Kinds of businesses and kinds of business(wo)men

Paul Kedrosky discusses some of the consequences coming down the pipe for the VC industry.  Paul draws much of his inspiration from his friend, Bill Stensrud, who's a VC investor himself.  Thinking about the current state of the VC industry, Bill observes that an overweening interest in getting to an exit (read: finding a buyer) has come to replace an interest in cash flow (read: making money).

What [all VC] firms have in common is that they exist to buy and sell equities.  They both buy from entrepreneurs and they both sell to acquirers or (very infrequently these days) to public shareholders.  They are, at their very core, traders.  Their job is to buy low and sell high.  This fundamental truth about the venture business informs every action they take whether mainstream of super-angel.  It also informs the culture of the businesses they create.  Everyone is looking for a pot of gold at the end of the rainbow - the life changing - all consuming - EXIT!!  The nature of their business model demands it.  These are close-end funds.  They have to return money - cash - to their investors.

In this blog over the next several months I am going to explore another - even more ancient - model for company creation.  This is art and practice of building and running a business for POSITIVE CASH FLOW.  Before there was venture capital and before there were EXITS, people built businesses to make money so they could pay their bills.  I will argue that re-discovering this model drives a corporate culture which is much healthier, more robust and more survivable than the EXIT-focused culture created by the venture capital model.  I will also argue that the cash flow model can engage the employees, the critical human capital asset of every business, to significantly greater efficacy than equity models.  Lastly, I will argue that we can modestly scale this model to the point that it can become a significant factor in new business creation.

One of the consequences of thinking about business environments as ecologies is that it makes it relatively easy to think the relationship between the people who run businesses and the generic conditions in which those businesses operate.  It becomes easy to see how VCs, in actively selecting with an eye toward the exit, might over time change the population of entrepreneurs they partner with.  It might be obvious that business ideas that make money, but have no clear exit strategies, do not fare well securing VC in today's market.  But business ideas are developed by and instantiated by businesspeople.

Today's VC climate actively selects against entrepreneurs who want to "build and hold" profitable businesses.  "Build and hold" doesn't just describe a business model--it describes a temperament:

• Thoughtful - concerned with long-term secular trends rather than high-velocity volatile fads
• Prudent - husbands scarce resources for the long haul--including and especially managerial stamina (contemporary VC expects managerial burnout, though it hopes to exit before it happens)
• Patient - satisfied to build a strong foundation for big success by stringing together a long series of small, cumulative successes

If we want businesses that are conceived and constructed as long-term money-making ventures, we need entrepreneurs with the right temperament.  If modern VC's intensive focus on the exit has changed the character of our pool of important and interesting business ideas, well, so what?  New ideas are easy to come by.  But I fear there may have been a more subtle and more fundamental change in the character of our entrepreneurs (as a group, not as individuals).  We now have one, maybe two generations of top-tier entrepreneurs (with the right experience and connections) who think of starting a business as aiming for an exit.

In order to make best use of our limited resources, we have created a streamlined system whereby everyone must exit at Easy Street.

Our current business culture of get-what-you-can-while-you-can follows directly from the preferences of the VC investors who hire people with that kind of temperament to build and run their businesses.  As go new businesses, so goes all business.  It's hard to see how we get sensible businesspeople to run our businesses until investors stop thinking like traders.

The value of inconvenience

By almost any meaningful performance measurement, the U.S. economy in the 20th century performed better under Democratic administrations than under Republican ones. Reflecting on this seeming paradox, Christopher Carroll suggests that

perhaps the best explanation has to do with attitudes, not doctrines: Maybe capitalism works better when its excesses are restrained by skeptics than when true-believers are writing, interpreting, judging, and executing the rules of the game. (The Democrats are surely the more skeptical of our two parties).

Most would agree that restraining the excesses of almost anything counts as good sense, but this is only a preliminary step toward a bigger and more interesting idea:

Capitalism works better when it is being held accountable to some external standard than when left to its own devices.

The whole system works better when "held accountable to some external standard," when it is, in a word, constrained. Optimal performance, in other words, is the fruit of struggle. Make things too easy and performance declines.

Relaxed external standards? Check. Highlight reel material? Not so much.

Consider how effective coaches pull outstanding athletic performance from their players. Good coaches don't let their players do whatever they want, without accountability or oversight; they create rules and systems of accountability. A good soccer coach makes you use your weak foot in order to develop it. A good swimming coach pushes you to hold your breath longer. Optimal athletic performance depends upon the measured application of psychological and physiological pressure. (Go watch Gavin O'Connor's Miracle to see a dramatization of great coaching.) Good coaches don't remove limitations--they use them.

Or consider architectural and industrial design. The famous designer Charles Eames (yet another famous St. Louisan) once remarked:

Design depends largely on constraints.

We tend to believe that creativity is best served by removing constraints. If we could just somehow make the process of invention easier for the inventor, we imagine that she would be more inventive. But the opposite is usually true. People get creative--truly creative--when challenged to negotiate constraints. Budgets (within reason) push architects to develop new strategies to solve old problems. (The story of how the design of Seattle's new public library building developed is a great example.) The particularities of manufacturing processes push industrial designers to find solutions which challenge convention. (The story of the how the first commercially viable computer mouse was designed is a textbook example.) Constraints drive creativity.

Artist Andy Goldsworthy creates astonishing ephemeral works using only the materials he finds on site during his wilderness hikes: creativity driven by constraint.

The same is true in business. Real innovation happens where someone discovers a new way to scratch an old itch, where someone thinks through a problem in a new way (even if it's simply a new application of an old technology). When we talk about innovation happening "at the edges" of a market or industry, what we mean is that innovation happens where business rubs up against constraints. (The "mainstream" of anything is where things flow smoothly, right?) We can't have innovation--and capitalism's greatest strength as an economic system is its powerful incentives for innovation--unless we have the right kind of rules and restrictions. (The question of "more" regulation versus "less" regulation is puerile. The kind of regulation matters more than the amount.) The free market, to put it pointedly, is only as free as its constraints force it to be.

Of course, constraints are damned inconvenient. And that's precisely the point. It's often--if not always--in response to inconveniences that people are most creative, most inventive, most innovative. And so we're led inevitably to the conclusion that inconveniences can be useful.

"Traffic lights are just the Man keeping us down! We will not be constrained!"

Some inconveniences, naturally, are more useful than others, but that hardly obviates the necessity of inconvenience for optimal performance. It's easy enough to see how inconveniencing others might be worthwhile, but it's one of the marks of emotional maturity to see the value of inconvenience for oneself. Politics--in the largest possible sense of the word--is only possible because we deliberately accept to be inconvenienced in certain ways (e.g., we don't simply use whichever car is closest, use guns to force our crushes to go out with us, or lynch elected officials from opposing parties). We recognize that our condition is collectively better when we all accept to be inconvenienced in certain ways. (Again, the kind of self-regulation matters more than the amount.)

Finding--and enforcing--the right kind of constraints is key to getting the most out of people, as innovators, as politicians, as artists, as designers, and even as citizens. We would all of us do well to remember that inconvenience--yes, even our own--often serves us much, much better than convenience.

18 inspirations for educators and social entrepreneurs

Some people collect stamps. Others collect curiosities. I collect (among other things) pedagogical models, theories of learning, writings on education, and great educators. Someday I'll boil it all down and give you just the bullion, just the essence. But I need more time. My collection is far from a complete 7-course chowdown; heck, it won't do anything more than whet your appetite... but at least that means I've probably gotten to hors d'oeuvre status.

"My! You have such an interesting collection of... um... what are these, exactly?"

Model Institutions, Organizations, Etc.

1. Danish Folkeuniversitetet ("Folk High Schools"). The keystone of Danish national and democratic identity. One of the great triumphs of modern liberalism (in the strict sense of the term).
2. Hampshire College. The Un-Ivy League. Classes, but no core curriculum. Written evaluations, but no grades. Books, but no teacher's dirty looks.
   
3. The Nueva Escuela ("New School"). A program aimed at the developing world which supports schools as agents of positive social change. Focuses on education which is "active, participatory, cooperative, child-centered, and life-relevant." The story is that the founder asked every Nobel laureate she could get her hands on what kind of school they wished they had attended.
   
4. The KaosPilots (of course). A new kind of business school, aimed at at the fourth sector.
5. The Acton MBA (of course). Business school on steroids, which aims to produce entrepreneurs rather than managers.
6. Y Combinator. Although it claims to be a new kind of venture capital firm, it's really an intense education in how to be a world-class tech entrepreneur.
7. Gever Tully's Tinkering School. Let your kids do dangerous things, otherwise they'll never learn how to handle dangerous things. When I put it that way, it's obvious, right?

Writings Worth Reading

1. "On Education." Ralph Waldo Emerson's seminal essay on the subject, in which he argues that "the secret of education lies in respecting the pupil."
2. "Talks with Teachers." Brilliant lectures on teaching by eminent 19th century American psychologist and philosopher William James.
   
3. "Complicity." Online journal on complexity (read: chaos theory) and education. Be warned: this journal has a rather pointy head.
4. Infinite Thinking Machine. A blog providing coverage of innovation in education.

Models, Movements, and Technologies

1. Ignatius of Loyola's Spiritual Exercises, by which I mean more than simply the book by the same name. The exercises are a masterfully conceived and carefully refined ethical technique (read: a practice by which one acquires a particular character).
2. Unschooling. Let the child set the educational agenda; teaching consists principally in encouraging and enabling.
3. Moodle. A widely used open source course course management system.

Educators to Emulate

1. Socrates. The gadfly of great Athens.
2. Johan Amos Comenius, the Czech (Moravian, to be precise) "Copernicus of education."
3. Nikolai Frederik Severin Grundtvig, founder of the Danish Folk High School.
4. Amos Bronson Alcott, the original Transcendentalist, and the greatest teacher [.pdf] in U.S. history.

From this spark, fire

At the behest of some smart people I recently had the good fortune to meet, I'm going to start using this blog to post concept sketches for some of my business ideas. (All such posts will be filed under--i.e., tagged as--"JPs Biz Ideas") I'm posting ideas in the spirit of cooperative thinking; I hope that my thoughts inspire reflection, conversation, and maybe even action. Just remember that this is thinking toward getting something started. Whatever you have which will help move the conversation forward--thoughts, criticisms, stories, whatever--I'm eager to hear from you.

For those worried that I'm only sharing the chaff, I can understand where you're coming from, but I'm not going to be driven by my fear. What you'll see here will only be the cream. And further, just because an idea happens to sashay in front of my mind's eye doesn't mean I'll post it; only those which my satisfy my rather demanding inner impresario will be offered up for your delectation. In other words, only the truly interesting ideas will find themselves in pixels.

Enjoy! And please add to the conversation. Comments and contacts welcome!

Sector four

A riddle: If you're not for-profit, and you're not non-profit, what are you?

"Ah..." says the clever reader. "You're the government."

"But my lawyers tell me that I really am the government."

But let's just say that you're not the government either. (You listening, George?) You're still a private organization, you don't live off charitable donations, and you're not just in it for the money. Is there a fourth option?

There is. Although not fully formed, the emergent fourth sector comprises organizations not interested in playing by the old rules. Goodbye Marx, Spencer, Jacobs, and even Keynes. Hello KaosPilots. Increasingly referred to as "for-benefit," 4th Sector organizations have the following features:

• Privately owned and controlled (not government)
• Sustains its operations based on income generated by their activities (not a charity)
• Returns some of their surplus to their equity owners in the form of profits (not a non-profit)
• Leaves some of the value it generates in the community where it can continue to accrue (not merely a profit machine)

While for-benefit organizations often represent the fruit of social entrepreneurship, they're not one and the same. Social entrepreneurship (which has very official support here in Canada and elsewhere) means using the tools, techniques, and attitude of for-profit entrepreneurship to tackle social issues. For-benefits are one possible outcome of social entrepreneurship, but so are innovative charities, non-profits, political organizations, one-off events... even for-profits can be conscripted sometimes.

While no one knows exactly what the 4th Sector is going to look like, it's increasingly obvious that it's coming. (Even the last-to-every-party NYT has caught the shift in the wind.) And it won't be just companies--it's a whole new ecosystem. They're even growing their own venture capital firms. Watch out, old order.

"4th Sector rabble resists Ancien Régime forces?" No way.
"4th Sector overruns final barricade manned by scruffy Ancien Régime holdouts." Oh, yeah.

Development of the slums, for the slums, by the slums

Shack / Slum Dwellers International (an organization which seems to take a Puckish pride in the lumpishness of its name) has undertaken a challenging mission: "Securing land tenure and housing" for the urban poor "in 24 countries on 3 different continents." Bold, but hardly original. Their approach, however, is another matter.

The group, known by the initials SDI and formed in India in 1996, is a loose network of grass-roots organizations of the urban poor. It’s grown to millions of members in 24 nations, cities spread from Manila to Cape Town, Mumbai to Sao Paulo. Typically, members are women ready to share their meager savings in collective efforts to upgrade their homes, secure titles to the land their houses sit on, build a latrine block, perhaps start a school.

Slum dwellers sit right across the table from local government authorities, designing projects and negotiating how they’ll be financed and carried out.

Of course, the slum dwellers get professional advice [.pdf], but we're talking about slum dwellers acting as their own real-estate developers. For themselves and on their own terms. And they just got an unrestricted grant of US $10M from the Gates Foundation.

Unbelievable? On the contrary: perfectly necessary. When governments, NGOs, and big businesses can't or won't get people what they want, people quite naturally just do it themselves. Although it's obvious, it bears repeating: the poor (like every other demographic) are their own best--and in many cases only--allies.

Caging the innovation bird

So, 800-pound Microsoft has begun developing a network of Innovation Centers around the globe as part of strategy to "to foster innovation and growth in local software economies." Hmmm....

I think most people would be at least a little suspicious of Microsoft's intentions in spearheading such an effort. Innovation is inherently a collaborative and not a competitive process. Microsoft claims to be cooperating with governments, universities, and other software companies; while I see no reason to think that they're not doing so, I do believe there are grounds for thinking that Microsoft may understand "cooperation" differently than some of its Innovation Center partners. Microsoft Founder Mr. Gates may or may not have reconnected with his inner philanthropist; it remains the case that Microsoft's behavior and corporate culture during his tenure was profoundly combative and territorial.

Soon every innovation in this neighborhood... will be mine!
(Photo by oddthingies)

A key question private businesses are asking themselves these days is how to capture value generated by an innovation process--how keep the innovation bird happy in its cage, as it were. Innovation, however, doesn't just thrive in an open environment--it arguably cannot even survive unless it can roam freely, build doors in impenetrable walls, outgrow its origins. While people can own innovation processes and products in the looser sense of taking responsibility for them, it's hard to see how anyone can own them in the stricter legal sense. (And I seriously, seriously doubt that Microsoft will be the one to crack this nut; their outlook is too closed.)

And if you've been wondering whether or not the new fixation on innovation is just a passing fad, it isn't. My ex-boss David Smith of the Affordable Housing Institute recently blogged about an April 2007 PNAS paper by Luís M. A. Bettencourt, et al., entitled "Growth, innovation, scaling, and the pace of life in cities." According to Smith, Bettencourt et al. divide all the factors of urban life into three categories:

1. Factors that scale linearly with the city's size, such as number of jobs, water consumption, etc. (Smith calls these "personal matters");
2. Factors that scale sublinearly with the city's size--i.e., those factors that enjoy economies of scale--such as consumption of energy and transportation resources (Smith calls these "hardware");
3. those factors that scale superlinearly with the city's scale--i.e., those factors which enjoy network effects--such as disease rates, innovation rates, and wealth generation (Smith calls these "software," or "social interactions").
   

Wealth is, as Jane Jacobs has noted, an urban phenomenon. But wealth moves hand in hand with innovation--both are superlinear urban effects. Which means that big cities both demand and generate higher rates of innovation and wealth generation. Note that superlinear effects are not merely epiphenomena--that is, it's not just that bigger cities "happen to" generate exponentially more innovation, crime, wealth, and disease. The economies of bigger cities, when they grow (again, as Jacobs has noted), grow on the basis of wealth and innovation. An ever-growing economy producing ever more wealth--the holy grail of Protestant democratic capitalism--both requires and produces ever more innovation. As long as our cities keep getting bigger we will keep getting wealthier and smarter, and innovation will weave itself ever more inextricably into our economies and cultures.

As anyone who's tried to innovate knows, innovation relies upon creativity, and creativity thrives in open systems, open networks, and open minds. It's no wonder that the interests in innovation and social entrepreneurship have developed in parallel, since social entrepreneurs seem willing to perform all kinds of commercial functions without basing their organizations on the pathological greed and egomania which lie at the heart of corporate misbehavior. Greed and egomania are diametrically opposed to the values of generosity and humility which form the basis of every successful culture of innovation.

Corporations today--and Microsoft is no exception--want the wealth that follows on the heels of good innovation, but they can't bring themselves to believe that "proprietary innovation" makes about as much sense as "a happily caged falcon." At bottom, I think it's our whole notion of ownership which needs rethinking. In a sense, after all, wealth belongs to communities (or societies, if you prefer). We just entrust it to corporations and families and individuals in the belief that they will use it responsibly if their personal well-being depends upon its sound management. A pretty smart system, overall. But can we imagine (and design) a better one? Can we imagine (and design) a form of ownership which engenders and protects responsibility, but also resists the excesses of the miser and the tyrant?

Maybe building a better cage means not building a cage at all; maybe it means becoming falconers.
(Photo by wallyg)