Risk-taking and risk aversion

The cover of the Wall Street Journal† Monday proclaimed:

Risk-Averse Culture Infects U.S. Workers, Entrepreneurs
By Ben Casselman

Three long-running trends suggest the U.S. economy has turned soft on risk: Companies add jobs more slowly, even in good times. Investors put less money into new ventures. And, more broadly, Americans start fewer businesses and are less inclined to change jobs or move for new opportunities.

The VC story isn’t quite as compelling as promised. Some of the story is already known — that VCs keep hoping for another Internet bubble that won’t return (but spawned excess entry). At least one measure — share of VC for seed capital — the trend isn’t monotonic, but shows peaks and valleys.

The concentration of VC in Silicon Valley can be read two ways: VC only wants Silicon Valley entrepreneurs, or entrepreneurs know they should move to Silicon Valley to get funding. And as everyone knows, the companies that VCs fund are only a small fraction of the nation’s startups.

And while Casselman reported new specifics, we know that the last four years has been a jobless “recovery.” Citing the work of Maryland economist John Haltiwanger, he wrote:

In the eight recessions from the end of World War II through the end of the 1980s, it took the U.S. a little more than 20 months, on average, for employment to return to its pre recession peak. But after the relatively shallow recession of the early 1990s, it took 32 months for payrolls to rebound fully.

After the even milder recession of 2001, it took four years. Today, nearly four years after the end of the last recession, employment has yet to reach its pre crisis peak.

No, what was really troubling is what the story said about America’s entrepreneurial culture. This is what made America successful over the past 150 years, and the envy of the world. (It is also why, as some have argued, the country needs a new frontier to keep entrepreneurial processes alive).

Instead, Americans are changing cities often, changing jobs less often, and working more for big companies than for small companies. Even family businesses are not being passed down, as the children of entrepreneurs opt for the safety and comfort of corporate jobs.

As a natural consequence of this cultural shift, young companies account for a declining share of both the population of companies and national employment. This is terrible for the country, because we know (especially from Prof. Haltiwanger’s research) that young companies account for all the net job creation in this country. These little companies are finding it harder to compete against established incumbents.

I wish I had an answer. The country has become more regulated and bureaucratic, and it’s taking a toll on entrepreneurial intentions. Thirty years ago, we had an effort to reset the country’s attitude towards risk taking and free markets, but the tide has been inexorably coming in ever since.

† It’s to the Journal’s credit that they devoted so much space to the topic. Twenty years from now, we’ll hold this out as an example of why newspapers were once a good thing and tragic that they all died.

Research on startup teams and startup success

At the ACAC lunch today, Kathy Eisenhardt summarized her decades of research on tech startups. For an academic conference (the Atlanta Competitive Advantage Conference), Prof. Eisenhardt literally needs no introduction: as host Bill Bogner of Georgia State said, “Kathy Eisenhardt needs no introduction: if she does, you didn't pass comps.” (Academics would know her paper that has 20,000+ cites, while tech entrepreneurs might know her as co-director of Stanford Technology Ventures Program or her many STVP videos).

Eisenhardt's focus was on the importance of a startup’s management (“Top Management Team” in strategy jargon) in determining the success of a small or young firm in a highly uncertain environment. She identified three factors that explained that success

1. Optimal management team
2. Optimal strategic decision process
3. Matching strategy and structure (at “the edge of chaos”)

1. Management Team

We know that successful teams need to be larger, diverse and have prior work experience together (and thus trust). However, there is an interaction effect between the team and the sort of opportunities they pursue. As scholars who study tech startups will tell you, firms tend to be veterans of an industry who start firms in that same industry that they know.

Her 1990 paper with Kaye Schoonhoven showed that the best firm growth came where a top team caught a great opportunity. A great opportunity was a market that’s at the takeoff phase of a growth market: at least $20 million of industry revenue and 20+% annual growth. In California-speak, Eisenhardt said this is a great surfer catching a great wave.

In specific domains, she cited the recent research of Anne Fuller and Frank Rothaermel on star faculty entrepreneurs as well as various papers by Sonali Shah on user entrepreneurs. As she noted, Chuck Eesley of Stanford (an MIT alum) who estimated when experience is more valuable than talent, based on a survey of entrepreneurs from among the 100,000+ MIT alumni.

2. Strategic Decision-Making

Her old studies on TMT decision making showed that for fast choices in highly uncertain environments, managers need more information and more alternatives, as well as a decision process that is midway from managerial fiat and (a hopeless search for) total consensus. She also noted later work of researchers who examined improvisation and bricolage.

Her former student, Sam Garg, has studied how CEOs manage their boards. The best CEOs constrain the interactions with the board and don’t give up their power over leading the company, using it to make decisions (not generate ideas), by using a divide and conquer strategy.

3. Strategy and Structure

Summarizing her research with Chris Bingham of UNC, she noted that young firms were most successful when they could use their experience to generate heuristics. Experience was valuable when it created “simple rules” that firms could apply over and over again: such rules were both quicker and often better in solving problems in conditions of high heterogeneity and high uncertainty.

Eisenhardt noted that firms (like parents “raising your teenager”) face a dilemma between too much and too little structure. In a simulation with Bingham and Jason Davis, they found that in a highly unpredictable or turbulent market, too little structure is more dangerous than too much. (This also sounds like raising a teenager).

Finally, in cases of high ambiguity (e.g. nascent markets), success is more determined by luck than skill. Therefore, skillful managers want to reshape the market to fit their skills — rather than leave the outcome to dumb luck.

The multi-dimensional 3D printing revolution

At @KeckGrad today, our graduate students are doing their year-end project presentations. In watching the presentation by mechanical engineering students gave me insight into how 3D printing is going to change entrepreneurship.

There are at least three different dimensions of how 3D printing is creating entrepreneurial opportunities. In each case, there are parallels between personal computers almost 40 years ago — and smartphones today — and how they gradually displaced mainframe computers. This is a classic Clay Christensen “disruptive innovation”.

Some of the emphasis on the impact of 3D printing has focused on the 3D printing companies. In fact, Scott Shane published a 2000 research paper on how a variety of companies licensed the original 3D printing technology from MIT. This has been the subject of news has also been on some of the larger and more successful 3D printer manufacturers, whether public companies such as Stratasys or 3D Systems or startups such as Shapeways.

A second opportunity — the one that captures the attention of the popular press — is the print-on-demand business.This nicely fits the mass customization vision of Silicon Valley marketing guru Regis McKenna and German innovation scholar Frank Piller. An example of this is Layer By Layer (@LayerByLayer3D) a company formed by Harvey Mudd students who are graduating next week, who proposed to custom-print iPhone cases.

An advantage of the 3D printing model is easier customization and lower setup costs. However, for now it’s slower and more expensive per unit, and has limitations in product reliability.

However, at the KGI presentation today, I saw a third category of opportunity. This seems like a much broader and more immediate application of 3D printing: changing the process of industrial design.

Among our Team Masters Projects, a team of KGI and Harvey Mudd students spent the academic year to create a mechanism for evenly coating seeds. As in previous projects, they used SolidWorks to design the mechanical components, and had some bent or machined metal components.

However, it became obvious to the team that the default prototype fabrication approach is the 3D printer. The students created two seed picking components that could be sized and shaped to fit whatever requirements they had. Once they had the design, they set the printer going and hard their part ready in the morning.

This reminds me of my first computer experience (pre-PC), when computing job turn-arounds took 10 minutes to several hours. To improve on batch computing, we eventually obtained timesharing — quick but expensive — and then desktop personal computing and handheld computing. Over time, as computing became quicker and cheaper, it allowed computing to permeate and enable every aspect of engineering, science, business and government.

So if 3D printing becomes cheap, ubiquitous and quick, what will that do to physical design? The marginal cost may not become as low as software products, but it will certainly close the gap and thus converge the innovation processes between physical and intangible goods.

Some tech startups are more high-tech than others

In the business press, academic teaching and research, there’s often a discussion of the unique characteristics of “tech startups”, “technology entrepreneurship” and “technology-based firms.” Such startups are the focus of this blog.

Often the distinction between high- and low-tech startups is measured by the proportion of technical employees — such as fraction of R&D employees or fraction of R&D spending (i.e. R&D intensity).

Still, tech startups are not homogeneous. Some of the distinctions that have been draw are science- vs. engineering-based startups, or industry-specific startups like IT, cleantech, or biotech.

This week I attended two business plan competitions here in Claremont: Wednesday’s business plan competition at the Keck Graduate Institute (which I organized) and today’s Kravis Competition across all the Claremont Colleges.

Judges at KGI 2013 Business Plan Competition: George Golumbeski, Stephen Eck, Bob Curry. Not shown: Liam Ratcliffe, Paul Grand

Our KGI business plans (from my ALS 458 class) were all about commercializing patented (or patent-pending) biomedical technologies (therapies, diagnostics, devices) developed by top research institutions such as Caltech, City of Hope, and USC. The Kravis competition included several IT concepts, some low tech businesses, and AccuMab, a cancer diagnostic company from my KGI class.

In comparing the KGI plans to the other Claremont projects — or those in our textbook — it seems to me that — at least from a financial standpoint — there are three types of companies: high tech, medium tech and no tech.

What is dramatically different about our students projects was that (with one exception) is that they’re highly capital intensive, requiring $5 to $50 million in outside funding. For example, the winning team — using technology from Children’s Hospital Los Angeles to repair Shortened Bowel Syndrome — estimated it needs $20 million in equity and $5 million in government grants to get to market. This project — like many others — is building on millions of dollars of NIH/NSF/foundation grants already received to develop the basic science. There is a certain minimum scale required to get FDA approval and thus generate first revenues.

2013 winning KGI team — Hadi Mirmalek-Sani, Porus Shah, Shrina Shah, Rajesh Pareta —
with Bob Curry, chair, KGI Board of Trustees

Think about the story of Mark Zuckerberg, who launched The Facebook in early 2004 and took its first outside investment (of $500k) later that year. (Yes, they didn’t monetize initially, but still they created a compelling product and reached a million subscribers using the founders’ money). The iPhone app startups were launched for tens of thousands of dollars: Rovio had 40 million Angry Birds users before they took their 2011 Series A investment.

Over the years, entrepreneurship researchers (and practitioners) have demonstrated that any new company or product has highest uncertainty and risk up until first customer sale. So from a practical standpoint, I suggest a new metric: how much R&D spending do you need before launching a product? How big a bet — with what scale of outside investment — does it take until the entrepreneur finds out whether (s)he has a viable business?

By this measure, the difference is not the % of the money that goes to R&D but the size of the R&D bet that’s needed to test the marketing hypothesis.

A company that takes 5+ years and $50+ million is fundamentally different from one that can ship a 1.0 (or revenue-generating beta) for less than $1 million. By that standard, after biotech the biggest bets required are for renewable energy. You can start dozens (or hundreds) of software companies for one fully mature biotech, biofuels or solar company.

Developing science and engineering majors

Last month I participated in the San Diego Festival of Science & Engineering, which touched more than 50,000 K-12 students interested in technical careers. In some ways, it was like a personal homecoming since the key event was the annual Greater San Diego Science & Engineering Fair, where I got my start as a pre-teen computer scientist and served for 12 years as a judge.

The supply of science and engineering college graduates is crucial on multiple levels. These are the students who grow up to be founders of high-tech startups — whether young entrepreneurs before or during college (as in Gates, Zuckerberg, Wozniak) or those that start a company after a few years of industry experience (as I did). You also need the engineers and scientists that work for these startups.

To follow up on one of the talks, I found an excellent resource for preparing K-12 students for science careers. But sending children to STEM college majors is not enough, as two articles demonstrated. One, in the New York Times, was entitled “Why Science Majors Change Their Minds”. A sequel, “Why Engineering Majors Change Their Minds,” was published at the Forbes website.

The upshot of these recommendations? Engineering is hard, the grades are lower than for easy majors, and the competition is particularly ruthless at the top school. (Berkeley comes to mind as a place that particularly likes to wash out engineering majors). They also note the deferred gratification: several years of lower division prep followed by the interesting stuff as a junior or senior.

To address this, Berkeley had my niece take a freshman engineering seminar to give her the big picture of what she was studying. I recall that my favorite (STEM) course freshman year — when I was still intending to be a EE — was taking the sophomore intro circuits class my first semester at MIT from a great teacher who later went on to be a IEEE Fellow.

A friend's son is hoping to join a top engineering program in 16 months, and so I’ve been giving his parents suggestions of how to think about picking a college and a career. One is to consider the top engineering teaching schools, like Harvey Mudd, Cal Poly, Olin or the military academies. (Or, if he goes to a top engineering research school, to join a professor’s lab as soon as possible). Other ideas include getting a summer job that involves working alongside engineers. Or, to do as my daughter is doing, attend a summer engineering program for high school students such as UC’s Cosmos.

Certainly what top students (and would-be entrepreneurs) need is an understanding of the technology and a curiosity to think about what that technology can do. For example, some Harvey Mudd students used their understanding of 3D printing to create a startup that makes custom iPhone cases (that can be self-printed or shipped).

Still, even with well-laid plans, there are plenty of opportunities to go astray, for the reasons identified by the NYT and Forbes. My friends who succeeded in engineering found a good job out of college (or as a summer job during college) that validated their choice and allowed them to reap the rewards of their long hard work.

In this era where the “new normal” is 8+% unemployment overall and 12+% for recent graduates, it seems more important than ever to find schools that find high demand for their graduates in the marketplace. Yes, some of this is a self-fulfilling prophecy — top schools attract top students who place well — but as a parent (or student) we want the best path to success. It’s great for students to take a direct path into entrepreneurship, but no one’s ROI on college investment should assume that lightning will strike during a four year window.

Finally, I advise every engineering student to do a business or econ minor (or even double major) — which will pay dividends in companies both big and small. I was blissfully unaware of business as an undergraduate, and had to do remedial education in night school to have a clue as to how to run my company. For business, I would recommend marketing, accounting, finance and general management. For econ, I'd recommend micro, if possible skip macro, and take managerial topics such as industrial/organizational econ, decision theory, law and economics or even econometrics or game theory.

Will high growth bring a failed marriage?

Everyone knows being an entrepreneur is stressful, particularly for a high-growth startup. Often entrepreneurs pay a high personal price — whether or not their firm is successful.

Still, last week I was surprised to read a New York Times blog posting that suggested that the outcome is predetermined. The article was written by a former entrepreneur who runs an entrepreneurial training program in suburban Atlanta:

Balance? Don’t Believe the Hype
By Cliff Oxford

“How can fast-growth entrepreneurs lead a more balanced life?” is one of those agonizing questions that I am often asked. The good news is that there is a rather simple answer: “You can’t.” Save your money, and don’t waste your time on the books and coaches who want to sell you advice. Here is why.

Fast growth is a 24/7 proposition. It is not just the hours you put in at work; it’s that it owns your head. You think about work in the shower and on vacation, and you get lost in all of the ideas while you are sitting at dinner. It is exciting and dangerous. Of course, the collateral damage on the big three — family, health, and faith — can be disastrous.
…
Now I work with hundreds of fast-growth entrepreneurs who struggle to find the balance they read about in airplane magazines as they zip off to see the next customer, and I see these tragedies happen over and over. I tell fast-growth entrepreneurs not to get married while they are in fast-growth mode. They always do.
…
I thought I could help entrepreneurs understand that balance is a fantasy — a good fantasy but still fantasy. … I have been told that this is about the same success rate for heroin users in rehab.
…
Here is the deal: Fast growth means all-in, 24/7 for the mission and success of the company. Balance is snake-oil that says it can all be pretty and nice. It can’t. But I think setting boundaries can help.
…
Boundaries are trade-offs, and entrepreneurs are good at negotiating trade-offs. Balance is propaganda that sells well but is a cruel hoax that will continue to write tragedies.

The author’s viewpoint seems to be strongly colored by his own divorce and regrets over his loss of time with his (now adult) daughter. I have my own regrets over poor work-life tradeoffs, but (perhaps with more distance) am less inclined to generalize.

Oxford correctly notes that Bill Gates held off on the marriage and kids thing until he was starting to wind down his Microsoft role. Similarly, I would note that Steve Jobs didn’t get married (or have his last three kids) during his original Jobs I period, but in the NeXT interregnum before the Jobs II era. Both Larry Page and Sergey Brin got married in 2007, when Google was nine years old and worth billions.

Still, there’s a difference between an increased risk and a deterministic outcome. I asked one friend who works with Silicon Valley entrepreneurs, and he strongly disagreed because, as he said, “Have seen people able to do both.”

Instead, I think it’s the personality of those who become entrepreneurs — not just the single-mindedness, but the insurmountable ego. It’s not just (as Oxford suggest) the single-mindedness of pursuing The Next Big Thing, but also the know-it-all confidence (aka arrogance aka hubris) and need for control that inevitably leak over from business into one’s personal life.

So the lesson is not one just for entrepreneurs, but a broader lesson for driven, successful people who do need that sort of balance in their life. Perhaps as Oxford suggests, boundaries can provide a way out for those who’ve lost all sense of perspective.

The opportunity cost of entrepreneurial education

A friend tonight tweeted a column about why entrepreneurs shouldn’t get MBAs. The Wall Street Journal column last Monday says “I no longer advise startups to hire M.B.A.s and I discourage students who want to become entrepreneurs from doing an M.B.A.” and a follow up Friday on LinkedIn makes similar points.

The author, Vivek Wadhwa, is a former entrepreneur who’s made a point of being an iconoclast on trade, immigration, education and a variety of other topics since taking his first adjunct position in academia at Duke back in 2005. Having seen some strong opinions in areas where I have direct knowledge, I’ve always tended to take his postings with a grain (if not a kilo) of salt.

The LinkedIn column identifies some important risks for entrepreneurs. The first is the cost ($100+K) of getting an MBA, which tends to push MBA graduates towards corporate rather than entrepreneurial opportunities. (This problem has gotten more severe as state-subsidized MBAs have gone away: a Haas or UCLA MBA that 20 years ago cost $10K in tuition is now over $100K). Related to this is the opportunity cost, i.e. two years out of the workforce: if you have the next Facebook, you should be starting it rather than getting a degree.

Wadhwa also questions the relevance of MBA programs for new and small companies — a point I observed when taking MBA classes (during my PhD) back in 1994-1996. Still, this is a terribly broad brush, given the wide range of programs around the country, and the number of serious entrepreneurship faculty (such as Tom Eisenmann) trying to provide real entrepreneurial insights in the MBA classroom.

I’d agree with Wadhwa that a good one-year specialized master’s is a reasonable compromise. I don’t know much about his own program at Duke, but certainly could recommend the engineering management programs at Berkeley or Stanford’s highly influential part-time program.

However, I find some of Wadhwa’s advice more than a little contradictory:

I believe very much in the value and importance of education and consider the bachelors degree to be a basic requirement for success in business — whether you are working for someone else or starting your own. If you don’t have this, you are at a severe disadvantage because you have too many gaps in your knowledge and you have not had a chance to develop important social and learning skills.
…
My team at Harvard and Duke looked into the backgrounds of tech entrepreneurs found that, on average, MBAs start their companies 13 years after graduating. Subsequent research revealed that what makes entrepreneurs successful is their experience — including previous successes and failures; management teams; and luck. Next on the list are professional networks and education. 

Yes, it’s redundant for someone with a good undergraduate business degree to get an MBA — whether trying to be an entrepreneur or not. Those with undergraduate business degrees may be well-suited at starting a franchise or retail firm, or (after many years’ experience) of being the finance or marketing cofounder of a tech startup.

However, the advice to avoid an MBA is problematic for would-be tech entrepreneurs. How do you get a bachelor’s in business when you’re majoring in engineering or computer science (or molecular biology) at a top school? The normal route — the one I have long advised — is for would-be entrepreneurs to get an undergraduate tech degree and a graduate business degree.

And just because you got your degree 13 years before you start your company, doesn’t mean it wasn’t valuable. A good degree from a good school admits you into a good firm, good experience, and good professional and social networks. Without some sort of business training, 13 years later an engineer or scientist will still be (“just”) an engineer or scientist.

I never got a formal business education before starting my company, but I did have a few UCSD Extension courses that helped tremendously. I would have done much, much better if I’d understood VC, entrepreneurial exits and consumer marketing before co-founding a company in a burst of excess (and unjustified) optimism.

Overall, these columns show the problem with black-and-white, one-size-fits-all advice. On the one hand, getting an MBA has a cost, and sometimes the cost is too high. On the other hand, tech entrepreneurs have almost insurmountable disadvantages if they don’t understand the basics of business — which might be solved by an MBA, a dual major, a business minor, or a well-trusted relative who will look after their interests when they are starting their firm.

So if the point is to say that entrepreneurs should never get an MBA, that’s clearly an exaggeration to make a point. If the point is to caution would-be entrepreneurs to carefully assess the risk-benefit of an MBA before starting, I’d say Amen! — but that would also apply to anyone getting a graduate degree, whether an MBA, a Professional Science Masters’ or a PhD.