Archive for the ‘Entrepreneurship’ Category

Venture Capitalists Expect to Lose Money on Some Investments

April 12, 2010 Leave a comment

Wall St. Cheat Sheet argues that there is a bubble in software companies and that it is going to end badly for investors.

The thing is, all of the companies cited are funded by venture capitalists and angel investors, all of whom build into their businesses a number of failures. So, I don’t really see where the bubble is, or why its consequences would be like that of the dot-com bubble. The distinction here is that a lot of the dot-com companies were publicly traded and so the man on the street could gamble with them. The small software companies building web apps, like AppMakr, ManyMoon, BaseCamp, and FourSquare (all of which are cited by Wall St. Cheat Sheet) are not financed by public equity holders, and so are not analogous to the dot-com companies. These companies are funded with private money.

The business model of venture capitalists and angel investors has always been that a few outsized hits will more than recoup the losses that most of their investments incur. This is why venture capitalists and angel investors are known for their “high risk/high reward” business model. (This is also why most individual investors had no business investing in dot-coms, but that is another story entirely.) But the notion that these companies represent a dot-com-style bubble is rather far-fetched.

Bad Business Models and the Consequences of Union Labor

April 8, 2010 Leave a comment

Megan McArdle has an incisive post about the problems that have driven US Airways and United into each others’ arms:

The airline industry is not a particularly attractive market. You’re selling a perishable commodity–once the doors close, any unfilled seats are worthless–to an audience that stubbornly resists treating your product as much other than a commodity. Attempts by the airlines to resist this, with their byzantine pricing rules and frequent flier programs, have by and large not succeeded particularly well; business travelers tend to have multiple frequent flier accounts unless they live near a single airline’s home airport, and economy fliers don’t care. Meanwhile, software is steadily eroding their ability to thwart bargain-hunting consumers through pricing power.

Clearly, the airlines have plenty of reasons for their current parlous state. But it is interesting to consider that, given the blame intransigent labor unions have in this state of affairs, how few people make the connection between rigid labor rules and poorly managed companies. Companies with a history of rancor between labor and management–which describes most unionized workforces–spend a lot of time and energy managing that fractious relationship and so spend less time on operational goals such as product innovation and revenue growth. Compare and contrast Apple and Google with the airlines.

Offshoring Jobs and the Myth of a Static Economy

April 6, 2010 1 comment

It has become a commonplace that American jobs have been eliminated in favor of cheaper labor overseas. To some extent, this is true, but it misses the real story. Most of the jobs that have moved overseas, and which are not coming back to the United States, are jobs for which educational requirements are minimal. The poorly trained and uneducated are the victims of structural changes in America’s economy.

(Other victims of structural changes in the American economy are the overeducated who pursue education in fields for which there is very little demand, such as humanities PhDs. But there is little sympathy for naive academics who find themselves unemployable.)

But, there’s nothing new about this. When elevators went from manual to automated, the people who lost out were elevator operators, who, of course, did not need much in the way of education to do their jobs. Likewise, when sock or textile manufacturers move their operations from, say, the Midwest, to China, it is the employees of American textile mills, who, by and large are relatively uneducated, who lose. Other Americans gain.

Now, to a very large extent, this is blaming the victim for economic forces beyond his control. That is true. However, it is also true that if the American economy wants to continue to grow over the coming decades, there will be winners and losers in it. Egalitarianism is a false ideal upon which Stalin murdered tens of millions of people. That is what social safety nets are supposed to account for (in part). It is also incumbent upon people to realize the precariousness of their current employment and pursue opportunities to develop skills that are transferable. The United States’ deplorable educational system does not help in this regard.

But we can’t conclude from any of this, as some do, that the overall number of jobs in the United States has decreased because a lot of those jobs have been moved overseas. Neither the economy nor the number of jobs is a static thing. Buggy whip manufacturers were driven out of business by the development of the internal combustion engine, but in the decades since the internal combustion engine was invented, many more jobs than were ever lost by buggy whip manufacturers have been created.

Loss Aversion

March 31, 2010 Leave a comment

Felix Salmon has a rather interesting blog post about loss aversion and sovereign investors:

Much has been written on the behavioral economics of loss aversion, where the pain of losing a certain amount of money is nearly always greater than the pleasure of gaining an identical amount. And what’s true of a country’s citizens is often true of its government, which is why the question of whether or not governments are making a profit on their bank bailouts is an interesting and important one.

He continues:

But the point is that if Treasury continues to speculate now, it’s mere speculation. When it was underwater on its investment, it at least could say that it was holding on to its stake until the share price rose enough that it could get its money back. Yes, that’s a form of speculation too. But it’s somehow a more acceptable form of speculation to hold onto an investment in the hope that you won’t lose money than it is to hold onto a profitable investment in the hope that you’ll make even more money.

Indeed, the whole argument about whether or not banks should mark their assets to market is at heart an argument about this very question. If banks hold loans on their books at par, even if they could never get 100 cents on the dollar for those loans in the secondary market, they’re essentially speculating that the value of the loans will return, over time, to more than they lent out in the first place. But they don’t call it speculation, they call it “commitment to our valued clients through thick and thin”, or something like that.

This is all very interesting, and I think Felix (and the behavioral economists) are correct when they say that the pain of a loss exceeds the pleasure of a gain. At least, intuition suggests that that is how man thinks. But, this makes me wonder: if man is so averse to losses, why is there such a clamor for short sales and mortgage cram-downs? Those are nothing if not recognition of losses made on a crappy investment.

A side question about real estate: Given that debt-financed assets lose value as interest rates increase, and most residential real estate is financed with debt, why do people claim that real estate is an inflation hedge? The likely answer is that most people who acquire real estate don’t really know what they’re buying and don’t understand its underlying economics.

On Immigration and Economic Growth

March 27, 2010 Leave a comment

This country will exit its current existential funk only once the economy is creating tens of thousands of jobs per month. While a few large companies can easily cover that for a few months, it is the creation of new companies–the entrepreneurial spirit–which will really create jobs in the coming years. Unfortunately, many entrepreneurs are also immigrants, and immigrants are not exactly encouraged to come to the United States:

Overall, some of the country’s highest rates of entrepreneurship are found among immigrants from the Middle East, Cuba, South Korea and countries of the former Soviet Union. These recent arrivals regularly build new businesses — from street-level bodegas to the most sophisticated technology firms.

Immigrants started one-quarter of all venture-backed public companies between 1990 and 2005. In addition, large U.S. firms are increasingly led by executives with roots in foreign countries, including 14 CEOs of the 2007 Fortune 100.

A good proxy for predicting the future performance of the US economy would be to see how seriously comprehensive immigration reform is taken by Congress.

Venture capitalists have an obvious interest in this effort; here is a particularly interesting take on the issue from the VC Fred Wilson.