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Cut costs now!

I was drawn to The Illusions of Entrepreneurship by a review from Luke Johnson in the Financial Times.

Luke was hinting at a Damascene conversion having read the book and as this new philosophy embraced some, to me, heretical thoughts I logged on to Amazon to obtain my own copy. We receive several books a month seeking reviews so my parting with hard cash gives a clue as to how deeply Luke’s suggested heresies had impacted, though to be fair to him he hedged much of his comment with caveats.

Let me say at once that it is a scholarly book. Author Scott Shane sits at the pinnacle of the intellectual side of business, his research, as is traditional with someone in his sphere of life, is extensive, he possesses a sense of humour in describing himself as a nerdy professor and none could argue that the conclusions drawn from the data might not be valid in a one dimensional view.
The problem is that he has completely missed the point and sadly, gives weight to views found in far too many areas of the civil service which is distinctly sniffy about small business, government which has not a clue about the subject, and academe, which contributes vast ledgers of research to the debate without ever quite grasping just what entrepreneurialism is all about.

Entrepreneurialism is about choice: a fundamental of a democratic society: for a view of the obverse, look at the appalling economic performance of societies where entrepreneurial opportunities are nil, or very limited. Recall that the USSR in its pomp could not feed itself through its collective farm and state controlled distribution programme. A huge percentage of the population was fed from, or sold or bought crops from, small patches of land allowed to individuals.

If enlightened governments, be they national or local, encourage new entrepreneurs into the arena with some hyperbole and financial assistance they are the realists. They acknowledge that no amount of centralised control is going to feed into their community those essential props, often one-man bands, that not only provide a service that the community needs, and here I am about to attack one of the tenets of Scott’s summing up, they also provide that abrasive element to the established entities with which they compete, to keep their prices down, to keep their service levels up, or lose business.

The one-man band, so low in Scott’s estimation, contributes far more to the efficiency of USA inc, UK plc or any other country, than all of the big accountants, McKinsey style consultancies, MBAs or business schools in the world.

OK Scott, be dismissive about one-woman hair stylists, but try telling a woman that the community does not need hair stylists with flair and sharp pricing. I wish you well. Or how would your community work without its one-man builders, window-cleaners, decorators, car valets, gardeners? Your managing directors and MBAs would be doing it for themselves when they could be completing that next project assessment. Or they might wind up in hospital because they are ill-equipped to be efficient and safety conscious in an unfamiliar role.

It is this competitive abrasion at the bottom of the economic pyramid that keeps the whole structure lean, mean, and efficient.

Take our one woman hairdresser. Because she will take custom from the high street salon, it has to become more efficient, keep its prices down. Because it keeps the cost of a hairdo down its customers do not press their employers for a raise in pay. Because of this the employer keeps its wage costs down so it delivers to its bigger industrial customers without trying to pass on additional wage costs. And so it goes on up the chain, wider across the commercial base. It is called competition and competition is the single defining factor that makes democracies and free economies efficient.

And competition in business, as in football teams, as in everywhere in life, depends upon a steady stream of new entrants, young hopefuls, to keep the established players at their best or helping them towards the exit.

Failure to address that defining element of entrepreneurial hunger, the vital energy in business success and efficiency means that all of the research in the world just produces statistics and those come after damned lies in the fabled chain of incredulity.

Contrary to what many believe, a university education does not of itself equip individuals to be entrepreneurs. Ask anybody involved in monitoring a graduate recruitment programme in a thriving company as to its outcome. Sure, one or two brilliant executives emerge but they go on to sustain the momentum of a proven commercial winner and perform an essential role. But they are premier league managers, they are not entrepreneurs. Peruse the list of non-graduate entrepreneurs, it is long and impressive, and their success provides much work for the premier league managers I have just described.

Scott concludes his book by comparing:

A personal cleaning business started by an unemployed high-school drop-out that is pursuing the customers of another personal cleaning business (heaven forbid – what is the world coming to?), is capitalised with $10,000 of the founder’s savings and is set up as a sole proprietorship.

An internet company that is started by a former Microsoft employee with 15 years of experience in the software industry, an MBA and master’s degree in computer science, that is pursuing the next generation of internet search, is capitalised with $250,000 from the founder and Band of Angels in San Francisco, and is set up as a corporation.

Speaking as someone with 28 years of banking behind him, someone who backed hundreds of start-ups and SMEs, it is a no-brainer.

Despite being a high school drop-out, our personal cleaner has managed to save $10,000 and is prepared to put it on the line. He is also prepared to take responsibility personally  for the activities of his business. Two plus points straight away.

Looking at his business plan, he is not frightened to take on an established company so he thinks he can do what it does better, or cheaper, or both. Another big plus point.

So the community benefits in many ways:

• he is not unemployed and costing it welfare payments;
• it gets another competitive personal cleaning service;
• it keeps the prices down, and the service up, from the existing player;
• and he may make personal cleaning available to those who could not afford it before – free them up to go take an MBA course?

I would back this guy and others like him. I did, hundreds of times. There are a few local multi-million turnover companies now as a direct result. These mean much more to our community than another Google. Certainly they attacked established businesses but if they were ready to crumble anyway, the jobs and wage packets could have gone to a competitor out-of-town. That is how capitalism works and it is more efficient than any other system in delivering real benefits to individuals and communities.

The second example I would walk away from.

Fifteen years at Microsoft so will Bill Gate’s lawyers be descending in droves for one of their attritional court battles because our man’s line of code bears a passing resemblance to something Bill did and patented two decades ago?

How much money has the founder contributed? I love a cushion of personal pain between my commitment and a write-off.

Will he come up with something commercial? The annals of companies such as this are littered with technologically brilliant products that could never be commercial. Look at Concorde, the Sinclair C5.
Will some brat down the road, the next Bill Gates maybe, come out with something that will trump our team’s product two days after launch?

And, do you really want to spend too much time with an egotistical nerd who stuck it out for 15 years with Microsoft before deciding that his brilliance was more deserving of recognition than that of Bill? Where is that naked commercial aggression? Been asleep for along time has it not?

Above all it perpetuates the all-too-often heard myth that success in business is academically formulaic. Just look at the ledgers of the, much-vaunted in Scott’s book, venture capitalists. Sure, there are one or two outstanding successes or they would not be here and maybe the example he cites came up with a Google. But there are regiments of living dead companies too and enough turkeys to supply a small town on Thanksgiving Day.

Scott’s thinking is all too prevalent amongst governments that pack their small business advisory bodies with civil servants, corporate premier league managers, and academics: enough degrees between them to fill a sizeable book. But not an entrepreneur in sight, where are the guys who have been there and done it?

Two classic paragraphs on page 150 sum it up.

Scott writes: “One way to know if we would get more economic growth by having more start-ups would be to look at the relative productivity of new and existing companies.”

The next paragraph contains the gem arising from academic research demonstrating that, unsurprisingly, firm productivity increases with age:

“This means that the average new firm makes worse use of resources than the average existing firm, which is not what you would expect if economic growth benefits more from the creation of new firms than from the expansion of existing ones.”

The over-simplistic, and one-dimensional, formula for productivity is sales divided by employment so we can immediately divine just why this flawed conclusion has been reached.

New businesses can only prosper by delivering more for the same dollar, or the same for fewer dollars, than established competitors so it is their customers that get the productivity benefits, the wider business community.

But the statement also begs the interesting question as to how the average existing company got there in the first place? Did it land from Mars or was it, and heaven forbid yet again, once a start-up! A debate re-ignited when we are told that only nine-year old companies and older create real new employment.

And never, ever, repeat the folly of pouring state money into mature businesses that lacked the wit, product or drive to find new markets and expand themselves. We would have a fine array of gas mantle, stage coach and buggy whip manufacturers: useless, living dead businesses that should die.
A free and democratic society depends upon the vital entrepreneurial energy that comes from the grass roots. It is the choice of the individual to be employed or work for themselves. It is a hard, cruel, unrelenting battle to succeed and only the fittest make it, and only the fittest should. By the same creed, the established businesses that fail to adapt to changing conditions or competition should die when challenged by vigorous newcomers.

Scott’s excellent piece of scholarly, but very tunnelised, research fails to explore the benefits to the broader community of the productivity gains delivered by start-ups. He appears to have ignored the indirect employment created by the ones that succeed: of golf club staff, restaurants, car hire companies, childcare staff, personal cleaners even, or the degree to which start-ups hone the efficiency of bigger companies by competing with them, or by performing tasks that free up others to use their time for more valuable activities.

Above all, the start-up epitomises the absolute right of a free person to go out and try to better their lives and by so doing, that of their community. It is the spirit that took us out of the caves.

The cover of the book alludes to “Costly Myths”.

If the content is taken too seriously a few more might take root, especially in areas where academic research is given more respect than it sometimes deserves: government and civil service: ivory towers where a sublime ignorance of the importance of the small business sector to any community all too often prevails.

Read it, but challenge its conclusions too, if only to remind you how vital it is that start-up businesses are encouraged.

Editor

Published by Yale University Press
Hardback £18
www.yalebooks.co.uk

Scott Shane is A Malachi Mixon III Professor of Entrepreneurial Studies, Weatherhead School of Management, Case Western Reserve University.