Marina Gorbis's Blog, page 1364

The Silent Killer of New Products: Lazy Pricing

72% of all new products don’t meet their revenue targets. And a quarter of companies, according to the same survey, confess that not one of their new offerings met its profitability goals.

This new (and alarming) data comes from pricing consulting giant Simon-Kucher & Partners, which conducts its survey every other year with the Professional Pricing Society, a professional association. The 2014 survey polled approximately 1,600 executives and managers from over 40 countries and across a range of industries. (About two-thirds were in B2B businesses.)

I talked to Georg Tacke(co-CEO of Simon-Kucher) and Madhavan Ramanujam (Partner at the Silicon Valley Office of Simon-Kucher) about what’s causing this high failure rate – and how some companies manage to improve their batting average. Not surprisingly, they advocate bringing marketing and monetizing concerns much further forward in the R&D process.

What follows is an edited version of our conversation.

 

HBR: Is new products’ high rate of failure really a pricing problem, or does it reflect a more fundamental innovation problem?

Georg: We believe that there is a more fundamental problem. Of course, the pricing is always what signals the problem, but behind that it is how the innovation process is set up. However, our experience has been that [when a product fails] it’s not a technology problem or a pure R&D problem — it is really around marketing, customer segments, and of course pricing.

Madhavan: This is very consistent in our experience working with both startups and large companies. They build a product hoping to monetize, but not knowing whether they will be able to. What allows a company to extract full value is having a clear pricing plan from the get-go, not waiting until the end and then saying, “Oops, we need a price!”

Your survey also details how hard some companies are finding it to raise prices. For instance, you found that only a third of all planned price increases actually get implemented, and for every 5% price increase attempted, only about 1.9% is achieved. Why are companies having such a hard time raising prices?

Georg: It’s partly internal, and partly external. Internally, most companies are only thinking about it at one point in the innovation process – usually right before launch. Our survey showed that 80% of companies fall into this trap.

Externally, the reasons vary by industry. Pricing pressure is more intense in retail, less so in areas like top-branded luxury goods or highly differentiated machinery. If you are undifferentiated, then it’s a no-brainer that the pressure on your prices is going go be even higher.

Geographically, we observed that countries like Japan have some of the highest pricing pressures. When there are lots of companies whose goals are to go for high [sales] volume and high market share, that creates a price war.

One of the odder findings in your survey is that 58% of companies say they are currently in a price war – but 89% of those blame their competitors, not themselves, for starting it. Why does pricing feel so out of executives’ hands?

Madhavan: For many years, CEOs and executives have focused on improving the bottom line through cost cutting, finding efficiencies in operations and the supply chain. Companies have gotten better and better at that. Pricing is also a highly impactful driver of revenue, but companies probably spent the least amount of time on it. Often it’s the most misunderstood driver in a corporate boardroom. It’s not something that gets a lot of attention in business school, relatively speaking. However, it is also one of the easiest things to change and companies tend to be more reactionary [than strategic] about it.

Let’s talk about the outliers – the top 10% of companies who, you found, actually could introduce new products and raise prices. What are they doing differently?

Madhavan: The #1 success factor really for us is the C-level involvement. Having senior leaders participate in pricing discussions is a must. They don’t need to be part of every discussion, but CEOs do need to make pricing and new product development their priority.

The second factor is focusing on pricing being considered from the very conception of an idea. Many companies go through an innovation process where there is a lot of focus on R&D and then right before they are about to launch the product, that is when pricing is considered. [Instead,] think about pricing in the R&D stage. What do customers value, what might they value? If you ask someone, “Do you want this feature?” they might say yes—but if you ask them, “Would you pay two dollars for it?” it’s a totally different conversation. And how to charge for the product is far more important than the price itself. For instance, will it be a subscription or a transaction? Will it be bundled with something else?

Third, the companies with the most pricing power use technological tools to measure value and willingness to pay in a systematic way. They let evidence and facts drive innovation processes. Our study found that the top 10% of companies use pricing software and technology 40% more often than the bottom 90%.

What’s an example of a company that really does do a good job of thinking about price at the R&D stage?

Georg: BMW has been very successful in this area. They do all their research and innovation in one building, and all the functions – finance, marketing, engineering – they either come from their offices to that building, or they are already physically located there. Having such a building sends a strong signal that all these different functions are committed to the innovation process.

Companies that are not as strong, they start with a business case that details the four pillars of their new product — value, cost, price, and volume – but then the development team works in isolation. They start adding features, perhaps, because the competition has these features. That leads to higher costs, which then affects the price, which then affects the volume projections. By the end of the process, the four elements don’t fit together any more.

The important thing is to have those synchronized throughout the whole process. The most effective companies ask their teams to sign off on those four elements throughout the process, at different milestones, to make sure they are still synchronized.

To Succeed in Germany, Uber Needs to Grow Up

How should Uber go about conquering the world? Currently, it seems to operate on the “invade first, ask questions later” model.

This became a problem for the company last week, when the taxi-hailing company found its app blocked by a German court due to a violation of the country’s Passenger Transportation Act.  While the decision is only temporary until a full hearing takes place, the case highlights Uber’s mounting legal difficulties in Europe.

Uber has vowed to disregard the court’s ruling, but the company’s own reasoning is full of holes. Uber has to contend with far more than just a foreign legal system. The German cab market already exhibits many of the consumer benefits for which Uber deems itself a unique solution – and many deficiencies of the U.S. market simply don’t exist in Germany (and most of the markets in Europe in which it has entered).

One thing is for sure after the recent developments in Germany: Uber’s current stance – “My way or the highway” won’t fly.  Here are several assumptions Uber must reconsider if it hopes to succeed in Europe:

German riders need our product. In the United States, cab systems in major cities feature outdated clunkers as cars, and cabs literally disappear when it starts raining. Here, Uber can be put to good use. As a resident of Washington, D.C., where cabbies still resent the introduction of metered fares, I know of the major shortcomings of standard cab service, which basically amount to a Soviet-style approach in terms of product diversity – and service reliability. Uber has helped me out of a pinch many a time when I had to make sure that dinner guests could get a ride back to their hotel and there were no cabs to be found. In the U.S., Uber’s introduction of higher quality, up-market cars and a vastly improved notion of service is a definite benefit to American consumers.

Contrast that with the basic situation in Germany. Taxi service works like clockwork. When you need a cab, you call one citywide number, and you can reliably expect a cab in front of your door within 5-10 minutes. Pretty much the same timeline as Uber. There also are basically no clunkers on the road – most operators buy Mercedes cars for their cabs, mainly for reasons of better durability. Riding in style is hardly what the Germans are lacking. From a consumer perspective, that implies a less immediate need for Uber, although it will find its place in the market.

National laws don’t apply to us. The most breathtaking element of the Uber standard operating formula is to argue, as the company’s top executives regularly do, that no laws apply to the company. Why? Because – get this – the sharing economy wasn’t invented yet when the relevant laws and regulations for taxicabs were written. Ayn Rand must feel like resurrecting herself in excitement.

Uber must follow nationally established laws and regulations. Saying it’s an app and therefore it’s different begs disbelief. Most nations have established rules to introduce a taxi service. That, by the way, is exactly what Uber offers, no matter how much the company tries to spin itself away from that and toward the fact that it’s an innovative new app. (German taxis offer app-based service too these days, in addition to order by phone). Uber can file applications, and once it meets the standards and tests others have to meet, it can start operating.

When companies argue that they are preternaturally above the law in other countries, it demonstrates exactly the type of hyper-arrogance that much of the world by now has come to expect from U.S. businesses. It ultimately neither helps Uber’s, nor America’s, principal causes.

We’re good for the entrepreneurial ecosystem. According to the breathless apostles of the sharing economy, it will do wonders to promote micro entrepreneurship. The basic hoax behind this claim, as far as the field of car sharing is concerned, has been exposed in plenty of news stories. Fleet drivers are still essentially at-will employees and can be easily terminated. Never mind that operating a taxi system, to Uber’s likely dismay, is still only a very early example of the sharing economy.

The taxi business in Germany is plenty entrepreneurial. Many operators are family-owned businesses – and hence represent a true blue case of entrepreneurship. Uber will thus detract from, not really add to, that equation.

Mind you, none of the arguments presented above are a case against Uber. It will find its place in the market, whether in the U.S., Germany, or elsewhere. But it needs to observe global differences, contradictions, and obligations.

The free world definitely needs constant innovation to find a suitable way to a prosperous future. But we also need a better balance between the need to innovate and the need to have everybody play by the same rules.

A Man’s College Degree Does Have Value: to His Wife

Although a man’s educational level has no impact on his own happiness, a woman married to a man with at least a college degree is about 5% more likely to be very happy with her marriage, according to an analysis of the General Social Survey, funded by the U.S. National Science Foundation. “There seems to be an inherent quality of a man having a college degree that makes a woman happier in marriage,” write economists Bruce T. Elmslie of the University of New Hampshire and Edinaldo Tebaldi of Bryant University. Men, by contrast, seem to have little interest in the educational level of their wives.

The Creative Benefits of Boredom

In a past life, I used to be required to participate in quarterly sales meetings. These meetings followed a typical format: fly everyone in the company to an amazing destination, then lock them inside a hotel ballroom for 10 hours a day and force them to listen to speeches from sales leadership, as well as marketing, research, and legal departments (usually with a motivational speaker to close it all out). Try as they might, these meetings were boring. The real shame was that they were intended to rally troops and get the sales organization excited about new initiatives, as well as inspire them to think up new and better ways to increase sales in the field. The only saving grace: the late-night dinners. After 10 hours of being talked at, my colleagues and I would escape the hotel, find a local restaurant and talk to each other. Despite our best efforts, these dinner conversations were always about work – and good thing too. These chats were filled with new ideas for dealing with problem clients or increasing sales of new products. Late-night dinners became the source of the new and exciting our meetings were supposed to elicit.

Boredom at work (and meetings) is something nearly all of us feel at times, but admitting that boredom to coworkers or managers is likely something few of us have ever done. It turns out, however, that a certain level of boredom might actually enhance the creative quality of our work. That’s the implications of two recently published papers focused on the link between feeling bored and getting creative.

In the first paper, researchers Sandi Mann and Rebekah Cadman, both at the University of Central Lancashire, explained the creativity-boosting power of boredom in two rounds of studies. In both rounds, participants were either assigned the boring task of copying numbers from a phone book or assigned to a control group, which skipped the phone book assignment. All participants were then asked to generate as many uses as they could for a pair of plastic cups. This is a common test of divergent thinking—a vital element for creative output that concerns ones ability to generate lots of ideas. Mann and Cadman found that the participants who had intentionally led to boredom through the phone book task had generated significantly more uses for the pair of plastic cups.

Next, Mann and Cadman wanted to see what would happen when they really bored people out of their minds. So in a second round of their study, they created three groups—one control group, one phone-number-copying group, and a third group given the even duller task of simply reading the phone book. All three groups completed another task requiring creativity. In this case, the most bored group – the completely passive group of phone-book-readers – scored as the most creative, even out-scoring those assigned to the same phone book copying task from the first study. The findings suggest that boredom felt during passive activities, liking reading reports or attending tedious meetings, heightens the “daydreaming effect” on creativity—the more passive the boredom, the more likely the daydreaming and the more creative you could be afterward.

In another paper, this one from Karen Gasper and Brianna Middlewood at Penn State University, founding a similar effect using a different mundane task and a different type of creativity test. In their study, Gasper and Middlewood assigned participants to watch a video clip designed to “prime” participants by eliciting feelings of relaxation, elatement, distress, or boredom—depending on which video was watched. (Participants were told, however, that the clip was random.) They then had their subjects take what’s known as a remote associates test, where participants are given three seemingly unrelated words (for example: string, cottage, and goat) and asked to think of a fourth word that links the three (in this example: cheese). Remote associates tests are commonly used to measure convergent thinking, a different but complimentary element of the creative process that concerns ones ability to figure out the single, correct idea for a situation.

Just as in the Mann and Cadman study, participants in the bored category of this study outperformed the participants in the other three categories. Gasper and Middlewood suggest that boredom boosts creativity because of how people prefer to alleviate it. Boredom, they suggest, motivates people to approach new and rewarding activities. In other words, an idle mind will seek a toy. (Anyone who has taken a long car ride with a young child has surely experienced some version of this phenomenon.)

Taken together, these studies suggest that the boredom so commonly felt at work could actually be leveraged to help us get our work done better…or at least get work that requires creativity done better. When we need to dream up new projects or programs (divergent thinking), perhaps we should start by spending some focused time on humdrum activities such as answering emails, making copies, or entering data. Afterward, as in the Mann and Cadman study, we may be better able to think up more (and more creative) possibilities to explore. Likewise, if we need to closely examine a problem and produce a concise, effective solution (convergent thinking), perhaps we should schedule that task after a particularly lifeless staff meeting. By engaging in uninteresting activities before problem-solving ones, we may be able to elicit the type of thinking we need to find creative solutions.

The Innovator’s Question: What Would Fosbury Do?

When 16-year-old Dick Fosbury first attempted the high jump in high school track-and-field, he couldn’t even qualify for his meets. With a bad back, bad feet, and an easily worn-out body, Dick was hardly champion material. He also had a terrible habit of jumping and landing the wrong way, to the dismay of his coaches and probably his mother.

Five years later, he broke high jump records, winning gold at the 1968 Olympic Games by

clearing 7’ 4”.

At the time, top competitors used what was known as the “straddle” technique. They’d run straight and clear the bar face-down, kicking pronated legs up and over in succession. At the Olympics, Fosbury shocked the world by running at the bar diagonally, jumping off the “wrong” foot, and arching himself over the bar backwards—resulting in implausible height and the record.

By the next Olympics, the majority of competitors were jumping with Fosbury’s back-first technique. Today, it’s rare to see a high jumper not use the “Fosbury flop.”

Fosbury’s breakthrough took his sport to a new level. He did it not by working harder or developing bigger muscles than his competitors, but by recognizing that a convention of his sport was not a rule.

The same pattern is present in breakthrough innovations in business. Dramatic progress in both macro and micro environments happens when players break rules that aren’t actually rules – in other words, when they rethink assumptions.

Psychologists call this “lateral thinking.” As the man who coined the phrase, Edward de Bono, explains, “In most real life situations the pieces are not given, we just assume they are there. We assume certain perceptions, certain concepts and certain boundaries. Lateral thinking is concerned not with playing with the existing pieces but with seeking to change those very pieces.”

We got printing presses and express trains and the American Revolution from lateral thinking. More amazing, we got stealth jets and digital projectors and sticky notes from lateral thinking inside existing enterprises. Gmail was once a one-man side project. Tipsy programmers developed Facebook’s ubiquitous “Like” button during a hackathon. They each approached the challenges in their businesses sideways, and created a new game for their competitors to catch up to.

The dilemma for most businesses is how to encourage unconventional thinking that leads to such breakthroughs while minimizing risk. Starbucks doesn’t want lateral-thinking baristas bringing bourbon from home and spiking lattes.

Unless bourbon lattes start selling.

And that’s the problem. We who’ve gotten far by playing by the rules or even writing our own as entrepreneurs have an easy time carving our assumptions about our businesses into stone. We become increasingly entrenched in “this is what matters” and “that’s the way it’s done” the longer we invest.

The key to flipping that script, to encouraging lateral thinking that doesn’t lead to liquor-license fines or bankruptcy—or turn a company into Enron—is to be honest with ourselves about what hard boundaries actually exist. And even then, we ought to spend time questioning those boundaries as well. The only hard line we ought to draw, at the end of the day, is a question that has little to do with profits: Is it ethical?

Fosbury recognized that there was no rule in his sport other than “clear the bar” and “jump off of one foot.” He could run from any angle, jump from either foot, twist and flail and land however he wanted. But his peers assumed that the direct approach was the “right” approach, and therefore only made incremental improvement.

How did Fosbury convince his nervous coaches to let him use his unorthodox technique? With cold data. He practiced his flop on his own, then showed up to practice with higher scores. It’s tough for a boss to be too mad about better results.

When Ben Franklin was a young man working for his brother’s print shop, his brother wouldn’t print his writing. So Ben stayed up late writing essays under a pseudonym, slipping them under the print shop door. He did this extra work on his own time, and his essays soon became a colonial hit. He bent the rules (though writing under a pseudonym was common at the time, he disobeyed his brother’s wishes), but his brother couldn’t deny their critical reception and benefit to the newspaper.

The calling of an entrepreneur is to forge her own path despite the obstacles, and true intrapreneurs have that mindset as well. Would Ben Franklin have put those letters under the door if they were garbage? No. Neither would he have written them during work hours. At a corporation like 3M or Google where time for experimentation is allotted, perhaps he would have. But in the absence of such encouragement, he built his own innovation on his own time.

“I use the phrase of responsibly ‘irresponsible’,” says Astro Teller, director of Google’s innovation lab, Google[x], which has produced Glass and Internet-bearing balloons called Loon. “It can’t just be Peter Pans. But they can’t just be PhDs. It’s Peter Pans with PhDs that’s powerful.”

The average business isn’t set up to encourage (or reward) rule-bending. Slippery slope analogies abound. Teller says, “It’s got nothing to do with anything but bravery.” And if the organization doesn’t have it, the intrapreneur can.

On a practical level, the brave intrapreneur will do well to ask herself a few starter questions to kickstart lateral thinking in her work:

What are the assumptions inherent to this question?
How could we change the question?
What if we couldn’t take the conventional approach?
What if we had to do this for 100x cheaper?
What if we had to do this 10x better?

Then there’s my personal favorite: What would Fosbury do?

How to Get the Most Out of Your Executive Education

My summer short course executive education “students” are terrific. They come from all over the world and radically different industries. They’re entrepreneurs as well as intra-preneurs inside established organizations. They’re motivated, dedicated and demanding—as they should be. They authentically want to be better innovators. I’m grateful for their commitment and how much I learn from them.

The single most important thing I’ve learned over a decade of summer studies is that cultivating new capability is more important than better communicating one’s expertise. These mid-career leaders and managers aren’t just seeking greater knowledge, they want to acquire greater skill. But this sensibility isn’t just confined to the classroom— the desire for getting better at getting better is a global phenomenon. I’ve discovered that the summer short course is a great laboratory for learning how human capital revitalizes, renews and retools. Here’s the seven lessons managers and executives should consider as they invest in themselves:

1)   Organizational impact matters as much as professional development. At mid-career, if you receive any kind of professional development, it has to have immediate impact on your organization. The course content and curricula need to clearly connect with what matters to your colleagues, clients and customers. A better view from 30 thousand feet or a firmer grasp of technology may exhilarate but will that translate to meaningful organizational influence within 100 days?

2)   Keener introspection facilitates greater external influence. I am no longer surprised when students email or share that the session forced them to become more self-aware. Being able to do more pushes people to re-evaluate what they really want to do. In my class, people revisited what kind of innovators they wanted to be and what kind of innovation they wanted to encourage. The surer their insight into their own innovation priorities, the more clearly they could communicate and motivate. Whether you spend time in a classroom or not, the message here is to look for opportunities to rethink not just what you can do, but what you want to do.  As you increase capability in one domain, look for adjacencies and complements.

3)  Rethink, repurpose and renew what we’re already doing. Revolution and new paradigms weren’t top priorities for my mid-career students. The primary opportunity was revisiting the fundamentals of everyday projects and processes. Instead of starting from scratch, my students sought innovative ways to leverage what their organizations were already doing. For example, their company already prototyped. How might simple changes in the prototyping process yield disproportionately greater value? In the same way, you should be looking for similar opportunities where small tweaks result in creating and capturing new value.  Don’t make “reinvention” your focus.

4)  See something differently. The classroom thrust was empowering students to individually and collectively “see” innovation in a different way. Students wanted novel perspectives and points of view that let them observe or appreciate something in a potentially valuable new way. Just as a microscope or MRI scanner offers new eyes, a different framework similarly invites a new vision. But seeing different is not enough; that vision has to be communicated. This is where social media can play an important role. How will you share not just a vision but a visualization?

5)  Do something different. Effective leaders and managers can’t simply be visionaries and voyeurs. Actions speak louder than words. The cultivation of capability means that “seeing differently” has to be translated into tangible actions. In our class, that meant collaboratively designing simple models, prototypes and experiments. Turning a novel “point of view” into a testable innovation hypothesis represented a different way of exploring value creation. But that “do something different” has to be made accessible and understandable. Simple exercise: Is there an “app” or “calc” that could have an impact?

6)  Measure the difference. Seeing and doing something different is the essence of new capability creation. But those differences need to be credibly measured. How do those differences make us more efficient or effective? How might our customers or clients experience that difference? It’s one thing to claim a new capability; it’s quite another to rigorously measure it. Serious executive education students are always looking for new ways to measure impact, influence and improvement. Similarly, whether you’ve learned in a classroom or on the job, what is the metrics conversation you want to facilitate? What gets measured gets managed. Incentives don’t follow too far behind.

7) Build an arc. What’s next for high impact professional development? How often are you asking yourself, or your boss, that question?

The lesson I take away from listening to, working with and learning from these students is that professional development requires a commitment to interpersonal development.  That is, the capabilities we cultivate aren’t just about getting better at getting better—they’re about getting our colleagues and collaborators better at getting better, as well.

What You Don’t Know About Sales Can Hurt Your Strategy

The goal of strategy is profitable growth, meaning economic value above the firm’s cost of capital. There are basically four ways to create that value: (1) invest in projects that earn more than their cost of capital; (2) increase profits from existing capital investments; (3) reduce the assets devoted to activities that earn less than their cost of capital; and (4) reduce the cost of capital itself.

In my experience, most CEOs, CFOs, and other C-suite executives involved in strategy formulation know these finance basics. (Or, they learn fast after a few investor meetings.) But far fewer understand and operationalize the core sales factors that materially affect each value creation lever.

Most projects and investment initiatives in firms are driven by revenue-seeking activities with customers. Hence, the customer-selection criteria of sales managers, and call patterns of sales reps, directly impact the first value-creation lever: which projects the firm invests in. But most sales compensation plans focus purely on volume incentives. In effect, the C-suite is saying to salespeople: “go forth and multiply!” That’s precisely what they do, selling to any customers and, in the process, generating a motley mix of investment initiatives in the selling firm. Soon, it really doesn’t matter what your strategic planning documents say. Your real “strategy” is the collection of investments made via this ad hoc process.

To increase profits from existing investments, the interactions between sales and other functions is crucial because those interactions accrete costs, time, and on-going asset utilization patterns in organizations. Consider the order cycle in most businesses. For the seller, an order typically touches multiple functions as it moves from a customer’s request for specifications or quote to a purchase and through any post-sale service activities such as delivery and installation. The process starts with a sale—as the old saying goes, “nothing happens until you make a sale”–and sales is involved in most of these activities, if only because it’s the sales rep who usually fields the customer’s questions or complaints and who then interacts with other functions to respond.

Smartly reducing assets devoted to activities that earn less than their cost of capital requires good links with evolving market realities. (My previous article emphasized how and why these links are broken in many companies.) But creating value also requires senior executives to get more serious and knowledgeable about performance-management issues in sales. Without that understanding of how sales hiring, incentives, organization, and training affect field behavior in your company, asset redeployment becomes an academic exercise that does not affect the actions of those using unproductive assets. Or, worse, C-suite initiatives become an unwitting impediment to the use of assets that in fact remain essential to profitable selling.

It may seem that sales has little impact on the fourth value-creation lever, the firm’s cost of capital. Isn’t that a function of risk parameters and the debt-to-equity ratio? (Call the investment bankers for advice, since they’ve shown how smart they are in managing their risks and leverage.) But consider the basics. Financing needs are in large part driven by the cash on hand and the working capital required to conduct and grow the business. Most often, the single biggest driver of cash-out and cash-in is the selling cycle. Accounts payables accumulate during selling, and accounts receivables are largely determined by what’s sold, how fast, and at what price. That’s why increasing close rates and accelerating selling cycles is a strategic issue and not only a sales task.

Interactions with customers affect all core elements of enterprise value and, in many firms the sales force is the sum of those interactions. If the C-suite can’t make these connections between sales and strategy, then attempts to increase stock price or valuations are at best limited and, at worst, going down the wrong path. For example, as a leader, you can worry prudently and diligently all you want about disruptive innovations in your industry, but you need a sales channel aligned with strategy to do something about it. Or as a character in a John le Carre novel says, “A desk is a dangerous place from which to view the world.”

Strategic Humor: Cartoons from the October 2014 Issue

Enjoy these cartoons from the October issue of HBR, and test your management wit in the HBR Cartoon Caption Contest. If we choose your caption as the winner, you will be featured in an upcoming magazine issue and win a free Harvard Business Review Press book.

“Ever since I hacked into that retail group, I can’t get off its mailing list.”

John Klossner

“They’ve passed their peak performance years, but they have access to fresh coffee and plenty of room to roll around.”

Teresa Burns Parkhurst

“I thought it might help.”

Teresa Burns Parkhurst

“Good heavens! What if they’ve come seeking market share?”

Patrick Hardin

And congratulations to our October caption contest winner, Tony Vance of Millersville, Maryland. Here’s his winning caption:

“So that’s where they hide the silent partner.”

Cartoonist: Crowden Satz

NEW CAPTION CONTEST

Enter your caption for this cartoon in the comments below—you could be featured in an upcoming magazine issue and win a free book. To be considered for this month’s contest, please submit your caption by September 23.

Cartoonist: Martin Bucella

If Your Kids Get Free Health Care, You’re More Likely to Start a Company

Starting a business is risky enough in the best of circumstances. Most new ventures fail, and the prospect of forgoing a salary is enough to keep many would-be entrepreneurs from taking the plunge.

But think about how much harder it would be if your child had a health condition, and you couldn’t get her insurance if you struck out on your own.

That’s less of a problem in the U.S. than it was a few years ago, thanks to Obamacare, but until recently it was a very real conundrum. So does the extension of publicly provisioned health insurance prompt more people to start companies? That’s the question asked by a paper released earlier this year by Gareth Olds of Harvard Business School.

Olds analyzed Census data from before and after the passage of the Children’s Health Insurance Program in the U.S. in 1997 to assess its impact on entrepreneurship. CHIP, or SCHIP as it was previously known, provides publicly funded health insurance to children whose families don’t qualify for Medicare, but whose incomes still fall below a cutoff (typically around 200% of the federal poverty line).

His results suggest that the policy did significantly increase business creation by those families affected. The self-employment rate for CHIP recipients increased from just under 15% of those eligible to over 18%. That amounts to an a 23% increase. The rate of ownership of incorporated businesses — a better proxy for sustainable, growth entrepreneurship — increased even more dramatically, from 4.3% to 5.8%, an increase of 31%.

What about all the other factors that might skew this sort of analysis? Olds used several quasi-experimental statistical methods in his research to control for such variables. The basic intuition behind his methods is that a family just above the CHIP cutoff isn’t all that different from a family just below it. Whether you make 199% of the poverty line or 201% doesn’t matter for much, except whether or not you’ll be able to enroll in the program. With that in mind, his methods zero in on this sub-group, in order to confirm that the policy actually caused the increase in firm creation.

The mechanism by which Olds believes CHIP boosts entrepreneurship is relatively straightforward: it reduces the risk of “consumption shocks,” i.e. the possibility of having to pay out a large chunk of cash unexpectedly for a child’s illness. Lower the risk and more people start companies.

Though it may seem counterintuitive given the political rhetoric around social insurance and economic growth, Olds’ is not the only research to suggest that welfare programs can promote entrepreneurship. Previous research has found that American self-employment rates jump at 65. Why is 65 a better age to start a company than 64? Because you qualify for health insurance through Medicare.

All of this serves as a reminder that bigger government needn’t discourage entrepreneurship and risk-taking. The relationship between the two ultimately depends on what government chooses to spend money on.

The final takeaway from Olds’ work is just how many business owners do depend on public programs like CHIP. “12% of households with incorporated businesses report enrollment in a public program,” he writes, not even counting Social Security, Medicare, or veterans benefits. And “disproportionately more entrepreneurs are receiving public healthcare benefits than would be expected based on their income alone.”

Overall, though, entrepreneurs still hail from disproportionately well-off families. The lesson from Olds’ paper is that starting a business doesn’t have to be a risk only wealthy people can afford to take — and the government can help.

Have Economists Been Captured by Business Interests?

To be an economist, you kind of have to believe that people respond to economic incentives. But when anyone suggests that an economist’s views might be shaped by the economic incentives he or she faces, that economist tends to get bent out of shape. This happened perhaps most famously in the documentary Inside Job, in which filmmaker Charles Ferguson posed his questions to the likes of Glenn Hubbard and Rick Mishkin as tendentiously as possible in order to spark just such reaction. But it’s actually pretty common to hear economists saying things like — this is from the usually no-nonsense John Cochrane of the University of Chicago — “the idea that any of us do what we do because we’re paid off by fancy Wall Street salaries or cushy sabbaticals at Hoover is just ridiculous.”

It is perhaps ridiculous to suggest that economists do what they do only because of the prospect of consulting gigs or think-tank stints. Economists are human beings, with diverse motivations. But it is definitely ridiculous to suggest that such rewards have no impact at all. Economists are human beings, and human beings respond to incentives. Right, economists?

Happily, Luigi Zingales, a colleague of Cochrane’s at Chicago’s Booth School of Business, is trying to correct his discipline’s blind spot by examining the economics of economists’ opinions. He does this in a chapter in the Tobin Project book Preventing Regulatory Capture, published last December, that has been trickling into the public’s consciousness mainly in this working paper format (there’s also a short version in the Booth School’s Capital Ideas magazine, but the full paper is so entertaining that you really should download it, if you’re into this kind of stuff). The economic lens Zingales uses is regulatory capture, the idea expounded by economists Mancur Olson and George Stigler in the 1960s and early 1970s that, as Zingales puts it, “regulators can be influenced and not all groups have equal opportunities in influencing them.”

Zingales looks at the ways in which economists can be influenced and who might influence them, then subjects his notions to an empirical test: Are there discernible patterns in what kinds of economists think corporate executives are overpaid and what kinds think they’re paid fairly? (He also examines views on whether executive pay should be more or less sensitive to corporate performance, but I don’t want to overcomplicate things here.) The answer turns out to be yes. Economists with appointments at business schools are more likely to give a thumbs up to executive pay than those without — and this even after controlling for “the Bebchuk effect” caused by the extreme productivity of executive pay critic Lucian Bebchuk, who teaches law, economics, and finance at Harvard Law School. Economists on corporate boards are more approving of current pay practices than those who aren’t. And articles in economics and management journals are more likely to be pro-pay than those in law or finance journals.

None of this is proof that the individual economists in question have been corrupted, Zingales writes. Maybe economists who sit on corporate boards simply understand executive pay better than those who don’t. But the evidence does suggest that, among other things “the optimal strategy for a junior faculty who works on executive compensations [sic] and wants to maximize her chances to get tenure is to write articles that show that the level of compensation is appropriate.” Which sounds a lot like capture.

What is to be done about this? Zingales thinks media attention is an important force, and lauds Inside Job for “curbing the potential effects of capture.” He also has some specific suggestions about the management of economics journals, the ways in which economists go about acquiring private data, and forcing economists to be more accountable for what they say in expert-witness testimony and elsewhere. Also, as an immigrant from Italy with a charming but distinct accent, he thinks there should be more economists like him:

Ceteris paribus a foreign economist with a thick foreign accent is less likely to be asked to be an expert witness or to find a job in the industry, except in very quantitative (and generally not very lucrative) positions. These economists are less likely to cater to business interests.

What Zingales doesn’t call for is any kind of blanket retreat by economists from consulting and expert witnessing and board memberships. Which is a good thing, I think. One of the reasons why economics rocketed past the other social sciences in influence and prestige over the past 75 years was because so many economists involved themselves in the worlds they studied. That has surely led to some amount of capture by outside interests, but it also seems to have counteracted the natural academic tendency toward insularity and obscurity. Lots of economists study things of direct relevance to business leaders and government policy-makers. We wouldn’t really want to take away their incentive to do that, would we?