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Customers Are Your Firm’s Capital. Invest In Them.

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In a book titled “Who Do You Want Your Customers To Become?”, Michael Schrage identifies customers as a firm’s human capital. The purpose of a firm, in his construct, is to design future customers: to anticipate how they will behave and think and feel when they adopt and use the firm’s new product or service.

This view has a lot of merits. It’s future-oriented as all entrepreneurial perspectives must be: what sort of future can I imagine and how can I bring it about? It’s based on customer primacy, recognizing that it is future users of the firm’s innovation who will be decisive in success or failure. It recognizes that value lies in customer experience and that there is a lot of uncertainty in predicting future value because the customer doesn’t know what that experience is going to feel like.

Can a firm design this future experience, as Michael Schrage suggests they do? It’s unlikely. Why? Because the experience is entirely subjective. The evaluation of it is in the consumer’s mind. And since it’s a future experience, and hasn’t yet occurred, then the feeling of it is impossible to frame.

However, there is a wonderful nugget of new understanding in the concept of customers as capital. In traditional economics, businesses invest in their own capital base in order to generate a future revenue stream. Investment in manufacturing capital enables the production of goods to sell and thereby generate sales revenue. Investment in people and their skills and technology to support them enables the delivery of services that generate customer revenue. Capital generates revenue flows. Interestingly, the revenue flows back to the capital owner from the customer. Do we have the picture the right way round? This kind of capital isn’t generating revenue flows, it’s attracting them from customers. Should customers think about investing in customers rather than in their own capital?

Capital increases capacity to produce and perform. When Apple puts an iPhone in the possession of a customer, it is enabling that customer to become more productive – to send e-mails more easily and frequently, to gather information faster, to make or view videos conveniently, to listen to music, to buy and sell through e-commerce, and a whole host of capabilities. Many of these new and enhanced capabilities will directly benefit Apple of course – using paid services, buying accessories, using the Apple Pay system, and generally expanding Apple’s ecosystem and network. Google search technology makes customers into better searchers, using the system more frequently, making it more intelligent, providing feedback.

Amazon Web Services rents or leases its own capital to customers in the form of cloud storage and cloud-based computing and additional digital services. The customers control that capital for the duration of the lease period. They are capitalized by AWS. They are more capable than they were before – they can produce more, and contribute more to both the amazon ecosystem and the economy as a whole. AWS is investing in making its customers better users of AWS by providing them with capital. When the capital is in the customer’s domain, the revenue flows back to AWS.

In the second sense of capital, Apple, Google and Amazon are investing in enhancing their customers’ human capital value. They become more skillful, have access to more knowledge, can make network connections more fluidly, and can work faster and with more convenience and remotely. At this new higher level of human capital value, they are more valuable customers. Customer loyalty is an old-fashioned way to think. Customer enablement is closer to the case. And every time Apple sends a software update over the network, or Google adds some code or some new links to its search algorithm, or AWS adds a new service to its suite, they add even more to the capitalization of their customers. More enabled equals more valuable.

How can your business invest in making its customers more capable by putting capital in their hands or putting it under their control? If you are a supplier of products to the building trade, can you provide them with ordering software or search software or payment systems software to make them more capable and more efficient? If you are a direct primary care physician, can you provide your patients with more access to knowledge or more connections on their network or some other knowledge capital that will make them smarter and better patients? If you are a trucking company can you provide warehouses with better tracking data so that the bay is more likely to be open when you arrive, saving both you and the customer precious turnaround time? These are not investments in your own capital, they’re investments in customer capital – in customers as capital.

The other side of the coin is that customer dissatisfaction that results from poor service or unkept promises is a wasting of your capital. Destroying your own capital is no recipe for success. Customer churn is like burning down your office building or your factory. Do everything you can to make sure it doesn’t happen to you.

Considering your customers as capital will change the way you think of investing and allocating resources.

87. Professor Matthew McCaffrey: The Austrian Definition of Capital and its Application for the Health of Your Business

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Key Takeaways and Actionable Insights

An understanding of the Austrian definition of capital is tremendously useful to all business owners and managers.

What is capital? Austrian economics has a precise and distinctive definition — unlike business schools and most business publications, books, and columnists. Among those entities, the term capital tends to be used very imprecisely. You might see sentences like, “Entrepreneurs must ensure they have sufficient capital to get their new product to market”, or “to get to break-even”. Such usages imply that capital is a cash reserve to be “burned off” in the process of launching and scaling a business.

Recently, it has become fashionable to coin terms such as human capital, or brand capital, or relationship capital, or even spiritual capital or street capital. All of these terms are sloppy definitions of capital from an Austrian point of view.

And it’s important to note that capital is not the same as capital goods, which are “produced means of production”. Capital is not a means of production, it is a consequence of production.

What, then, is the precise Austrian definition of capital?

On the E4E podcast #87, Professor Matthew McCaffrey gives us this definition:

Capital is the monetary value of a business’s claims to income. This includes all of its marketable assets, whether they are tangible or intangible. It’s a sum of individual values. These values are ultimately determined by consumers, because the value of a firm’s assets and the value of its income streams ultimately depend on how consumers value the final product. Crucially, capital is distinct from what are called capital goods or production goods, which are the physical goods used in production. Those are also vital for understanding how entrepreneurship works in practice, but they are not capital in the sense in which we mean it.

In summary:

  • Capital is a flow (rather than a stock)
  • Coming into your business
  • From consumers
  • Reflecting the value consumers perceive in your company’s services.

B2B businesses can substitute the term “final purchasers” for consumers if producing goods and services purely for business customers. But it is important to remember that the value of capital always eventually reflects the valuations of goods and services by consumers. The software or professional services your B2B business provides to a business customer will command less of a claim to income if that business customer faces a change in preferences and a decline in market demand from their consumer population. When forecasting future income flows, every business must bear in mind the climate among ultimate consumers.

What are the implications for entrepreneurs and business managers?

  • Flows can be generated via tangible or intangible assets.
  • Consumers’ valuation of services is the key variable.
  • Entrepreneurs must be able to appraise which assets — in which combinations — are generating the flow.
  • The flow can change — even disappear — when consumer preferences change: entrepreneurs must be able to adjust.
  • Large flows can result from a low asset base — and vice versa.
  • Appraisal — predicting future prices and flows — is the vital skill to determine what to invest in, how to organize, and what to produce.
  • Cash flow is the measurement variable.
  • Use cash flow to calculate asset productivity.
  • Update appraisals continuously based on cash flow.

What about capital goods?

  • Capital is NOT the same as capital goods.
    • But capital goods can be generators of capital flows.
  • IF consumers value their output.
  • Austrians stress HETEROGENEOUS capital goods, both tangible and intangible.
    • A jigsaw puzzle to assemble, disassemble, and reassemble in the right combination, based on consumers’ valuations.

What actions should entrepreneurs take as a consequence of the Austrian view of capital?

  • Always focus on the value you are facilitating from consumers.
    • They, in turn, will generate your capital flow.
  • Measure the flow in dollars — especially the trend.
  • Be a master appraiser: know your asset productivity.
  • Set up your assets for flexibility — be fully able to disassemble and reassemble capital combinations.
  • Experiment frequently with different combinations.
  • Become comfortable with continuous change in asset combinations.

Free Downloads & Extras From The Episode

Professor McCaffrey made reference to Frank Fetter’s role in defining capital in his online discussion, “Frank Fetter and the Austrian Tradition in the United States”: View Online Discussion

Professor Peter Klein explains why metaphors like Human Capital are unhelpful to entrepreneurs in his article, “A Note on Human Capital“: View Article

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

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The Entrepreneurial Advantages of Building Human Capital While Young.

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While you were young, did you gain knowledge and learn skills that gave you the human capital necessary to become an entrepreneur or a small business owner? Human capital consists of the knowledge and habits developed as a youngster that form skillsets that later in life can be used in the business world. These skills are developed either through the family unit, culture, or regional location and determine the success or failure of entrepreneurial pursuits and performance. In the young, the development of skills and knowledge are applicable to future ventures in entrepreneurship or small business ownership.

Everything you learned from family dinner conversations and your culture served to build your human capital. Across the globe, the people of various regions cultivate certain skills that enable individuals to consider entrepreneurship as a viable choice of work. Some of you never had the social or family setting that gave you entrepreneurial insights. Some people get this while they are young, and some do not. Acquiring human capital at a certain age bolsters the chance of entering entrepreneurship or small business ownership. If human capital or business insights are not embedded culturally or acquired at a certain point, some individuals will never consider entrepreneurship or be successful at it.

We cannot all become successful entrepreneurs, especially if only a few of us come from a cultural background that rewards an ethic of hard work and related values versus a cultural background in which achieving entrepreneurial success is never even thought of.1 What is valued in the family unit and what is rewarded or praised contributes to our future entrepreneurial skills. Ludwig von Mises noted, “the inequality of men, which is due to differences both in their inborn qualities and in the vicissitudes of their lives, manifests itself.”2 The region of the world in which one lives and the context of the acquired human capital skills are equally vital to having an entrepreneurial skillset.

We hear from many entrepreneurs, and those who are not entrepreneurs per se, that much of their education occurred around the family dinner table, or that they lived in a place where small business activity was plentiful.3 Human capital that is based on family, culture, and regional differences has consequential effects for many considering entrepreneurship.

Cultural factors are critical in developing entrepreneurship. Often these cultural factors are overshadowed by the technical aspects of operating a business—the seen versus the unseen. Parents and the elderly pass on their values to their children, values such as taking risks, being independent, challenging uncertainty, etc. Children who are rewarded or not rewarded will either be encouraged or discouraged to pursue entrepreneurial activities in the marketplace. If a child is never taught to be independent, how is he or she able to systemically think of and identify potential profit opportunities and bring opportunities to fruition?

Habits form over time, and many are culturally based. In some cultures, some children spend up to twelve hours a day playing videogames and entertaining themselves on social media. In other cultures, children are expected to work long hours helping mom and dad with their business or studying to earn the best grade. These youths may work at an uncle’s garage learning all about vehicles or attend college to gain business knowledge. In either situation, these youths are learning about private property, e-commerce, revenues, profit and loss, bookkeeping, and so on—gaining skillsets and knowledge in order to run a business of their own in the future.

Generally, whatever is cultivated in the family unit and culture will manifest and have consequences in the marketplace. Children who acquire a work ethic and values related to entrepreneurial success will have an advantage over their peers who have not had the same experience. The children who have not learned these things will have a much later start or never acquire the skills and the know-how needed to pursue entrepreneurship or small business ownership.

Not everyone has an equal opportunity to become an entrepreneur, as some must acquire a collection of basic skills, knowledge, and habits that may take decades to develop. Taking risks, working longer hours, and making critical decisions require a certain upbringing. Entrepreneurs are not created overnight but over time. However, ten years of working with mom, dad, or an uncle as a youth, gaining practical knowledge, surely provides advantages later in life.

We cannot disregard the location and region in which we lived during the time of our early human capital acquisition. Being located in one region of the earth versus another can surely impact our ability to develop a predisposition or entrepreneurial insights needed for entrepreneurial behavior. Perhaps we live in an area where several industries exist. Being surrounded by these industries allows us to either work for or start a business in a vein that is familiar to us.

As with any location or local market, our human capital can be stymied in a region or location where a product or service is not valued or not supported although it might be highly valued in another market (i.e., if one has to take their product knowledge to another region where the consumers have higher subjective valuations of their productive goods or services).

Unfortunately, the opportunity to attain the same human capital at the same time and place that leads to entrepreneurship is not equally available to everyone. Without the requisite human capital, one can only dream of becoming a successful entrepreneur or business owner. Families and family cultures vary among peoples across the globe, and so does the dissemination of knowledge at the family dinner table. We all come from backgrounds that either reward or punish certain behaviors that later transform into predispositions and values that underpin our ability to, at a minimum, think like and be an entrepreneur. Ludwig von Mises said that entrepreneurs “owe their position exclusively to the fact that they are a better fit for the performance of the functions incumbent upon them than other people are.”4 An interpretation of Mises on this point is that the skills and knowledge develop over time that enable entrepreneurs to uniquely perform the production of products and services for the consumer.

  • 1.See Thomas Sowell’s The Quest for Cosmic Justice. In the section titled “Freedom versus Equality,” he discusses equal performance and social barriers.
  • 2.See Ludwig von Mises’ Planning for Freedom.
  • 3.See Ryan McMaken’s article “Three Economics Lessons I Learned from My Dad.” For example, three lessons that he learned were: lower the cost of doing business, politicians drive up the cost, and the world is always changing.
  • 4.See Ludwig von Mises’s Human Action on the Entrepreneurial Function.
Author:

Raushan Gross

Raushan Gross is an Associate Professor of Business Management at Pfeiffer University