Yearly Archives: 2012

If you can sing (and you can), can you innovate?

Many people firmly believe they “can’t carry a tune” even though studies demonstrate that fewer than 1 percent of the population is literally tone deaf.  For most the ability to become at least competent is a function of practice and confidence.

Lena Groeger writes in Scientific American that:

A study published online in the Journal of Experimental Psychology reinforces scientists’ growing belief that the culprit is not the ear but the throat. In a series of pitch-matching experiments, nonmusicians were pretty good at adjusting an instrument to match a specific note, suggesting that they could hear it just fine. They had much more trouble, however, imitating the same note with their own voice. The authors suspect that poor motor control of vocal muscles is partly to blame—findings that reinforce the idea that almost anyone can learn to sing.

Could the same be true of the ability to innovate?

In a recent article at the HBR blog network, Scott Anthony asks why, with virtually every corporate leader extolling the virtues of innovation, so many companies have so much trouble with it?  In his analysis, the author cites academic research on innovation that parallels the pitch-matching experiment mentioned above.  From Anthony’s The Four Worst Innovation Assassins:

The reflexive response is that it is a human capital problem — that is, that most people just don’t have what it takes to successfully innovate. I reject that view. Academic research in fact shows that almost anyone can become a competent innovator (with sufficient practice). I’ve seen countless examples of ordinary individuals displaying the creativity, ingenuity, and perseverance of the world’s great innovators.

Those people can only be effective in the right context, but, ironically, many of the things leaders do to encourage innovation actually kill it.

Notwithstanding the memorable (if a tad cheeky) categories of “unintentional innovation assassins” (Cowboy, Googlephile, Astronaut, and Pirate), Mr. Anthony draws excellent counter-habits from each of them.

For example, the Pirate’s “plan” for innovation is to “find the money when we need it” – which may sound entrepreneurial but makes it all but impossible to know how to get resources approved.  The best companies “(M)anage innovation in a disciplined manner. They have dedicated budgets for it, with clear rules for how to obtain funding.”

The piece has several good recommendations for how to approach the task of innovation in a structured environment.

Wizards of American medicine, Part II

A little over two years ago in a post entitled The wizards of American medicine we quoted Daniel Henninger’s argument that top-down health care reform would fail due to the “unimaginable complexity” of the system:

According to data compiled by Hoover’s business research from the U.S. Census, the health-care industry consists of 340,650 separate establishments employing 5,508,926 people. I leave it to a mathematician to calculate the number of possible economic relationships this would produce every day, much less annually….
There are 8,616 separate medical-device companies in the U.S., employing 359,065 people. Within the device industry, its two largest categories are electronic and precision equipment and surgical appliances. These are the wizards of American medicine.  The president says the special interests oppose his bill. But to pay for the bill, Congress would levy a $2 billion annual tax on the medical-device industry, which ardently opposes the legislation.

Last week in Improvised Explosive Device Tax the editors of the Wall Street Journal updated the argument with more specifics of the complexity involved with hiding just that one job- and innovation- killing tax:

(C)hanges to the ordinary corporate tax code wouldn’t raise enough money and would have hit many other innocent bystanders in manufacturing. So they chose an excise tax. About the only exemptions are for things that retail consumers buy directly, such as contact lenses or hearing aids.

So for the first time ever, the Internal Revenue Service is now writing rules that will treat some of medicine’s most inventive and complex products the same way it does gas, cigarettes, liquor and wine, guns, airline tickets and tires. Those are the commodities on which the political class normally attaches excise taxes, and the appeal is that the levies are hidden in higher prices, rather than listed separately like a sales tax.  This is somewhat awkward for a law that claims to aspire to make health care more “affordable.”

The device tax is also worse than advertised because it won’t apply to actual sale prices. The industry’s supply chains and distribution networks are idiosyncratic, but different buyers usually pay different prices due to rebates and discounts. The draft IRS rules don’t credit these common business practices and instead apply to the “highest price for which such articles are sold to distributors in the ordinary course of trade” or the “normal method of sales,” as if there is a normal method. So the tax will be assessed on income that device makers never earn.

Naturally the businesses involved will cope with the taxes by cutting their costs (personnel, R&D) or raising prices… if it were allowed:

All of this has already touched off a wild lobbying rumpus. Many providers including all the major hospital trade groups are asking the IRS to prohibit the device makers from “passing the tax to their customers, including some hospitals” by certifying on their tax statement that they haven’t.

They want civil and even criminal penalties for false claims, though how this could be proven is anyone’s guess. Perhaps the Bureau of Alcohol, Tobacco and Firearms—which does most excise-tax enforcement against bootleg smokes and rum running—should be dispatched to the device-company hubs of Boston and Minneapolis.

The providers will also be hurt from the device tax because of something they don’t like to mention, which is the government’s price controls. Medicare and Medicaid pay fixed rates per procedure, such as replacing a hip, and the rates don’t change when device prices do. So a hospital that must buy a higher-cost joint due to the device tax will have a smaller share of the reimbursement.

Fortunately, bi-partisan support to repeal the tax is growing:

Minnesota Republican Erik Paulsen’s device tax repeal bill has 238 cosponsors, including a dozen Democrats. Speaking of which, Elizabeth Warren isn’t the only apostate. Al Franken (D., Medtronic) says in a statement that “there were better ways to pay for health reform” and that he will be “fighting hard to continue to further reduce the unfair burden.”

Device tax repeal is on the docket when Congress returns from Memorial Day and maybe the most important consideration is the drag on U.S. competitiveness. Europe, Israel and Asia are working aggressively to overtake the American lead in the life sciences, which include emerging breakthroughs like tissue engineering, nanotechnology to fix individual cells and gene-based diagnostics. The rest of the world is looking on agog as Washington rushes to impose this tax.

Stupid experimentation

Guest-blogging at The Atlantic, Jim Manzi (author of Uncontrolled: The Surprising Payoff of Trial-and-Error for Business, Politics and Society) writes about the role trial and error plays in innovation.

From Hayek Was Right – Why Cloud Computing Proves the Power of Markets:

Many things about our company turned out differently than we had expected…  The Hayekian knowledge problem is not a mere abstraction.  Our innovations that have driven the greatest economic value uniformly arose from iterative collaboration between ourselves and our customers to find new solutions to hard problems.  Neither thinking through a chain of logic in a conference room, nor simply “listening to our customers,” nor taking guidance from analysts distant from the actual problem ever did this.  External analysis can be useful for rapidly coming up to speed on an unfamiliar topic, or for understanding a relatively static business environment.  But at the creative frontier of the economy, and at the moment of innovation, insight is inseparable from action.  Only later do analysts look back, observe what happened, and seek to collate this into categories, abstractions and patterns.

More generally, innovation appears to be built upon the kind of trial-and-error learning mediated by markets.  It requires that we allow people to do things that seem stupid to most informed observers — even though we know that most of these would-be innovators will in fact fail.  This is premised on epistemic humility.  We should not unduly restrain experimentation, because we are not sure we are right about very much.

Manzi touches on several of our favorite themes:  iterative collaboration, how to fail the right way, the incremental, adaptive ways by which success is achieved, and even the role of luck – although we’ve described it a bit more favorably as “serendipity.”  Serendipity is the province of the happy accident and relies on inefficiency.  There’s an “optimal degree of wastefulness” in any creative endeavor in which the mind wanders and activity can seem directionless.  Watching or even playing with mistakes is productive and exciting because you notice unexpected things.

Saras Sarasvathy, a professor at the Darden School of Business, teaches that great entrepreneurs thrive on contingency and improvise their way to an outcome that only feels ordained in retrospect.  She likens them to Iron Chefs, “at their best when presented with an assortment of motley ingredients and challenged to whip up whatever dish expediency and imagination suggest.”  Trial and error, in her view, gets the best results when it includes an “almost anthropological approach” to customer interaction, actually working alongside them.

 

 

 

Integrity is more than a virtue

The May edition of HBS Working Knowledge features an ambitious research paper by Werner Erhard and Michael C. Jensen entitled Putting Integrity into Finance: A Purely Positive Approach.”  The authors strive at length to define “a purely positive theory of integrity that has no normative elements whatsoever” and to demonstrate how it applies to both individuals and organizations. They draw from behavioral economics and behavioral finance to argue that organizations operate counter to their long-term self interest by systematically engaging in “out-of-integrity” behavior, due in part to the way integrity has been historically (mis)framed.

If integrity is viewed as merely a virtue, the temptation to sacrifice it for short-term gain can be great:

For many people, virtue is valued only to the degree that it engenders the admiration of others, and as such it is easily sacrificed especially when it would not be noticed or can be rationalized. Sacrificing integrity as a virtue seems no different than sacrificing courteousness, or new sinks in the men’s room.

Properly understood, integrity is more than a virtue.  It’s a necessary (though not sufficient – companies also need competitive, organizational, technological and human strategies) condition for value maximization:

In effect, integrity is a factor of production just like knowledge, technology, labor and capital, but it is undistinguished – and its affect (by its presence or absence) is huge. Integrity matters. Not because it is virtuous, but because it creates workability.  And workability increases the opportunity for performance, and maximum workability is necessary for realizing maximum value.

Erhard and Jensen build their case and explain their terms:  personal integrity is (broadly speaking) “honoring one’s word,” while an entity or system has integrity when it is “whole, complete and stable.”  (I.e., its design is capable of producing the intended result, its implementation is faithful to the design, and its use is consistent with the design’s purpose.)  To illustrate what they mean by workability – “the bridge connecting integrity to value creation” – they describe a wheel with missing spokes: “It is not whole, complete and stable. It will become out-of-round, work less well and eventually stop working entirely.”

All this applies to an organization as well as human beings. An organization or system is in integrity when it is whole and complete. This means it honors its word, both to its employees and to its customers, suppliers and other stakeholders. This means nothing is hidden, no deception, no untruths, no violation of contracts or property rights, etc. And if the organization refuses to play by any of the rules of the game it is in, integrity requires it to make this clear to all others and to willingly bear the costs of not playing by one or more of the rules of the game.

This line of thinking resonates with something we argued two years ago in When Business Promotes Honesty.  Quoting sometime guest blogger Will Harrell (founding partner of Capco Asset Management in Tampa), we wrote:

The upside from being perceived as a reliable, consistent, trustworthy, &etc. vendor of certain kinds of goods and services is simply huge. Costco’s CEO has a line I love: “No easy hits on the customer.” Honesty is just a sub-category of this thesis, which in many cases has more to do with product quality or user experience than honesty per se: McDonald’s consistency, the taste of a Hershey bar, etc. It’s also not limited to customers – similar considerations apply to suppliers, capital sources, and employees.

The paper is thought-provoking, as one would expect from these authors.  Our own less scholarly endorsement of the business case for honesty (the moral case is another discussion) rests on the near-universal desire for repeat business.  While a short-term advantage in a single transaction might be gained by jettisoning the “virtue” of integrity, honesty and consistency are critical to success over the long term.  We also put a premium on transparency, as it’s easier to remember the importance of being honest when everyone involved in a business relationship can observe how decisions are being made.

We’ll close with one final thought, one which we made in that same piece two years ago:  there’s a good argument to be made that businessmen are more honest (or less dishonest) in their dealings than preachers, politicians, and professors.  Dwight R. Lee makes the case over at The Independent Review:

Businessmen interested in long-run survival are more honest in their professional dealings than are many other groups in society—not because they are more virtuous, but because they face more effective constraints. Their customers can usually detect and avoid deception more easily than can a politician’s constituents, a professor’s students, and a preacher’s congregants. …It turns out that, because most businesses are profitable only by earning the patronage of returning customers, they have stronger incentives to be truthful than do preachers (“no one can ‘test drive’ a preacher’s most important promise,” Lee observes), politicians (for whom elections are sporadic and often predetermined by gerrymandering and other devices), or professors (whose customers, the students, “often do not care much about the honesty of the professors’ claims”).

 

 

Southeast dominates CEOs Top 10

For the eighth consecutive year, Texas has been voted the best state for business by Chief Executive magazine. 

The Top 10 looks familiar to us, as it constitutes most of the geography in which we have focused our investment efforts for over twenty years now, and adds to the growing list of evidence that some states understand job creation better than others.  The 2012 edition of their annual survey of CEOs includes a feature on What Keeps Texas on Top:

The state is growing its own companies but also is displaying remarkable success in luring investments from other states, particularly California, which once again ranks last in our survey. A raft of small, technology companies have either relocated to Texas or moved key operations there.  Bigger California companies, such as Facebook, eBay and PetCo also have recently opened operations in Texas, and major manufacturers from different states, such as General Electric’s transportation unit and Caterpillar have located big new plants in Fort Worth and Victoria, respectively.  “Employers from around the nation and all over the world continue to look to Texas as the premier location for business expansion, relocation and job growth thanks to our low taxes, reasonable and predictable regulations, fair legal system and skilled workforce,” Gov. Rick Perry told Chief Executive.

Texas has powerful momentum and it’s difficult to see what could halt it…  The sheer diversification in its economy—all the way from wheat farming to semiconductors—suggests that the state could absorb many punches and keep on rolling.

The VC industry is in good shape

Writing at Forbes, Todd Hixon reports on indicators which suggest the venture capital industry is in good shape:

  • Entrepreneurial innovation has picked up over the last five years.
  • Exits are back in both quantity and quality, and should be aided by the JOBS Act.  
  • New software methods have shrunk the cost of starting a software company. 

The article seems written from a little bit of a East- or West- coast perspective, and perhaps with a slight early-stage tech bias.  Our business model is not dependent on the IPO market and is diversified both geographically and across several sectors, so we still enjoyed an increase in deal flow throughout the “down” decade Hixon contemplates.  But it’s still good to hear our industry has rebounded.  Here’s Hixon:

Venture capital returns took a huge hit in 2001-2003, when the tech bubble collapsed — investors lost 40% in two years. Since then the industry has been recovering, and the severe 2008-2009 financial crisis produced only a small dip. Absent the financial crisis, returns have been in the 12%-16% range.

Half the supply of venture capital has disappeared since 2006. The cost of starting businesses is way down. Exits have rebounded, and the “IPO On-Ramp” provisions of the JOBS Act promise further upside. Fundamentally, the prospects for Venture Capital investment look very bright.

 

 

How to recruit a Board of Directors

While the “owners” of public companies often get to pick their board members more in theory than in practice, owners of private companies get to pick both their investors and their board members. Choosing partners who best fit over the long term requires as much rigor and thoughtfulness as any decision an entrepreneur makes.

Many small private companies have no or underdeveloped boards.  We encourage all our portfolio companies to build great boards and then use them constantly.  Entrepreneurs are almost always surprised how much value a good board can bring to their companies, and the best boards are a function of both the quality of the people involved and, just as importantly, how they operate.

Here we share two recent items on the subject of board recruitment – one that deals with the topic in broad terms and one that looks specifically at recruiting “digital” directors.

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In Recruiting the Digital Director, Julie Hembrock Daum, Greg Sedlock and Dana Wade of Spencer Stuart discuss the implications social media’s growth has for the recruiting process.  Demand for digital expertise at the board level is rising faster than the supply of qualified candidates, who can come from nontraditional backgrounds.  Boards may have to recalibrate their perceptions about what an ideal director looks like, define what digital means for the company, and understand the talent trade-offs:

Recruiting board directors from the digital, consumer Internet or technology fields may mean compromising on conventional benchmarks, such as prior board experience or international expertise, in favor of more contemporary skill-sets, for example, experience with social media platforms or digital advertising. Additionally, boards should understand that directors with digital expertise may not have achieved the same stature as candidates from more traditional fields; many of these candidates have not reached the C-level, for example. These young, ambitious and, oftentimes, time-starved executives can be more transient than more established executives, and they may be less familiar with the customs of a corporate boardroom.

Several questions during the recruiting process must be explored.  Is public or private experience critical?  How relevant is governance expertise?  What core competencies does the board require? Are they seeking broad experience or something specific to a hot technology of the day?  And then, once recruited, the new director must be positioned for success:

(C)arefully define the role that the new director is expected to play on the board. Is the new director expected to contribute in the same manner as other directors, or is there a digital-specific function he or she is expected to fill? Is the new director expected to chair a committee? Answering these questions is important when recruiting any new director, but especially [for digital directors].

***

Firas Raouf of OpenView Partners makes parallel recommendations, with a broader view, in How to Recruit a Board of Directors:

Recruiting a board starts by you realizing that you should recruit a board the way you would recruit employees. Start by defining your needs.  One approach is to examine your skill sets as a founder/CEO… Then think about the skill sets you lack and where a mentor could help in the role of a board member… Then think about your plans for growing the company and the role of a board member in opening strategic partnership doors, whether for funding or business development.

Rauof also describes a few symptoms associated with a bad board:

  • The CEO frequently laments that board meetings take up too much of time for the value added
  • The CEO feels the urge to hide things from them, and/or doesn’t think they’d understand the business
  • Members spend too much time between projects. When you run out of things for them to do, it’s time to recruit their replacements.

Most founders/CEOs think that a board is something that creates a lot of unnecessary work for them, adds little value, and is manned by individuals who will get in the way of running the company.  That can be true if you recruit bad board members. But if you recruit great board members, you will get great value.

 

Pitfalls of entrepreneurship, ecosystems of innovation

Two new books recently landed on our desks, on two different subjects:  the pitfalls of entrepreneurship and the ecosystem of innovation.  We’ll consider them for The Library in St.Pete, but in the meantime the reviews were interesting enough to merit spilling some ink here.

The Founder’s Dilemmas, by Harvard Business School professor Noam Wasserman, compiles 10 years’ worth of studies of 3,600 start-ups (and nearly 10,000 founders) to examine the pitfalls of entrepreneurship:

People are motivated by high-profile stories of hugely successful entrepreneurs, but the truth is that it’s very hard to become one.  The “ultimate” entrepreneur combines someone who’s passionate and has a strong vision that they pursue single-mindedly with someone who is analytical and looks down the road and wants to understand the pitfalls along the way before they make early decisions that will get them in trouble.  [It’s a hard combination to strike.]  My mission is to inform entrepreneurs about key lessons based on data, rather than merely what’s anecdotally “known,” so they don’t have to learn the hard way and they don’t get burned by anecdotes that capture the wrong lessons.

In one review, Professor Wasserman is asked, in light of this analysis – the rare combination of skills required to succeed – whether or not co-founders make sense:

You have to judge founder by founder, and idea by idea. Some ideas lend themselves to one person being able to tackle it. Others that are more complex require disparate skills, and to maximize success you need things that you don’t have. Some founders who’ve accumulated work experience in the industry and are able to manage multiple functions, and whose goals and personalities fit with being solo, might be better off alone than a founder with big holes [in his experience] who will open himself up to much bigger risks if he doesn’t fill them.

Irrespective of how many founders are involved in the idea’s germination, growing the acorn into a mighty oak is a long-term project that will eventually include adding partners who share the vision and can bring additional resources – financial, expert, and network – to bear.  Choosing partners who best fit requires as much rigor and thoughtfulness as any decision an entrepreneur makes.

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The Wide Lens, by Tuck School of Business professor Ron Adner, explores the “business ecosystem” – distributors, retailers, and salespeople – critical to the launch of any successful innovation.  Adner recounts successes (Apple’s path to market dominance), monumental failures (Michelin’s run-flat tires or Pfizer’s inhalable insulin), and works-in-progress (electric cars or electronic health records).

Companies understood how their success depends on meeting the needs of their end customers, delivering great innovation, and beating the competition; but [they fell] victim to the innovator’s blind spot: failing to see how their success also depended on partners who themselves would need to innovate and agree to adapt in order for their efforts to succeed…  To be sure, great customer insight and execution remain vital, [but] two distinct risks now take center stage:

  • Co-Innovation Risk: The extent to which the success of your innovation depends on the successful commercialization of other innovations.
  • Adoption Chain Risk: The extent to which partners will need to adopt your innovation before end consumers have a chance to assess the full value proposition.

When you try to break out of the mold of incremental innovation, ecosystem challenges are likely to arise… a strategy that does not properly account for the external dependencies on which its success hinges does not make those dependencies disappear.  It just means that you will not see them until it is too late. … Dependence is not becoming more visible, but it is becoming more pervasive. What you don’t see can kill you.

Adner provides an easy-to-grasp example in an excerpt printed in The Atlantic:  the first portable digital audio player (1998), cleverly (?) named “MPMan”:

It sold 50,000 players globally in its first year. But [it was very different than the Walkman] 20 years earlier.  You couldn’t purchase them in traditional retail settings.  Downloading an album – legally or not – could be a multi-hour affair. It didn’t matter that MPMan was first – it wouldn’t have mattered if they were 6th, 23rd, or 42nd. Without the widespread availability of mp3s and broadband, the value proposition could not come together.

As we reported in The 10 rules of entrepreneurship, the best products don’t always win.  Compelling innovations can and do fail after launch – as did this precursor to Facebook.  It’s a long and difficult journey from idea to successful business, involving many inter-related factors.

The eternal sunshine of an entrepreneur’s mind

Evaluating investment opportunities is not for the weak at heart, not only because trend-spotting is tough and IP difficult to protect but also because of the sometimes mercurial nature of The Great Entrepreneur.  It’s not always so simple to plumb the depths of those original minds that see meaningful combinations where others do not and have abnormal levels of optimism.

Scott Anthony, writing at the Harvard Business Review Blog Network  gets at the nature of the thing – and coins a great phrase – when he advises not to confuse passion with competence:

When I’m evaluating entrepreneurs and their ideas, I look for “innovation bipolarity,” a version of F. Scott Fitzgerald’s first-rate intelligence: “the ability to hold two opposed ideas in the mind at the same time and still retain the ability to function.” Entrepreneurs should be able to argue passionately that their idea will change the world, and then, without skipping a beat, honestly assess the risks standing in the way of its success and describe what they are doing to mitigate them.

Of course, there are examples of dogmatism and fanaticism triumphing in the face of healthy skepticism. But that’s not a scalable approach to innovation.

Mr. Anthony’s “psychoanalytical” recommendation ties in nicely with the “genetic” markers identified by Dyer/Gregersen/Christensen in their double helix analogy from The Innovator’s DNA

Innovative entrepreneurs have something called creative intelligence, which enables discovery yet differs from other types of intelligence (as suggested by Howard Gardner’s theory of multiple intelligences).  It is more than the cognitive skill of being right-brained. Innovators engage both sides of the brain as they leverage the five discovery skills to create new ideas.  In thinking about how these skills work together, we’ve found it useful to apply the metaphor of DNA. Associating is like the backbone structure of DNA’s double helix; four patterns of action (questioning, observing, experimenting, and networking) wind around this backbone, helping to cultivate new insights.  And just as each person’s physical DNA is unique, each individual we studied had a unique innovator’s DNA for generating breakthrough business ideas.

In our experience, the entrepreneurs who make it from garage to funding to successful high-growth company display another type of bipolarity: the ability to reason causally and effectually.    Saras Sarasvathy, professor at the Darden School of Business, likens great entrepreneurs to Iron Chefs,  “at their best when presented with an assortment of motley ingredients and challenged to whip up whatever dish expediency and imagination suggest” (effectual reasoning), while successful corporate executives “set a goal and diligently seek the best ways to achieve it” (causal).

Different authors, different analogies, but on the same quest:  to capture the eternal sunshine of an entrepreneur’s mind.

What is StartupBus?

Wired describes it as:
 
Part road trip, part code jam, the annual competition plunges participants, known as “buspreneurs,” into two days of frantic business development on the open road to the South by Southwest conference  in Austin, Texas.”
 
What started in 2010 with one bus driving from Silicon Valley to Austin for the SXSW conference has grown into a 10-city competition to arrive in Texas with the best idea and compete for early-stage funding from a board of potential investors.  

BumperCrop

This year Tampa has its own bus in the competition, and one of the teams on the bus includes former BPV intern Doug Smith.  You can read about Tampa’s entry at examiner.com, and you can check out Inc‘s write-up from last year’s event.  Doug will be tweeting his team’s progress at @_BumperCrop, their entry that “helps local small-scale farmers and home-growers connect to local consumers to easily share and exchange their excess crops.”  You can also check out their project site BumperCrop.com, or follow @StartupBusFL for our state’s other competitors.  StartupBus.com provides real-time comprehensive coverage of the entire competition.

Best of luck to Doug and all his fellow Floridians!  We look forward to reporting back on your success.
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