From food cart to IPO in 10 years: innovation and “competitive capitalism”

March 12, 2015

In The only thing he ever made fly was government money, a post about the Wright Brothers’ government-backed competitor who failed badly, we wrote that:

The process of productive capital allocation is a critical ingredient of innovation and job growth. Entrepreneurs spending their own (and their partners’) money will create more jobs, more innovation, and a more vibrant economy than politicians picking winners and losers based on cronyism, campaign contributions, and constituent pork.

It is not an automatic process, of course. When $5,000 computers become $500 tablets, and conveniences ranging from steamships to Kodachrome to flip phones are supplanted by better ideas, the resulting surplus capital is not stuffed under plump mattresses – it’s used to fund the next round of businesses and innovations that enhance and enrich all our lives.  Including cheeseburgers.

shakeshack3Kevin D. Williamson points out that Shake Shack has gone from food cart to IPO over a period of time during which McDonald’s has struggled to tread water.  This might surprise some consumers but not likely anyone who’s worked for an archetypal big, faceless corporation (like McDonalds).  Start-ups may lack the economies of scale and R&D budgets of larger firms, but that’s the support venture capital can provide.  Those start-ups that do gain traction are able to raise capital, and, with hard work and a little luck, become large companies… who then face the next generation of start-ups.

Williamson goes on to make a broader defense of “competitive capitalism,” the aggregate effect of which is “indistinguishable from magic.”

(W)e are so used to its bounty that we never stop to notice that no king of old ever enjoyed quarters so comfortable as those found in a Holiday Inn Express, that Andrew Carnegie never had a car as good as a Honda Civic, that Akhenaten never enjoyed such wealth as is found in a Walmart Supercenter.

The irony is that capitalism has achieved through choice and cooperation what the old reds thought they were going to do with bayonets and gulags: It has recruited the most powerful and significant parts of the world’s capital structure into the service of ordinary people

For people who dislike and misunderstand capitalism (or free markets, or laissez-faire, or economic liberalism, or whatever you want to call it), the governing principle of market competition is the “Walmart effect.” According to this model of how the economy works — a model with very little basis in reality, but never mind that — big companies such as Walmart muscle into a market or a territory, use advantages of scale and predatory pricing (“predatory” here meaning “saving consumers money at the expense of relatively well-off business owners”) to drive out so-called mom-and-pop operations, lower workers’ wages, and then make like Scrooge McDuck doing his Greg Louganis impersonation into a mile-high stack of hundred-dollar bills.

Big businesses vs. small businesses, employers vs. employees, factory owners vs. consumers: Every relationship in the marketplace is in this view distorted by power imbalances that almost always work in favor of entrenched business interests that use their relative power to further heighten the advantages they enjoy.

The opposite of the “Walmart effect” understanding of how the economy operates, a view more prevalent among people who like or simply understand capitalism, is the “Bill Gates’s nightmare effect.” Back in 1998, when Microsoft was at the height of its power — it had just become the world’s most valuable company — and Gates was at the height of his prestige, he told Charlie Rose that what worried him wasn’t competition from IBM or Apple or Netscape: “I worry about someone in a garage inventing something that I haven’t thought of.” That was in March of 1998; in September, two guys in a garage in Menlo Park incorporated Google.

Or, as we put it in The dignity of innovation:
It seems paradoxical, but failure is what makes us rich. Well over half of the companies on the 2009 Fortune 500 list began during a recession or bear market. The patents for the Television, Jukebox, and Nylon were granted during The Great Depression. Also born at that time: the chocolate chip cookie, Scrabble and Fender Guitars (kinda). The decline of U.S. Steel was bad for the company’s shareholders and its employees, but it was good for people who use steel — meaning everybody else in the world. Without the pressure and opportunity created by the possibility of failure the entire U.S. economy would be (at best) stuck in the early 19th century.
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