption is ensured. 

Dr. Bakshi had commitments from target customers that “if you build it, I will use it”. That turned out to be an unreliable promise. Dr. Bakshi had to take an engineer’s approach to understanding how the market really worked. In this case, the higher education market, there is no incentive for the adoption of the best technology and best practice. In business, there is an expectation of switching to a new service – e.g. a CRM suite – if it is the best performer and an improvement over existing choices. This is not true in higher ed. The instructor has the academic freedom to use whatever techniques he or she prefers.

The engineering solution was direct sales: one-on-one, telephone, e-mail, online and in-person, whatever it took to influence one instructor at a time.

The final part of the journey is “crossing the chasm” from early adopters to early majority. 

The famous technology adoption life cycle chart suggests that the first 2.5% of a market are the innovators who grab at new technology. The next 13.5% are the early adopters who like to be not necessarily the first but at the front end of adoption. But then there is a chasm to cross before bringing in the early majority, who are more skeptical and less open to change. Dr. Bakshi feels she is still not across the chasm, but is making progress.

The keys, she suggested are:

  1. Focus – don’t be tempted to stray from your core mission and core product. Stick with what you do well, and what your core knowledge and core capabilities fully support.
  2. Never compromise – and always keep improving – product-market fit. Is the user experience exactly what the customer wants – and ideally, even exceeds their expectations. Obsess about this fit, and make sure the people in your company think and act as one in their alignment around this singular purpose.

When there is time to reflect on the journey, Ikigai is a good philosophy. 

Ikigai

IKIGAI CIRCLES SMITA’S IKIGAI
Find out what you love. Engineering.
Invest in becoming really good at it. 3 degrees, teaching, working at small and large engineering companies.
Impact: find out what the world needs. A better way to teach and learn computer science.
Business model: make sure you can be paid. Design, launch, get adoption for, and scale Zybooks.

The result is a life well-lived.

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23. Per Bylund on Entrepreneurial Strategy

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Business strategy in books and business schools has tended to towards metaphors of sports or war. There are playing fields or battlefields, and the strategy question is “Where to play, and how to win?” In other words, it’s a competitive strategy, where one firm wins and others lose, within some pre-set boundaries of industry structure. This is hardly useful for the start-up or SME entrepreneur, or indeed for any executive in any company who is dedicated to delivering customer value.

Austrian entrepreneurship, built on foundations from Austrian Economics, focuses on the strategic question of how to facilitate customer value. That requires a 100% focus on the customer — not competitors or industry structures. Per Bylund explains how adherence to this one core principle drives a very different approach to business strategy.

Show Notes

Strategy in business schools is about how to gain a competitive advantage. Austrian entrepreneurs think differently — they are constantly probing their own customer understanding rather than thinking about competition. An entrepreneur’s time is his or her most valuable resource, and they don’t waste it thinking about other entrepreneurs. Competition is usually understood as a firm’s relative position in a well-defined industry. It’s an idea from the economics of the early 20th century, when economists were thinking about market structures like oligopolies producing near-identical goods and services, and how firms performed within these structures. 21st century entrepreneurs don’t think that way.

Entrepreneurs pursue uniqueness: to become the customer’s choice by delivering the greatest value. Entrepreneurs spend their strategy time focused externally on customers and target customers. They are the ones who create value, in the form of an experience of satisfaction or pleasure. The entrepreneur’s task is to facilitate that value experience by offering a product or service that will be perceived as valuable. If the customer is dissatisfied with the status quo, then the entrepreneur’s strategy is to bring to market a solution that eliminates that felt dissatisfaction.

Deep understanding and deep empathy are the entrepreneur’s strategy tools. How can entrepreneurs facilitate value, if customers are the only ones who can create it? The answer lies in deep understanding of customers at the emotional level — how they feel. There is no shortage of data to help shed light: just initiate a conversation with them and they’ll talk about their dissatisfactions and hopes and concerns. They won’t design new products and services for you — that’s the entrepreneur’s job. But the application of deep empathy — truly understanding how the customer feels by seeing things from their perspective rather than yours — will take you to the level of understanding that’s required. If you are really, really good at this — in fact, if you can make it a unique capability — then you’ll realize success. Empathy is the best strategy.

Austrian entrepreneurs are rivals with each other for the customer’s dollar. Entrepreneurs’ continuous striving for uniqueness enables more and more satisfying and valuable customer experiences. All entrepreneurs are rivals — to do a better job of facilitating value for customers. If the customer buys a new digital printer rather than a new dress, the printer maker and the dressmaker are rivals. The dressmaker is stimulated to raise their game in value facilitation so that, next time, the customer buys the dress instead of, say, a bathroom rug.

There are some tools for customer understanding. The best one is conversation. We discussed various research techniques and tools such as the Voice Of The Customer, a method of data and information collection across all kinds of knowledge categories, capable of analysis and potentially leading to insightful interpretation. Dr. Bylund thought these tools worthwhile, but with the risk of being too formalistic. The Austrian route to deep understanding is one-on-one conversation: talking with customers about their feelings and their lives and their preferences, and perhaps getting them to discuss a prototype or rough description of a product or service. Numerical surveys and quantitative analysis are less useful.

Voice of the Customer Tool

There are also tools for internal allocation of resources to support uniqueness of products and services. We discussed the VRIN principle: reviewing the resources and capabilities of the entrepreneurial firm to ensure they are:

V – Value-creating: how much does a resource or capability or software feature or service element directly contribute to facilitating a valuable experience for the customer.

R – Rare: to achieve your uniqueness in delivering value, look for resources and capabilities that are unique, or at least rare. These could be particularly skillful individuals on the team or processes and recipes developed over time that are uniquely refined and uniquely aligned with the value preferences of your target customers.

I – Inimitable: if your capability can be imitated with a similar (but perhaps not identical) feature that delivers the same level of customer value, then your uniqueness is temporary.

N – Non-substitutable: if you are able to preserve uniqueness, but customers find they can substitute an alternative about which they feel just as good, then you are marketplace position in not sustainable. Customers can sometimes find value not only in direct substitutes but also indirect substitutes — like choosing a glass of wine over a glass of beer. Your unique beer recipe isn’t non-substitutable.

The VRIN formula is a useful lens to look at your internal capabilities. But Dr. Bylund stressed again and again that the strategy answer can not be found inside the company. Entrepreneurs must only think about the customer, and how to facilitate the greatest possible value for them. It’s the only way to build and sustain a business. Always reinvent and innovate. Always look for some new value that you can deliver. Keep talking to the customer, keep tapping into the infinite resource that their dissatisfactions represent — just ask them, they’ll tell you.

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22. Steven Phelan on Managing Expectations

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Entrepreneurs operate in the future. They imagine a future where lives are improved because dissatisfactions are removed and there’s greater well-being to enjoy. Everyone can embrace that future. So what could go wrong?

Well, your customer may expect more than they feel they actually get, so they stop being a customer. Investors and bankers may expect you to get to your next milestone faster, putting you in a race to recover their confidence. Suppliers may expect a better relationship than they actually experience, and they become more difficult to deal with. And heck, you didn’t expect all this angst, so you are dealing with your own disappointments.

What’s the commonality here? Mis-managed expectations. Steve Phelan reckons you might spend half your time as an entrepreneur on the task of expectations management. If you can do it well, it’s a resource for you. Follow these management steps.

To comment, ask questions or interact in any way, join us at mises.business/group, our LinkedIn Group Page.

Show Notes

Definition: Expectations management is actively and purposefully changing someone’s opinion about the value of a resource or asset. 

For example, many start-up or growing businesses suffer from a perception liability of newness or smallness. Target customers or potential investors or even potential employees might have a negative expectation about the company’s future prospects, which might present a barrier to securing capital or resources. You need to overcome the risk premium of smallness/newness in their eyes. You do so through expectations management.

Expectations Management Infographic

At the outset, when you are identifying your entrepreneurial opportunity and polishing your idea for a new business, a new project, or a new expansion phase, the expectations that most require management are your own. Get help. 

Entrepreneurs are confident, action-oriented people. Confidence is good – but research indicates that entrepreneurs are often over-confident about their plans. Steve Phelan calls this the Identification Phase, the point at which the entrepreneur forms the belief that arranging a new set of resources to serve customers in new and better way will achieve a profit.

While start-up entrepreneurs tend to over-confidence, those in business over 5 years tend to demonstrate tighter control over their expectations about what’s possible. So experience can be a good expectations management tool. But, if you don’t have the experience, try to gather more perspective from people who have. Assemble an extended team, even if it’s only by e-mail or Slack. Ask them to share their experience to substitute for your own experience gaps.

When you’re assembling resources, your goal is to give the right impression of a solid plan, trustworthy management, and a well-paced path to profits.  

Your target audience may be investors, whether friends and family or venture capital, or credit providers, like banks. In addition to the quality of your plan, your ability to manage expectations is also influenced by soft skills such as presentation style, and environmental variables such as how you dress. As always, the entrepreneur’s go-to tool is empathy. Take the time to learn about your audience’s history and preferences and form a clear idea about their goals and motivations. VC’s are portfolio managers – show them you fit. Bankers want zero defaults – assure them you can easily clear that bar.

If you are managing potential employees’ expectations, try to be sure you know how they form them. Are they thinking about future equity and getting rich? Or is security a higher preference for them? What about commuting versus working from home? What improvement over their current job are they are expecting? In order to manage expectations, you need to know and understand what the target audience expects.

In your growth phase, expectations management shifts to customers. They form their expectations entirely subjectively, and your task is to align with them emotionally. 

Austrian economists understand that it is customers who create value – it’s a consequence of their satisfaction, which only they can determine. In fact, they form satisfaction expectations in advance, based on your value proposition. If their experience is less than their expectation, they’ll be disappointed, even if your product or service performed well. Therefore, expectations management with customers is a matter of alignment.

If you operate a B2B business, the alignment vector is always trust. Customers are taking a risk when they embrace a new supplier or a new idea or a new product. Trust helps them embrace that risk. What is the signal of trust that will make the difference? Can it be influenced by guarantees or warranties? How can you demonstrate that the service level you promise will be the service level you deliver? And take the time required to identify the customer’s transaction cost (the cost of taking on a new supplier) and opportunity cost (what’s the alternative to your service). Be sure to address those two costs directly.

At some point, you will prefer to release assets. This is the time to manage expectations upwards. 

The exit stage may apply to selected assets – for example, you may want to reshuffle your capital structure by selling some and buying others – or you may be exiting a business by selling it. Steve Phelan had two pieces of advice for the exit stage. One was directed at the entrepreneur’s own expectations – to think about exit at the purchase stage (“making money on the buy”) so that there’s an advance plan for a realistic exit price. The second was to let multiple bidders be the influencers of each other’s expectations. Otherwise, you’ll need a strong case to manage expectations to be higher than the market average. For a hard asset, you may have to demonstrate how your ownership was a positive contributor to value – e.g. a superior maintenance regimen. For a financial asset, you may have to demonstrate the opposite – that new ownership can get a higher return. For example, entrepreneurs selling a business to a strategic buyer must create the expectations that the greater resources of the new owner can accelerate growth, reduce costs or increase profitability.

Do’s and don’ts. 

Manage expectations every day. Where are they set in the minds of others? Do they need adjusting?

Don’t create negative expectations (e.g. by failing to meet deadlines or over-promising). Don’t ignore inputs or advice. Don’t set expectations that can’t possibly be attained.

Your brand is not just your promise. It’s keeping your promise.

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21. Peter Klein on Transaction Costs

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Are you transaction cost-savvy? Peter Klein explains why it’s important.

We emphasize profitable value creation as the role of the entrepreneur. Managing costs can contribute to profitability – but there are some costs that are not easy to calculate and not even that easy to identify in some cases. They are not captured by traditional cost accounting. Economists call them transaction costs. They are the costs of acquiring, assembling, monitoring and managing and, in some cases, discarding or re-purposing the resources and assets your firm utilizes to produce output. They are not production costs per se; they are not value creation costs. They’re administrative and managerial costs.

Peter Klein explains:

Show Notes

Think of any transaction, like buying a cup of coffee at a Starbucks store. Now think of all the economic costs of that transaction above and beyond the actual dollars you hand over to the barista.

There’s the cost of traveling to the store, in both time and money (gasoline if you drive) and wear and tear on your vehicle. There is time spent on studying the menu, explaining your choice and waiting for delivery – and time is the entrepreneur’s most precious scarce resource.

Now apply that same thinking to the acquisition of any resource you want to bring into the firm to support your business model. There are many transaction costs in addition to the purchase price.

There is the time taken to research features and attributes, and comparative pricing. There may be negotiation or haggling with the vendor. There may be legal costs in a contracting process. There may be integration costs to fit the new resource into your production chain. If you’re buying from a wholesaler, there are issues of timely delivery and accurate order fulfillment you must monitor and manage. If the new resource is an employee you are hiring, there are advertising, interviewing and negotiation costs, as well as the benefits package that accompanies the salary agreement. All of these transaction costs, across the entirety of your business, add up to an amount that is pretty significant.

And, once you own the resource, transaction costs don’t disappear. They transform into monitoring and management costs.

Peter used the example of Walmart’s trucking fleet. Walmart owns many trucks and the drivers are employees. There are extensive monitoring costs associated with the ownership of these resources and the employment of the drivers and mechanics and service technicians. This group of costs can be characterized as the cost of confidence that you are getting the performance that you want out of the resource you own. In the case of Walmart’s truck fleet, these costs include monitoring the vehicles themselves (location, speed, downtime, tons hauled, gasoline used, etc), the drivers’ productivity, the maintenance burden, delivery accuracy and many more metrics. Walmart employs people and uses technology assets to implement all this monitoring, and those monitoring resources are not really creating value; they’re supervisory overhead.

Another kind of transaction cost arises when you decide you want to recombine, reshuffle or discard assets, or to use them in a new way.

In the entrepreneur’s uncertain business environment, it’s never certain that the asset you have acquired or the people you have hired are always going to be perfectly tuned to your business model. Circumstances change, and you want to make adjustments. Is the asset adjustable? Does the employee have exactly the skills you want for a new process or method? Will you be able to reprogram the asset or redirect the employee to a new job function? In many cases, you might have need of the legal system for a revised contract (legal costs are transaction costs), or there may be regulations preventing you from closing a plant or laying off workers. Any time you are constrained from making the adjustments you want at the speed you prefer, you are facing transaction costs. Could you have anticipated the situation when you first contracted for the resource or first hired the worker? Probably not – but trying to do so would be a transaction cost in itself!

Often, the issues raised by the problems of transaction costs are characterized as “make versus buy” decisions. Or rent versus own. Or in-house versus outsource.

It seems that there is a tendency today towards organizational models that are asset-lite, with a lot of the control that the firm seeks to exert over resources being exercised through renting or outsourcing, or by utilizing independent contractors rather than directly hiring employees. (Actually, Peter disputes this, suggesting that many such business models get a lot of publicity but there is no general tendency across multiple business sectors.) Does a virtual organization chart or a network model compared to a hierarchical model always have lower transaction costs?

Not necessarily. Compare Amazon, which mostly utilizes FedEx and UPS and USPS to make deliveries. Amazon still has many of the monitoring costs that Walmart has – it’s just that they are monitoring an outside vendor. Yes, FedEx and UPS bring their own tracking systems and technologies, but Amazon can’t afford to let its vendors go un-monitored.

In fact, in-house transaction costs are declining at the same speed as outsourced transaction costs.

With the advent of software HR and CRM systems and other kinds of monitoring and management technologies, internal transaction costs are not as burdensome as they were in the past. It would be unwise to make the automatic assumption that in-house transaction costs are always higher than outsourced costs.

Transaction Costs Types

Actionable Insight

So what’s the answer for entrepreneurs? There’s no simple formula, just the admonition to be transaction cost savvy. In every situation where there are alternative scenarios, the savvy entrepreneur thinks through the transaction costs of each one, and makes a best estimate of the economic costs. He or she thinks about the present costs, the future ongoing monitoring costs, and the potential costs when there is a future adjustment to be made.

Always relate this economic calculation of transaction cost alternatives to the creation of customer value. What is the best alternative transactional mode or organizational mode to deliver value to the customer, today, tomorrow and a year from now? What is the cost of the resource control you need in order to deliver value, especially if customer preferences change and you want to change with them?

Download our transaction cost checklist to help you become transaction cost savvy.

Buy Peter Klein’s book Organizing Entrepreneurial Judgement on Amazon.

Here are extra links to information that Peter Klein mentioned in the podcast:

An article Peter wrote to commemorate Oliver Williamson’s Nobel Prize – he is the originator of “transaction cost economics,” which is closely related to today’s discussion topics, though not directly dealing with entrepreneurship.

A longer, more academic survey on transaction costs – may be a useful reference.

Also, listeners may enjoy the comments on this blog post.

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20. Dr. Keith Smith on How Austrian Economics Helped Me Innovate

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Dr. Keith Smith is an anesthesiologist and founder of both the Surgery Center of Oklahoma and the Free Market Medical Association. Surgery Center of Oklahoma has innovated in healthcare with a completely free market offering of transparent pricing with no hidden fees, with a radically patient-centric organization and different and better patient and doctor relationship protocols. Free Market Medical Association is a movement to encourage medical practitioners throughout the country to pursue a similar pathway of radical innovation. Dr. Smith took inspiration from Austrian Economics principles. Here are the seven principles he talks about on the Economics For Entrepreneurs podcast:

1. Subjective Value

This was the first Austrian principle that Dr. Smith learned from reading Menger and Mises. He applied subjective value thinking to the healthcare industry by asking, “Who is the customer?” and “Are health care industry participants focused on creating customer value?”

He realized that, since the patient is not paying the anesthesiologist or the surgeon, then there was no value exchange between the customer and the service provider. Therefore, there is no market relationship. The customer was not in a position to evaluate the quality and efficiency of the medical service that Surgery Center Of Oklahoma and its surgeons provided.

When a third party payer is paying the fees, the patient is not acting as the customer. The fee from the third party can never represent the right price — the one that properly reflects customer preferences — and much of what is dysfunctional in the health care system stems from this arrangement. The industry can not accommodate the fact that patients who wish to consume medical services value different aspects of the service in different ways. Some will pay any price to experience the value of immediate service: surgery today. Some will defer service to a later date to pay a lower price. Some want a surgeon that spends a lot of time with them before and after surgery. Some prefer speed and efficiency. All individuals create value in their own minds, and should be able to decide what price they will pay for that value. Subjective value theory guides Dr. Smith to run his surgery center to serve patients’ preferences.

2. Preference Rankings

The idea of preference rankings may sound theoretical, but Dr. Smith has found a practical way to make them a tool for building an organization.

When the patient and the surgeon are both customers of the surgery center, it can be hard to align the interests of both without conflict. Dr. Smith calls this desired outcome “accommodating all interests with boundaries”. Both the surgeons and the patients can make unreasonable demands that can’t both be accommodated in the service of good care. How to accommodate both? Just ask them what their preferences are and how they rank them. Many times, just having the conversation is a revelation — it reveals considerations to the patient or surgeon they had not appreciated before. For example, if a patient demands a local anesthetic and the doctor reveals a preference against it, the reasons for the surgeon’s ranking may bring new information to the patient and may change their preference.

Preference ranking provides an organizational tool to help Dr. Smith build his team of surgeons. A surgeon that frequently shows up late, or habitually takes an excessively long time for a procedure, may be revealing a preference for revenue over patient quality. By observing behavior, it becomes easy to identify a doctor (or a hospital) that is revenue focused compared to one that is truly focused on value, taking the long-term view and making every value exchange mutually beneficial. If a surgeon is observed acting in a way that is not in the patient’s best interest, Dr. Smith does not want him or her on the team. Asking preference ranking questions — what is important to you and how do you rank it? — is a good way to get to know someone you are considering for your team. It’s a troublesome thought process for some, and an enlightening one for others.

3. Self-Examination

Preference ranking can be applied in self-examination. Dr. Smith says, “I scour myself for inconsistencies”. He found one when he realized he was filing Medicare insurance claims that were paid with government funds which, he declares, is like “receiving stolen goods”. That, he realized, was inconsistent with his free market principles. And so he abandoned the practice and now treats Medicare patients at no cost. The acceptance of the market is the determinant of his business success — “to hug us or crush us”. Dr. Smith’s preference is to be consistent in his commitment to free market practices.

4. The Errors of Interventionism

The refusal to accept government money was just one step in expunging the corrupting and distorting effects of government intervention in the health care market. Dr. Smith examines every element of government intervention in the market and attempts to eliminate it from his business, to make sure his business does not benefit from it. He scrutinizes one situation after another and attempts to eliminate them all.

5. Dynamic Flexibility.

Austrian Capital Theory — and the Resource-Based View of the firm that derives from it — prescribes extreme flexibility of capital assets and resources to enable shuffling and recombining in response to changing consumer preferences. Dr. Smith describes the process of continuously looking for more knowledge, more learning and more flexibility as “radical entrepreneurship”. He looks for texts like Peter Klein’s The Capitalist And The Entrepreneur to provide new ideas and new initiatives. Continuous learning is part of Dr. Smith’s recipe, and he is always searching out readings that will change his mind.

6. Time Preference

Time preference is a core concept in Austrian economic theory. Entrepreneurship takes time. It requires patience, and the elevation of long-term goals over short term goals. It also requires foregoing present opportunities in order to pursue future benefit. What are you willing to forego in order to be an entrepreneur?

Dr. Smith found the most striking discussion — “jaw-dropping” in Dr. Smith’s words — of time preference in Hans-Hermann Hoppe’s Democracy: The God That Failed (i.e., the relevant passage starts at the very beginning of Chapter 1).

He found an immediate application in the business model for Surgery Center Of Oklahoma. As surgeons get older, their time preference changes. They want to monetize their ownership position in the partnership — to “cash out”. This often leaves junior surgeons “holding the bag”, because the partnership (or an intervening VC) may buy the departing surgeon’s position, but this is paid for out of the future earnings of the remaining partners. Through his understanding of time preference, Dr. Smith was able to anticipate this situation and organize his surgery center like a law firm — no partner pays anything to join and receives no exit payment when they leave. They also don’t own the real estate. So there is no opportunity to monetize on exit, which “saved SCO as a business” and brought stability by de-fanging an activity that doctors are known for.

7. The Austrian Way of Thinking

As important as any principle of economics is the Austrian Way of Thinking: rigorous reasoning based on logic and a priori axioms; being aware of assumptions and always examining them; respect for how others value things; understanding the difference between risk and uncertainty, and looking uncertainty in the eye; and generally exerting more logic and less emotion in conducting business.

Economics is the study of human behavior. Humans move from A to B because they prefer B to A. Understanding the logic of human action — and the motivation behind it — provides a lens through which to observe what is going on around you and to see it more clearly, obscuring distractions and perceiving conflicts of interest you might not see without the lens. The Austrian Way of Thinking brings confidence, decisiveness and calm. Physicians — and anyone — can benefit.

 

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