Tag Archives: economics

Silicon Valley Shakeout: Yes, Many Startups Fail

The press is going crazy here in Silicon Valley with pieces about the coming shakeout in startups. The basic story is that over the past few years, the growth in angel investors led to a lot of mediocre ideas getting seed funding, and now that the froth is off the market, those mediocrities are finding it difficult to raise additional money from venture capitalists.

PandoDaily gives a good summary here. Dan Lyons, a well known tech journalist (and creator of Fake Steve Jobs), has a more savage take here. The following quote kind of summarizes his piece:

For the past few years we’ve had people calling themselves “investors,” who have no experience investing, swanning around the Valley, slinging money at people calling themselves “entrepreneurs” who have never held an actual job, let alone run a company.

My view is that this shouldn’t surprise anyone. The current social/mobile bubble has been obviously following the trajectory of the 1999-2000 dot.com bubble (see my prior posts on this topic here, here, here and here), and any rational observer could see how it was going to end. Just like a decade ago, the promise of quick riches drew hordes of young, aggressive tech wannabes who launched me-too companies, features posing as companies, or simply bad ideas. And just like a decade ago, huge amounts of capital desperate to be put to work meant that bad ideas got funded. But bad ideas become bad companies, and bad companies start to fail, and VCs don’t put more money into failing companies.

Ten years ago, the mantra was “let’s dot.com category X.” Now it’s “let’s take category X social. Or mobile. Or both.” But either way, good ideas with good execution get traction, and bad ideas don’t. PandoDaily looks at the travel space and explores it as a microcosm of everything that’s happening. Bad companies with bad names ( Dopplr, Tripl, Gtrot) are all going away, because they never should have existed.

This is really a standard Silicon Valley cycle; it’s just getting worse. There was once a time when VCs funded one hundred disk drive companies, which also ended poorly. Now it’s that the cycles are stronger and draw more wannabes from further away. More press and more billionaires mean more people coming to enter the lottery. I mean, now we have a reality TV show about good-looking young entrepreneurs (or perhaps I should say “entrepreneurs,” since the folks on that show are exactly the people Dan Lyons savaged). Back in the 1980’s nobody made a reality TV show about 45 year old engineers starting disk drive companies.

Immigration Policy and the 1%

Here is an interesting take from economist Dean Baker, pointing out that while US immigration policies let in lots of low-skilled workers, driving blue collar wages down, our policies make it very difficult for skilled workers (doctors, lawyers, economists) to enter the US and work, keeping white collar wages high. Coincidence?

Multinational Corporations and the American Commons

Harvard Business School recently launched what it’s calling the US Competitiveness Project, which is “a research-led effort to understand and improve the competitiveness of the United States.” To publicize this effort, Harvard Magazine just published a series of interviews with some of the professors involved. I don’t normally like reading interviews, because they tend to have a ridiculously high length to content ratio, but these were quite dense in content, and I recommend the whole set of interviews as important reading for anyone interested in the state of US business or multinational corporations operate.

The interviews ran to almost 20 magazine pages, so I won’t even try to summarize them. But I will note a recurring theme, which was about American companies investing in America. The professors called this America’s “business commons,” which they defined as “a skilled workforce, an educated populace, vibrant local suppliers, basic rule of law, and so on.” They pointed out that “historically, American businesses invested in these resources deeply, and that helped to build many of America’s strengths.”

Copyright 2012 Thoughtbasket

Interestingly, the professors went back and forth between reasons to support America’s business commons, from what I call “hard” reasons (those that drive profitability) to “soft” reasons (patriotic calls to support America).

Hard reasons included:

  • Outsourcing calculations often overestimate cost savings
  • Local manufacturing can drive product and process improvements
  • For most multinationals, the US still makes up the majority of their business

Soft reasons were more vague, with a desire of “many in the business community to roll up their sleeves and do things in their communities” being a typical statement. Michael Porter (a giant in the strategy and competition fields) and Jan Rivkin define US competitiveness as including “raising the living standards of the average American.”

This all raises an interesting dilemma. If the role of corporate executives is to maximize returns to shareholders (this is how most US managers operate, although there is in fact disagreement regarding shareholder v. stakeholder approaches: read relevant articles here, here, here and here) then they shouldn’t care whether they build America’s business commons or China’s business commons or any other business commons, except to the extent that any given commons supports their business. In other words, if Jeff Immelt at GE thinks that investing in China’s educational system will generate higher returns than investing in America’s, that is what he should do.

However, I suspect that most executives at big US companies would feel uncomfortable with that. Since most of them were born in the US, raised in the US, and live in the US, there is probably some part of them that feels a loyalty to the US, that wants to build America’s commons even if building China’s commons has a higher ROI. How do these CEOs reconcile their duties to shareholders with their inherent patriotism? I don’t know. The professors in the US Competitiveness Project would suggest that the disconnect is not as great as many think; that building the US commons DOES have a high ROI. But based on my reading, it sounds like they would also give executives permission to foreground their patriotism over pure shareholder analysis, at least on borderline cases.

In addition to Michael Porter and Jan Rivkin, other professors interviewed included Willy Shih, Rossbeth Kanter and Thomas Kochan (who actually teaches at MIT, not Harvard).

Aside

First of all, how come nobody told me that Richard Posner and Gary Becker had their own blog? I have never referenced Becker in this blog, but he is a big hitter economist of the Chicago school. But I have … Continue reading

Luck Drives Pop Music AND Wealth?

Yesterday’s Baseline Scenario (one of my favorite blogs) had an entry describing an academic paper which modeled how income gets distributed in a society and why income inequality is so strong in some economies. Based on the abstract of the paper, and on Baseline’s summary of the rest of the paper (yes, I am admitting that I did not read the whole paper), the model shows that a set of homogenous homes will diverge in wealth, with wealth accumulating over time in fewer and fewer households, based purely on exposure to “idiosyncratic investments” which have higher returns. And in this model, exposure to these investments is random: based on luck.

Clearly this paper is not the be all and end all of explanations. Equally clearly, the assumption of homogeneity does not match reality. What I want to point out here is the connection to Duncan Watt‘s work on the development of hit pop songs, which he shows is also based on luck. Please see my posts here and here regarding Watts.

It’s interesting that two different approaches to modeling two different things come to such similar conclusions: the distribution of success is essentially driven by luck, not skill. Again, these are models, not complete explanations. I, for one, would certainly like to think that my skill will lead to success. However, judging by my reader counts, that may not be the case. Regardless, I think it’s important for us all to remember the role that luck plays in much of what we do.

Matt Taibbi on Romney and Private Equity

Matt Taibbi has a new piece in Rolling Stone about Mitt Romney’s time at Bain Capital, and how Bain used large amounts of debt to execute its buyouts. The overall theme is one of financial engineering vs. making things, of pillaging companies to generate wealth vs. building companies to create jobs.

Like most things Taibbi writes, this article is:

  1. Very funny
  2. Savagely mean
  3. Only about 75% accurate, and you need to know a lot about Wall Street to know which quarter is wrong

However, in light of my prior post on private equity, there are two paragraphs that I wanted to quote because they are both amusing and apt.

Talking about the private equity model of loading up a company with debt and then paying fees and dividends to the buyout firm, Taibbi says:

This business model wasn’t really “helping,” of course – and it wasn’t new. Fans of mob movies will recognize what’s known as the “bust-out,” in which a gangster takes over a restaurant or sporting goods store and then monetizes his investment by running up giant debts on the company’s credit line. (Think Paulie buying all those cases of Cutty Sark in Goodfellas.) When the note comes due, the mobster simply torches the restaurant and collects the insurance money. Reduced to their most basic level, the leveraged buyouts engineered by Romney followed exactly the same business model. “It’s the bust-out,” one Wall Street trader says with a laugh. “That’s all it is.”

And then, comparing Romney’s speeches decrying America’s level of debt with his Bain Capital strategy of loading up companies with debt, Taibbi writes:

To recap: Romney, who has compared the devilish federal debt to a “nightmare” home mortgage that is “adjustable, no-money down and assigned to our children,” took over Ampad with essentially no money down, saddled the firm with a nightmare debt and assigned the crushing interest payments not to Bain but to the children of Ampad’s workers, who would be left holding the note long after Romney fled the scene. The mortgage analogy is so obvious, in fact, that even Romney himself has made it. He once described Bain’s debt-fueled strategy as “using the equivalent of a mortgage to leverage up our investment.”

I like that one because it makes the connection between private equity and mortgages, as I did in my post.

Again, I’m not fully supporting Taibbi’s reporting or his conclusions, but he makes some good points.

Viral Growth & User Base Do Not a Business Make

Everybody in business wants to “go viral.” If you create a funny YouTube video, or tweet cleverly, or create a web service that people invite their friends to join, then you will spread like a flu pandemic, generating massive growth in users without massive marketing expenditures. Whether you are Old Spice or Dollar Shave Club or Instagram, growth without marketing expense is a good thing. And I agree: it IS a good thing. Going viral is awesome for a business, of course. Achieving growth without buying it is clearly good.

But companies are also learning that growth itself is not enough. A user base is not a business. If you can’t make money off those users – both revenue and profits – then all your viral growth is kind of a waste. We saw this last week with Facebook, which has had huge viral growth over its lifetime, and now has a billion users, but is having problems turning those users into money, leading to a stock chart that looks like this:


Ouch!

Or take the Dollar Shave Club. Their video is definitely hilarious and it went viral, which allowed them to sign up lots of users. But if their razor isn’t good enough to keep customers ordering more, or if they can’t sell the razor for more than it costs to make, no amount of viral growth will help them be a successful business. I haven’t heard anything about their razor quality, or their margins; they could totally succeed, and I hope they do. My point is that a clever viral video is only a means to an end. The end is a profitable business.

In the social bubble we have seen this year, people have been losing sight of what really matters in business: profits. User growth and virality are to 2012 what eyeballs were to 1999. Having lots of users is good, and your user base is an important metric to track, but at the end of the day, you need to make money. Not making money is what pops bubbles.