Friday, October 09, 2015

Reading :: The Innovator's Dilemma

The Innovator's Dilemma
By Clayton M. Christensen

The Innovator's Dilemma is a "classic bestseller," according to the cover. And it's a classic business book in the sense that it makes the whole of its argument in the first chapter. The rest of the book consists of elaboration and proof.

Here's the key insight: "in the cases of well-managed firms ... good management was the reason they failed to stay atop their industries. Precisely because these firms listened to their customers, invested aggressively in new technologies that would provide their customers more and better products of the sort they wanted, and because they carefully studied market trends and systematically allocated investment capital to innovations that promised the best returns, they lost their positions of leadership" (p.xv).

That's the innovator's dilemma: "the logical, competent decisions of management that are critical to the success of these companies are also the reasons why they lose their positions of leadership." It's difficult to balance the demands of innovating with the demands of current customers.

If that sounds familiar, perhaps you have read Peter F. Drucker's Innovation and Entrepreneurship, which warns of the same issue. But Christensen makes at least two other contributions.

The first is the "theory of resource dependence," in which he claims that "in the end it is really customers and investors who dictate how money will be spent because companies with investment patterns that don't satisfy their customers and investors don't survive" -- and that fact means that "these companies find it very difficult to invest adequate resources in disruptive technologies .... until their customers want them. And by then it is too late" (p. xxiii).

The second is the author's research into the question. The author examined business data on the disk drive manufacturer industry, which was characterized by extremely rapid innovation, to look for indicators of how this industry developed disruptive innovations. That's the bulk of the remaining chapters, and they do a good job of supporting the author's points.

Should you read The Innovator's Dilemma? Yes, if you're trying to sustain innovation in a company. But, as the above suggests, you don't actually have to finish the book in order to get the main points.

Reading :: Risk, Uncertainty, and Profit

Risk, Uncertainty, and Profit
By Frank H. Knight

This 1921 classic argues that to understand profit, we must recognize the roles of risk and uncertainty. The difference, he proposes, is that risk is quantifiable (think in terms of actuarial tables); uncertainty is qualitative and unmeasurable (pp.19-20). "It is this 'true' uncertainty, and not risk, as has been argued, which forms the basis of a valid theory of profit and accounts for the divergence between actual and theoretical competition" (p.20).

In Ch. 2, Knight reviews theories of profit. Of special interest to me is his assessment of Marx's contribution, which he dismisses: Marx's understanding of profit was "narrowly literal... wholly uncritical and superficial" (p.27). Thus "they derive a simple classification of income in which all that is not wages is a profit which represents exploitation of the working classes" (p.28).

Knight lists five ways to deal with uncertainty:
1. Consolidation
2. Specialization (including speculation)
3. Control of the future
4. Increased power of prediction (p.239)
5. Directing industry to areas of less uncertainty (p.240).

Knight concludes: "Profit arises out of the inherent, absolute unpredictability of things, out of the sheer brute fact that the results of human activity cannot be anticipated and then only in so far as even a probability calculation in regard to them is impossible and meaningless" (p.311).

Should you read this book? I'm no economist, but I found it easy enough to follow, and for me, the thesis was provocative. Naturally, I like the idea of profit emerging from unquantifiable uncertainty, and the criticism of Marx seems plausible to me. If you're interested in the question of profit, take a look.

Tuesday, September 29, 2015

Reading :: Joseph A. Schumpeter

Joseph A. Schumpeter
By Richard Swedberg

Joseph Schumpeter infamously declared that "Early in life I had three ambitions: to be the greatest economist in the world, the greatest horseman in Austria, and the best lover in Vienna. Well, in one of those goals I have failed" (p.3). As the quote suggests, Schumpeter was quite boastful of all three capacities.

He was perhaps justified in at least one of them; let's focus on it, although this biography adequately covers his other two pursuits. At 28, he published his second book, (the German version of ) The Theory of Economic Development, in which he attempted to analyze the economic process through not just economics but also the other social sciences. It is in this book that he first developed the figure of the heroic, charismatic entrepreneur (evidently influenced by Weber's charismatic leader): a figure that innovates by creating new combinations, but does not invent per se (pp.34-35). Eight years later, he became the Austrian finance minister. (He was fired after seven months because he kept trying to undermine the socialist government) (p.60). Schumpeter has been considered Weber's greatest successor as economic sociologist, as well as a close compatriot of the great sociologist (Ch.5). Indeed, Schumpeter excelled at sociological approaches to economics, and was quite poor at mathematics, even though he tirelessly promoted mathematical approaches to economics.

In 1932, after being turned down repeatedly for a position at the University of Berlin, Schumpeter settled for a position at Harvard—just in time to avoid the Nazi takeover (Ch.6). There, he ignored the fact that his students called him "Schumpy" behind his back, and he attempted (unsuccessfully) to attract graduate students to his seminars in mathematical economics. (Undergraduates were beneath his notice, and he wondered aloud whether they were really necessary.) Meanwhile, he worked tirelessly on his enormous two-volume book on business cycles, which was poorly received. His follow-up, a little popular book called Capitalism, Socialism, and Democracy, was quite well received and is now considered his masterpiece, although he thought it far less serious and consequential than Business Cycles.

"Schumpeter was the only economist of any stature in the United States who took Marxism seriously," Swedberg adds, and his project was similar to Marx's: both understood economic evolution as a process generated by the economic system (p.153). Schumpeter's approach, of course, was Weberian: it understood that the economy and social structure could influence each other (p.155). Although Schumpeter respected Marx as a sociologist, however, he noted several problems with Marx's economics: the labor theory of value was "dead and buried." He took a similarly dim view of Marx's doctrine of surplus value. Marx had no theory of business cycles. Yet he appreciated Marx's achievement in "developing a purely economic theory of change" (p.155).

There is much more in this book on Schumpeter's upbringing and values, his achievements and failures, and of course his adventures as a horseman and a lover. If you're interested in this fascinating economist, I encourage you to read the biography.

Reading :: The Culture of Entrepreneurship

The Culture of Entrepreneurship
Edited by Brigitte Berger

This collection is the product of a 1990 conference by the same name, supported by the Institute for the Study of Economic Culture. It "explores the cultural dimensions of modern entrepreneurship" through contributions by "economists, anthropologists, sociologists, political scientists, and management experts" (p.1). Let's dip into two of these contributions.

In Ch.3, "The discovery and interpretation of profit opportunities: Culture and the Kirznerian entrepreneur," Don Lavoie argues that we need a theory of entrepreneurship that "should help us identify the conditions—economic, political, legal, and cultural—that enhance decentralized developmental processes" (p.33). Unfortunately, on the one hand, entrepreneurship is typically treated in terms of individual psychology, not culture (p.34); on the other hand, anthropologists understand culture, but have focused on "statics rather than dynamics" (p.35). "In other words, the study of the relationship between culture and entrepreneurship demands working with both meaning and economic change, whereas the way disciplinary divisions have evolved, few researchers are capable of handling both categories together" (p.35). Similarly, Lavoie argues, "economists have failed to leave room for meaning and have not done well with change either"—especially the radical change that is associated with entrepreneurship (p.35).

Lavoie argues that "culture has everything to do with" the entrepreneurship process; entrepreneurship "fundamentally consists in interpreting and influencing culture" (p.36). So: what are some of the main elements needed by a theory of entrepreneurship as a cultural process? Lavoie identifies two underdefined terms: "discovery" (that is, radical change; "genuine novelty and creativity") and "interpretation" (that is, finding opportunities via "a discerning of the intersubjective meaning of a qualitative situation") (p.36). In sum, "What is needed is a theory of entrepreneurial change that makes it intelligible without reducing it to a predetermined mechanism" (p.37).

The Austrian school (von Mises, Hayek), Lavoie argues, has come the closest to such a theory (p.37). And of these, Lavoie recommends Israel Kirzner most highly (p.37). Kirzner argued that it was a mistake to treat entrepreneurship like any other scarce resource; rather, he suggested that we should consider "entrepreneurial alertness," in which the entrepreneur has deployed a "choice framework" or "conditions in which the decentralized, entrepreneurial process can be expected to flourish" (p.40).

Yet, Lavoie argues, Kirzner still sees entrepreneurial alertness as raw discovery of what's already there; Lavoie argues instead that opportunities are interpreted (p.44). After discussing von Mises and Hayek, Lavoie proposes to build a theory of entrepreneurship instead on Gadamer.

In Chapter 10, "The rocky road: Entrepreneurship in the Soviet Union, 1986-1989," Walter D. Connor discusses the then-new market liberalization in the USSR. (As he notes at the end of the chapter, between the time he wrote it and the time the book was published, the USSR began the crisis that would lead to its collapse.) Connor notes that "the last time a high level of private enterprise was tolerated in the Soviet Union" had been during "Lenin's New Economic Policy (NEP) of 1921-1928" (p.198), which was ended by Stalin shortly after Lenin gave up the ghost. To the Soviets of the mid-80s, "the 'NEPmen' were exploiters and speculators who unjustly enriched themselves and were thus justly banned as the country embarked on the 'building of socialism' under Stalin" (p.198). The intervening years, especially under Brezhnev,
produced in most of the Soviet population a mind-set, which in two senses has complicated perestroika and the place of cooperative entrepreneurship within it. The first evokes a rather deep, if general, egalitarian reaction, intolerant of people within one's range of vision doing significantly better than oneself. The second reflects an incomprehension of the market, the dynamics of supply and demand, and how these will naturally—in the absence of state control or intervention—play out. (p.199)
When Gorbachev liberalized the economy, workers, who were disconnected from the market, did not understand entrepreneurship and saw it as utterly unfair. Why could someone who made bra fasteners make 100 rubles in a day, when a tractor driver with a broken tractor could only make 2-3 rubles a day? The tractor driver, Connor adds, was paid by the furrow, not for producing something demanded by others. But he expected recompense for the effort, not the usefulness of his products (p.199). This system encouraged both dependence and sloppy work (p.200). It also encouraged envy. One sociologist interviewed a woman who disapproved of her neighbor, who sold spring vegetables on the side; the woman said, "'I don't want to live like her; I want her to live like me'" (p.201).

According to Connor, "the Eastern Orthodox moral and ethical tradition," which did not emphasize individual conscience, also played its part. "Methodical work, well done, as its own reward—in a sense, the Protestant ethic—did not figure so prominently in this culture as in others farther west"; thus "few, under such a regime, could develop the internal controls that are so essential to the entrepreneur's organization of effort" (p.203).

In the final two pages, Connor notes the Soviet crisis, which would eventually lead to its collapse. "The people of the USSR ... are living in a period of uncertain transition" (p.209).

Although the other chapters are worthwhile, I found these two to be the most interesting. If you're interested in understanding entrepreneurship from a cultural perspective, take a look.