Rethinking Entrepreneurship in the 21st Century

Industrialized countries are in the middle of an era marked by economic stagnation. Take S&P 500 for instance. This index is supposed to be an important lead macroeconomic indicator. Well, S&P 500 has grown 22% compared to 10 years ago, which is equivalent to an annual growth rate of 1.97%. Canada’s CPI for the same period is equal to 2.08%!

Of course, being the great forecasters that they are, large corporations took part, since the 80′s, in a cost cutting effort that mainly translated into massive off-shoring of labor, especially in the manufacturing sector. This strategy seemed unavoidable since a company must, when it doesn’t see any growth lying ahead, cut costs to stay financially attractive. While some of the current economic problems in advanced countries can be explained by the demand-side issues that this collective labor off-shoring has caused, one cannot fail to notice that it did not serve the largest corporations either. The stagnation of S&P 500 is in fact a sign that large corporations, despite these cuts, are not more attractive from investors’ perspective.

This painful situation has led some in industrialized countries to dream of the manufacturing sector’s return. However, many know deep down inside that their manufacturing sector is no longer competitive. Manufacturing relies mainly on the learning curve principle, which states that manufacturing capabilities improve with experience: the best way to be good in manufacturing is to be manufacturing! Having off-shored manufacturing, advanced countries have inflicted damage to their manufacturing capabilities and are in a position that they are no longer competitive.

This is why the voice of those who preach entrepreneurship as a solution to these economic woes resonates so strongly among different spheres of society. It resonates strongly because it implies a certain level of social organization that would help the transition from a manufacturing economy towards an entrepreneurial one. While general consensus is in general a good thing from a policy perspective because it avoids the pitfalls of inaction, it will not easily translate into successful economic reorganization. In my view, the big problem ahead is that most of the things that have been collectively learned about entrepreneurship are no longer valid in the new economic context.

Being often present in entrepreneurship seminars, I often hear successful entrepreneurs praise lean startups with “release early, release often” as their motto. Such product development strategies, however, are more likely going to lead to products that have limited added value and that are therefore be easily imitable. Also, the technological complexity that drives today’s economies makes it increasingly difficult for new ventures to succeed in earning market shares by introducing incremental improvements over existing solutions.

Another message often sent concerns team size. I repeatedly hear that large teams (more than 3 persons) must be avoided because they are difficult to manage and slow in their decision makings. This idea is somehow connected with the lean startup philosophy. Again, small teams will have a hard time to come up with radically novel ideas in a complex world because they cannot easily integrate ideas coming from a variety of disciplines.

Another myth often heard concerns rhetoric against higher education. There is such a fixation with successful dropouts that it appears as if higher education dumbed people down. Although higher education can, must and increasingly does emphasize on the development of social skills, it is hard to imagine that a successful new venture in the aerospace sector could take life out of a dropout’s imagination. While these kind of things happen once in a while, dropouts are more often bound to fail in a knowledge economy as shown by sheer unemployment figures.

In my view, many myths regarding entrepreneurship as an economic phenomenon have been developed in order to satisfy short-term imperatives. While money cannot be asked to be patient, it doesn’t mean that the type of projects that it fosters are going to be socially profitable in the long run. It will thus be up to collective initiatives to fill the void left by the short-term vision that characterizes the financial sector.

Tech Bubble 2.0: This Time is Different

Remember the crazy pre-dotcom crash days? Investors where financing businesses that had little more than a business plan to show for. As a result, many of these investments translated into financial loss. Combined with unscrupulous accounting practices by some large firms, we witnessed what we today call the tech bubble.

But no need for worries as those days are over. Markets have learned their lesson and they are much more selective. Today, only the top revenue generating companies are subject to IPOs. Think of Linkedin, Zynga, Groupon and, recently, the all-mighty Facebook. No more IDontHaveABusinessModel.coms.

Well, let’s take a look at these huge IPOs. Groupon is a total disaster. After seven months of trading on the market, the company is worth half its IPO valuation. It would take a lot of “forecast-beating quarters” before prices go back to initial levels. And with a dubious business model and an economy plagued with demand-side issues, it does not seem to be a probable scenario. Although too soon to speak in the case of Facebook, the company has lost 30% of its value in a week. And this goes without saying about trading irregularities and selective dissemination of information. Zynga has also lost a quarter of its value after 6 months of trading. LinkedIn is the only “happy” story, with a ~5% gain after 12 months of its IPO. Lets not forget that these companies are trading at crazy P/E ratios. If stock prices do not grow fast in a fast paced industry, it could translate into a lot of money thrown out the windows…or into someone else’s pocket…

The thing that all these companies have in common is tons of data. Facebook has personal information about 1B people and is supposed to use it to make money through advertizing. If stock markets can be viewed as a place where resources are allocated to promising business opportunities, then Facebook’s value has to be more or less equal to the gains in marketing efficiency associated with the interaction and targeting possibilities not offered through traditional promotion channels. Yet, advertisers seem to have doubts about the platform’s potential as we have seen through GM’s recent pullout. Could it be that markets have overestimated the potential of unlocking value from terabytes of data?

In my view, there is a way to make money out of data, but that requires technical knowledge about this kind of thing. Google’s AdWords platform is so far a success story in terms of targeted advertising. But the fact that one company is able to translate data into sales doesn’t mean that all companies that have access to data can do likewise. Facebook might have to do a lot more investments in R&D before it can be skilled enough in this area. The big question is: how long would it take, and how low will it go before then.

Of course, Facebook can always charge fees to its users. Dating website match.com makes around $350M with less than 2M paying subscribers while there are free alternatives like plentyoffish.com available. Why can’t Facebook do so? In fact, if there is any free website on this planet that can charge fees without loosing most of its clientele, it is well Facebook. After all, whatever Facebook charges to its customers will always be marginal compared to the time wasted on Facebook!

The Decline of Entrepreneurial Intent and the Case for Social Risk Absorption

It is often said that entrepreneurship and risk aversion do not go hand in hand. Often, management gurus argue that entrepreneurs have to be optimistic and self-confident or else they would never be willing to take the risks inherent to starting new ventures. Alas, optimism will not make risks disappear, that is the probability of the occurrence of a negative event will always be the same no matter one’s subjective perception of it. Therefore, entrepreneurs always put themselves at risk of failing because of that same feature which makes them be entrepreneurs: optimism and self-confidence. Given the fact that there is no study quantifying the proportion of entrepreneurs who succeed, is it correct to say that entrepreneurs are in fact nothing but fools that put themselves in situations where they could incur losses without guarantees for rewards?

In my view the answer to this question lies in the presence of social risk sharing mechanisms. It is known that new ventures have social benefits: they create around 50% of jobs and represent a quarter of national GDP in industrialized countries. Of course, this contribution comes from successful businesses as new ventures that fail do not contribute as much if any to productivity. However, unlike the banking sector where benefits are privatized and losses socialized, entrepreneurs are the ones who absorb the losses for their risk taking attitude. Therefore, they take the risks personally but share the benefits socially. I believe that this mismatch in the distribution of risk among entrepreneurs and society is at the core of the decline in entrepreneurial intent in advanced economies.

If societies desire to appropriate some of the returns associated with a human behavior commonly known as entrepreneurship, they must also share some of its risks with entrepreneurs. In my view, this principle was so far neglected in advanced economies because they were so far managed economies that heavily relied on the well being of their manufacturing sector. Entrepreneurship was a cute little thing that existed along the manufacturing sector which sometimes, if not most of the time, was the real thing that allowed new ventures to be created around it. Nowadays, with the decline of traditional industries in advanced countries, entrepreneurship is increasingly recognized as an engine rather than a peripheral component or byproduct for economic growth. This calls for setting up policies that encourage risk taking behavior by sharing part of it with entrepreneurs.

Research In Motions: Where to Go From Here

The once amazing Research In Motion is no longer Canada’s most valuable company. How did that happen would make a great case study in business schools. However, there is something else that interests me in RIM: its imminent acquisition.

The imminent acquisition of RIM

Let’s face it, RIM will not be able to dethrone Apple or Samsung. The dominance of the smartphone market will be fought between iOS and Android. Even the enterprise sector, RIM’s self-proclaimed stronghold, is at danger of switching into Android. It simply doesn’t make sense for anyone to go with a BlackBerry.

RIM is however a technology company and own a relatively large patent portfolio. And in an industry marked by intellectual protection litigation cases, a strong patent portfolio is a valuable thing to have. Patents however, are not enough to generate income. At least not the kind of income that can support the operations of a large smartphone manufacturer. All of this points out to the imminent acquisition of RIM.

RIM’s patent portfolio value

Smartphones are complex technology. Every single product is a combination of dozens (or hundreds) of patents. In such context, single patents are not so valuable but bundles of patents do matter. For instance, Google paid the equivalent of $400,000 per patent when it acquired Motorola Mobility with its 17,000 patents. Rockstar Consortium, which acquired Nortel’s portfolio (6,000 patents), paid $750,000 per patent.

With 2700+ patents, RIM can be sold for somewhere between $1-2B if we extrapolate with the above data. Based on similar considerations, other analysts put a price tag of $2.5B. Yet, stock markets do not seem to agree with such valuations as RIM has a ~$6B market cap with a P/E ratio around 5 as of May 2012. What would an intelligent investor do?

Groupon’s Steady Disappointment of Investors

In a previous post, I was critical about the potential benefits that Groupon has to offer to consumers. My main argument is that while group buying seems to offer money saving opportunities by leveraging collective consumer action, it cannot compete with a retailer that can sufficiently guess future demand for a certain product. Since then, the company went public and bad news come almost by the month.

First, prior its IPO, sources have told Reuters to avoid groupon stocks because “the deals and coupon website operator has an unproven earnings record and slow growth… A $10 billion market value is a lot for a company with no profits and an unproven business model“. That’s nice!?

And matter of fact, it wasn’t long time after that Groupon announced that its 2011 fourth-quarter loss was wider than initially reported because “it needed to increase the amount of money it sets aside for refunds”. How about “we don’t have control over our own business model?”

Recently, Groupon has lost so much of its value that it is now worth half its initial IPO valuation. But still, management blames weak accounting processes. Nothing about the business model.

If you are interested in what its chart look like since the IPO:

Social Media, Information Cocoons and Weak Ties

We all have close friends and family members with whom we spend a lot of time. We spend a lot of time with them because we have a lot of affinity with them. We think in the same way and we have the same interests as them. Incidentally, they are the people in whom we have the highest level of trust. These people constitute our strong ties.

We also have other acquaintances with whom we spend less time. They are people with whom we have some affinity and trust but at a lower level than our strong ties. We can call them our weak ties.

While it is natural that we pend time a lot of time with people with whom we have greater similarity, we shouldn’t ignore the impact that it has on our perception of reality. Since our strong ties have views and opinions that are similar to ours, they will interpret all the things that happen in their life in more or less the same way that we do. Therefore, when we exchange or share opinions with our strong ties, we are seldom sharing or exchanging new ways of thinking. By sharing opinions with strong ties, we are merely reinforcing what we already believe as being the right way to interpret events in our lives. In such a setting, social media becomes an information cocoon, meaning that it merely serves for clustering together people with similar ways of thinking.

Weak ties on the other hand have much less in common with us. Sharing views with them will therefore lead to us being aware of new ways of thinking. In my view this is precisely where social media can be useful. Social media offers the possibility to maintain a lot of weak ties without spending too much effort in maintaining them. By being able to maintain a lot more weak ties that we could traditionally, social media give us the possibility to add diversity to our thinking. It can be used to escape information cocoons. In this regard, using social media to strengthen relationships that are already of strong nature is counterproductive.

Another implication of this concept is that high profile social media users such as top bloggers, gurus, celebrities, etc. should not be followed too much on social media. These people already have strong presence in traditional media and their views are highly promoted. Sticking too much to what these people say will have the same effect than sticking only with close friends and family members: we will be exposed to the same perspective of reality whether watching TV or reading blogs.

The real benefit from social media comes from the possibility to explore different paths of thought with little expenses. When using social media, if people follow what is already in the mainstream media, then little gains will come from this new communication platform.

Convergence and the Poor State of Social Media

Social media is supposed to be more than a bunch of people sharing picture about their last night drinking spree. Social media (ex: Facebook, Twitter) is also supposed to be an alternative source of information to traditional media (ex: CNN, FOX). User generated content means that information is no longer created by institutions, but by real people. With social media, reality becomes what people describe it to be as opposed to what they see on TV. After 7 years of social media use (since Facebook was launched), 2 big players have emerged as the dominant platforms. These are Facebook and Twitter. Let’s see how these websites measure up against the promise of being an alternative source of information.

Facebook

The main advantage offered by Facebook is in the possibility of sharing pictures and status updates with friends and acquaintances. Most of these Facebook friends come from our immediate social environment. In other words, they are people with whom we can have face-to-face interaction and with whom with would have contact even if Facebook didn’t exist. In other words, Facebook doesn’t offer the possibility of receiving information that would otherwise be impossible to receive.

Of course, sharing and commenting news on Facebook means that we have to put less effort to let a lot of friends know what we think of a particular issue. However, if everyone of our friends share links and comment news at the same rate, we will be plagued with information overload. In such a scenario, the information that will be noticed by all and that will be recognized as a credible source will be the one posted by the initial source of news, namely traditional media. In such scenarios, Facebook converges with traditional media. Or worse, it becomes a source of narcissistic shouting, meaning that all that every single user cares of is getting his own view broadcast to as many people as possible without paying much attention to other users’ views.

Now, the fact that not everyone shares or comments news at the same rate might seem to indicate that information overload will not occur in practice. Everyone has an activist Facebook friend who comments vigorously on news. Naturally, his voice will be more present in his friends’ walls. But then, by being an activist, he’s just acting as another journalist in traditional media. He’s just another source of news among many available sources of news out there. What Facebook offers here is the possibility for an activist to reach a lot of people without having to spend great sums in terms of broadcasting techniques. Maybe the content created by an activist is not as professional or polished as the content created by a professional journalist, but the information dissemination role played by both of them is very similar. Again, if Facebook is all that social media can be, the reality of what can be accomplished through social media is far from what was initially promised.

Twitter

Compared to Facebook, Twitter offers a slightly different communication model. Here, connections are week, meaning that there’s no need for mutual agreement between two people for them to be connected. In fact, connections can be one way, meaning that when one person follows another person, the former will be exposed to all the messages created by the latter. Obviously, those who have a lot of followers will be more influential and their opinions will be hurt by a larger proportion of users. But who are these influential and highly followed people? A quick look at the top followed Twitter accounts will shows that they are all celebrities. In other words, these are all people who already have a strong presence in traditional media. The single instance of a Twitter-made celebrity has still to come. Therefore, Twitter fails in giving the opportunity to promote discussions that are different from those that are already taking place in traditional media. Again, there seems to be convergence between Twitter and traditional media.

Conclusions

Some would argue that the Arab Spring is an example of how social media can lead to change. It is possible that in the case of authoritarian regimes, the use of social media leads to being exposed to views that are contrary to what state television shows. Social media becomes an alternate space where people can freely express their thought, which eventually leads to people realizing that they were not alone in seeing thing in the way they see them. However, if social media did really offer a new sense of reality to people who lived in those countries, maybe it was because state controlled media (the equivalent of traditional media in free society) in those countries did not do the effort of having a presence in social media. In other words, they have neglected the importance of convergence between traditional media and social media.

When it comes to having a strong presence in social media, the fact is that institutions dispose of greater resources to allocate than ordinary people. Institutions can hire professional social media optimization experts to make sure that they play a more central role in social networks. The same way they use resources to create content in traditional media, they can use resources to create more content and better quality content in social media. Also, the fact that they are already known as ‘reliable’ source of information gives them extra credit in social media. If the Internet displaces TV, main broadcasting corporation will have to switch resources from TV to  Internet content creation and promotion. And if both sources of information coexist, the natural convergence described above will lead to the obsolescence of social media as an alternative source of information.

Can Group Buying Bring Value to Consumers

Can group buying services provide real value to consumers? I’m a bit skeptical about this.

Retailing 101

Retailers make money by buying large quantities of an item and by selling each unit individually at a higher price. The general principle behind this is that of economies of scale: the more we build of something, the cheaper will be every single unit’s production cost. The difference between the price at which each item is sold and the price at which each item is bought will constitutes the retailer’s profit margin.

However, buying large stocks of a product comes at a price. First, large sums of money are needed to purchase the items. Also, a warehouse where products will be stocked is required for which rent will be paid. Of course, if the warehouse is owned by the retailer, the cost of storing the items is equal to what could be collected by renting the warehouse. The retailer must therefore be very good at correctly forecasting demand for the item. Since forecasting is not an exact science, the retailer will always buy less or more of a good than what the real demand will be. In the case where actual demand is more than what was forecast, the retailer will pay a higher price than it could have if his forecast was equal to the actual demand. In the case where actual demand is less than what was forecast, the retailer will be left with overstock which, if not sold, will contribute to the decrease of profit margin.

This is where group buying comes in. Group buying uses the Internet as a tool for synchronizing consumers who are willing to buy the same product. This can be viewed as an attempt to have a better forecast of demand. The point with group buying is that it acts as a retailer for the account of a group of consumers who are interested in purchasing the same product. In that way, demand is generated for people who would otherwise not be willing to buy that product at a regular retailer price. In other words, where retailers fail in forecasting demand and ultimately fail to offer the optimum price to the consumers, group buying helps in reaching those customers. Ultimately, retailers become irrelevant since demand for all products can be synchronized in one place where all consumers will shop in group.

The problem with group buying

Well, all this is very nice, but the realities of our physical world will soon or later make its presence felt. The first issue with group buying is that of delay. If producers have to wait until the group buying service comes with the right number of actual demand, then consumers will have to wait until production is finished and until shipments arrive. Here, retailers that will be able to predict demand with more or less accuracy will have an edge over group buying services since they have products ready on the counter. Since for most products, consumers are not willing to wait indefinite amount of time before they can enjoy their purchases, group buying services will only be able to generate slightly more demand than that is already forecast by retailers. Consequently, resource savings resulting from such demand will be negligible and eventually unattractive to the final consumer. Moreover, retailers can use the public information provided by group buying services (i.e. information about prices and quantities on demand side) to readjust their own prices and therefore disrupt the expected return from the group buying service

Another issue with group buying is one that is more real and connected with current services. If you take a look at the deals on group buying websites, you will notice that most of them are services such as spas or restaurants. Yet, services are known to be difficult to put a price tag on since the producer and the retailer are the same person. What is the difference between one therapist and another? You can only know if you try both. And again, someone else who tries those same two therapists will have a different opinion than yours. Also, services are not always subject to economies of scale. A therapist will not be cheaper if asked to perform her work on twenty customers rather than one. In fact, in the case of twenty consecutive customers, the last ones will most probably have a less relaxing experience than the first ones. Then, how can we say that demand coming from a group of  customers for the same service will lead to a better price for everyone?

Finally, there is an argument for group buying that claims that the service can be used by new businesses to advertise their product or services and gain exposure on the market. Well, this argument would be true only if there was an infinite number of business that were opening every year in every city. But this is rarely the case. How many new restaurants and spas open every year in a city? Not enough to cover a deal for every day of the year. In other words, the deals that will be displayed on group buying service will not always be real deals motivated by the need to gain exposure. Rather, they could be regular prices advertised as money saving deals with the hope of luring consumers.

Group buying in reality

If group buying has so much drawbacks, then how-come they’re making money? One way to answer this question is in the peer pressure and scarcity illusion that it creates. When a site is believed to offer good prices because it aggregates demand from other consumers like us, there is a feeling that what will be bought there will have a better price tag. Moreover, when we go on a website and see that there are 50 people getting a deal and that there are only 20 places left, we get a feeling that we need to act quickly before the deal is over.

The other reason for group buying services to exist is that they can act as advertisers. As I claimed above, the price of services cannot be compared from one retailer to another. Again, group buying will give the illusion of saving through group demand. In reality, the site is a place where people will freely go without thinking that it is only advertising, but by thinking that there could be a good deal.

Entrepreneurship: Why There is a Lack of Intent

I stumbled upon an article about Canadian entrepreneurial intentions, and a few things stroke me. Let’s take a look at the following table:

Besides the difference between provinces, the proportion of those who start a company versus those who have the intention is constant between provinces. More or less, only half of those who have the intention of starting a company actually do it.

Being active in the academic spheres, one thing I noticed in young graduates is that many who dream about starting a company never do it because they think it is too risky. Whether this perceived risk has anything to do with reality is something that can be debated. For instance, the above table shows that a very high percentage of people own a business compared to the percentage of those who have the intention. In Quebec, a province where 6.9% of people have the intention of starting a company, 5.1% of people own their business. That’s close to 3/4 of people who succeed in running a business. It appear that unless entrepreneurs starve to death while trying to start a business, they will eventually succeed even if it takes a few failed attempts.

Many would therefore argue that those who are not willing to take risks aren’t real entrepreneurs and therefore we shouldn’t worry about them. However, the decrease in entrepreneurial intention is a real phenomenon and given the importance that entrepreneurship plays in society, it is something that needs to be thought of. And given the fact that we live in an advanced country in an era of knowledge economy, young university graduates are among those who form the most important pool of entrepreneurs.

It is popular belief among young graduates that starting a business is risky when they have contracted a relatively high student-debt after years of studying. Indeed, their first goal after graduation is to clear their student-loan by entering the job market. Being exposed to successful entrepreneurs in seminars and conferences doesn’t seem to change this perception as many students believe that a large proportion of entrepreneurs have failed for every one who succeeds.

In my view, what needs to be done to overcome the decreasing attractiveness of entrepreneurship is to send a message that society is willing to share risks with young entrepreneurs. Of course, this doesn’t mean that angel investors or VCs should invest in projects that don’t seem realistic or financially attractive. Rather, it is the role of support centers that have to be enlarged. More power should be given to these institution so they can do a better job of recruiting and supporting young graduates who are willing to start businesses.