Recently someone compared me to a bomb throwing revolutionary. I thought that was a bit overstated. I merely believe that we should be in a constant state of improvement, even if we are working on an impossible problem. Frequently I believe that reducing the scope of government is a productive part of innovation. A few thoughts related to these themes:
Spirituality is reaching an understanding that life is iterative
Constructive anarchy is replacing government with an egalitatian populism
Network theory says that large well organized networks do not need dominant nodes
Do not fan the fire but take a new approach
Increasingly I believe that we can form a new social contract using the technology available to transfer increased decision making authority to the individual. Rather than "fan the fire" or fight the status quo we should use the technology to avoid the current nodes of power and explore alternative approaches at the individual level. Everyone acknowledges that the current paradigm shift in technology will have profound economic and social changes, but we should not overlook the chance to change the political system.
[This article was influenced by ideas that have existed for thousands of years.]
This year's reading list is shaped in part by a new course I want to teach, "Cognition, Neuroscience and Artificial Intelligence". Also, I am still trying to answer some questions for a new book on market opportunities. All of this is increasingly tied together by my growing interest in evolution and biology. For several years I have told my students to think like ants. Now I have enough background to defend the position.
The recommended readings are:
"The Master Algorithm" by Pedro Domingos The book is a history of artificial intelligence with a focus on machine learning (no math). The notion of a master algorithm that can create all knowledge is a very interesting idea.
"Money Changes Everything" by William Goetzmann A history of money. Should be the first reading in every introductory finance class.
"Our Mathematical Universe" by Max Tegmark Reconsiders the age old question of what is reality.
"The Invention of Nature"by Andrea Wulf A biography of the first naturalist scientist--Alexander von Humboldt
"The Evolution of Everything"by Matt Ridley Questions many traditional explanations of issues and shows that evolution is a better explanation
"The Pre-history of the Mind" by Steven Mithen Scholarly work on the cognitive origins of art, religion and science.
Overheard on the street, "I buy my eyeglass frames at Goodwill and then have the lenses custom made". Looks like a great example of functional fixedness overcome and re-using materials.
It looks like more and more people are combining communities with marketplaces as a way to address a social problem in an economically self-sustaining way. Etsy maybe comes close to this idea, but I expect the community to drive the traffic to the marketplace and not the suppliers.
I find it interesting that there is a significant percentage of the viewers of my TEDx talk on poverty who watch it multiple times. Not sure what it means but it intrigues me.
U.S. is in the midst of a food craze. People have to stop talking to me about their food ideas. Nobody yet appears to know how to get an incubator off the ground.
The best young entrepreneurs I see in Miami are women. Not sure we need to focus on helping women start companies, but I understand that "woman entrepreneurship" is a way to differentiate an incubator or accelerator.
Much has been written about entrepreneurship, but the beginning of the process is the least explored and described. In fact, little has been written to describe how one identifies the business opportunity, which sets the theoretical size for the business. I have been thinking quite a lot about opportunities in what will be my third book on entrepreneurship and have identified ten types of opportunities that have repeated throughout history and have always been large "new" markets. The overall framework of such market opportunities falls into three categories:
Human values
Neuroscience (think Kahneman)
Complexity
The reader should note that each category of opportunity represents a basic, almost primitive, understanding of human beings.
What follows is an early draft of a chapter on networks that comes from the section on complexity. I would appreciate any comments, including by email.
"Chapter IX—Networks
“So in the future, ideas will be the real scarce inputs in the world - scarcer than both labor and capital - and the few who provide good ideas will reap huge reward”
The Second Machine Age Brynjolfsson and McAfee
In the last chapter we learned that complex human systems, such as social and economic systems, are non-deterministic, adaptive, self-organizing systems that process and store information. The dynamic tension between exploration and exploitation makes a complex system adaptive. The behavior that cannot be ascribed to any individual part of the leaderless system is the emergent quality of complex systems, which is more easily understood in the context of networks, which are the subject of this chapter.
One classic example of complex systems in both biological and human systems is networks. The term network refers to the framework of routes within a system of nodes. A route is a single link that can be tangible or intangible between two nodes. Networks can be physically constrained, such as transportation systems, or non-spatial, such as certain social and economic systems.
Examples of networks and their role in the history of economic development is shown in this quote from Jean-Paul Rodrigue and Cesar Ducruet’s article, “The Geography of Transportation Networks”:
“Transportation networks have always been a tool for spatial cohesion and occupation. The Roman and Chinese empires relied on transportation networks to control their respective territories, mainly to collect taxes and move commodities and military forces. During the colonial era, maritime networks became a significant tool of trade, exploitation and political control, which was later on expanded by the development of modern transportation networks within colonies. In the 19th century, transportation networks also became a tool of nation building and political control. For instance, the extension of railways in the American hinterland had the purpose to organize the territory, extend settlements and distribute resources to new markets. In the 20th century, road and highways systems (such as the Interstate system in the United States and the autobahn in Germany) were built to reinforce this purpose. In the later part of the 20th century, air transportation networks played a significant role in weaving the global economy. For the early 21st century, telecommunication networks have become means of spatial cohesion and interactions abiding well to the requirements of global supply chains.”
Carlota Perez is a history of economics scholar who has devoted much of her research and analysis to understanding paradigm shifts or more simply put—technological revolutions. In a paper in 2004, “Finance and Technical Change: A-Neo-Schumpeterian Perspective”, she includes a graphic, shown below, that traces each of the major technological revolutions, starting with the Industrial Revolution in 1771. [graphic omitted]
If one examines each example of the “New or Redefined Infrastructures” (Column 3 above), almost every example is a network. If one accepts Perez’s analysis, this graphic clearly demonstrates the role of networks in the history of economic development and by extension in entrepreneurship. (Perez’s analysis shows all the network examples as infrastructure. The other common form of economic or social networks is a marketplace, which we discuss in the next Chapter.)
When one considers an explanation for the close link between paradigm shifts and networks, traditional economic considerations of production, distribution and consumption provide me with no insight. However, if we return to the insights of Ronald Coase, we see economic activity in a less traditional way as a combination of property rights [information], arrangements for collective choice [collaboration/feedback] and contracts for motivating managers and employees [social exchange/signaling]. [Footnote: Coase paper] Stepping back, what one realizes about economic networks is the efficiency a network provides. Networks provide connectivity, communication, operations and management, all in a self-organizing mechanism for information. Networks are nature’s answer to the Swiss Army knife.
Networks are such a “popular” and versatile mechanism for four reasons:
Networks lower the cost of searching for information
Networks lower the cost of verifying information
Networks lower the cost of processing and storing information
Networks lower the friction in exchanging information
Economic and social networks achieve these benefits in part through trust amongst participants, which we discussed in Chapter I. The further disclosure and transfer of information within the network builds the trust and fosters the organizing, processing and archiving of information. Trust also lowers transaction costs, thereby facilitating the construction of larger networks.
Herbert Simon writing on hierarchies [networks] cites three reasons why they are so common [Footnote: Simon 1962]:
Networks facilitate the formation of complex systems (see Metcalf’e’s Law below)
Networks have direct channels of communication (connectivity)
Networks are naturally redundant (lower transaction cost)
Strengthening the versatility of networks is Metcalfe’s Law, which says that networks follow a scale-free power-law distribution. (Every additional node in a network increases the value of the network.) As Albert-L´aszl´o Barab´asi explains it, “This feature [power law] was found to be a consequence of two generic mechanisms: (i) networks expand continuously by the addition of new vertices [nodes], and (ii) new vertices attach preferentially to sites that are already well connected. A model based on these two ingredients reproduces the observed stationary scale-free distributions, which indicates that the development of large networks is governed by robust self-organizing phenomena that go beyond the particulars of the individual systems.” [Footnote: “Emergence of Scaling in Random Networks”]
Mitchell makes an interesting point about the size of networks:
“Self-regulation in complex adaptive systems continually adjusts probabilities of where the components should move, what actions they should take, and, as a result, how deeply to explore particular pathways in these large spaces.” [Footnote: Mitchell, Melanie (2009-03-02). Complexity: A Guided Tour (Kindle Locations 2952-2953). Oxford University Press. Kindle Edition]
Mitchell’s probabilities, what might in the vernacular be called uncertainties, are discussed in more detail by JK Galbraith:
"the greater the uncertainty of the task, the greater the amount of information that must be processed between decision makers during the execution of the task to get a given level of performance".
This rather simple observation explains the evolution of “organizations”, which is the subject of the next chapter, and leads to two observations:
In small, resource constrained networks there is usually a large node or organization that dominates
In large networks the need for a large, dominant node is reduced (because of the distributed information processing power)
This relationship between network and the number of organizations [node] explains why early U.S. colonies required a federal government. Conversely, with today’s large, global, interconnected networks, perhaps we can downsize federal government in the U.S.
The relationship between networks and entrepreneurship is only now emerging, mostly due to the growing fields of information theory and complexity economics. However, in some ways the practitioners are ahead of the academics in their understanding of this relationship. Notable venture capitalist Fred Wilson of Union Square Ventures sees the establishment of a network as a competitive advantage that prevents competition from entering a market. Peter Thiel of PayPal fame recommends that startups go after small markets where dense networks can be created. (Giulio Tononi’s Integrated Information Theory uses “dense network” as a measure of how much more a system is than the union of its parts.) Thiel sees networks as a mechanism to achieve monopoly, his preferred position in any market. Facebook’s eclipse of MySpace shows, however, that networks are not a panacea or invincible business model, An even better example of the network model is Google. Google’s search algorithm targeted nodes with a large number of connecting links, just what Barab´asi explained about networks when he said, “new vertices attach preferentially to sites that are already well connected”. The insight here is that the Google algorithm followed the pure theory of power laws and networks and the opportunity proved to be quite large. Google’s approach also used autocatalysis, a characteristic of some complex systems, where the product of the search reinforced the importance of the information in future searches
Academic research has shown that companies using the network business model create more shareholder value. In an HBR article, “What Airbnb, Uber and Alibaba have in Common” [Footnote: https://hbr.org/2014/11/what-airbnb-uber-and-alibaba-have-in-common], the authors analyzed companies in the S&P 500 over a forty-year period starting in 1972. Companies were categorized as one of four types:
Asset Builders
Service Providers
Technology Creators
Network Orchestrators
Companies that were network orchestrators showed “higher valuations relative to their revenue, faster growth, and larger profit margins”. The researchers also discovered that only five percent of S&P companies are network orchestrators. The authors explain the value creation, “We believe this occurs because the value creation performed by the network on behalf of the organization reduces the company’s marginal cost, as described in Jeremy Rifkin’s The Zero Marginal Cost Society.” Looking for a more network-oriented explanation, I would think that the scarcity of network operators perhaps shows the challenge of successfully building and sustaining a network model. The efficiency of network value creation perhaps demonstrates Michael Porter’s findings that the competitive advantage [in successfully building and sustaining a network] is a key requirement for extraordinary value creation.
As we look to the future and the market opportunity offered from our understanding of networks, “The Second Machine Age” perhaps provides some guidance:
“The winners are no longer those able to compete solely based on cheap labor or ordinary capital, both of which are being squeezed by automation. … Fortune will instead favor a third group: those who can innovate and create new products, services, and business models. … So in the future, ideas will be the real scarce inputs in the world - scarcer than both labor and capital - and the few who provide good ideas will reap huge rewards.”
The Manifesto 15 Handbook discusses a new pedagogy, but I believe it can be generalized to show a type of market opportunity:
“Our traversals across networks are our pathways to learning, and as the network expands, so does our learning. In connectivist approaches to learning, we connect our individual knowledges together to create new understandings. We share our experiences, and create new (social) knowledge as a result. We must center on the ability of individuals to navigate this space and make connections on their own, discovering how their unique knowledge and talents can be contextualized to solve new problems.”
Scientists have long believed in the power of networks to foster research and learning. The Royal Society in England was founded in 1660 to support understanding in science. My point here is not to foster the further development of learned societies but rather to show that scientists have viewed the world in a similar way to The Second Machine Age since 1660. The opportunities suggested to me by this expanded networking include increased outsourcing, more hands-on learning between masters and apprentices and more tools for curating information.
One of the most interesting and difficult to understand parts of complex systems is that all complex systems are emergent. Before proceeding further, we should heed Melanie Mitchell’s warning that what do not understand about a complex system is not necessarily an emergent characteristic. Emergent properties are characteristics or behaviors that cannot be explained by the leaderless system of independent variables. Some scholars explain consciousness as an emergent property. Others explain sexual desire as an emergent property. Facebook perhaps demonstrates an interesting emergent property of some networks. A report by the international audit and consulting firm Deloitteestimates that the economic impact of Facebook on a global basis in 2014 was [Footnote:http://www2.deloitte.com/content/dam/Deloitte/uk/Documents/technology-media-telecommunications/deloitte-uk-global-economic-impact-of-facebook.pdf] $227 billion, of which $29 billion was attributable to “platform effect”—third party apps and services that attached to the Facebook infrastructure. I believe that “platform effect” is an emergent quality that enriches both the original network and the third party extension. Another example of an emergent characteristic might be many authors joining a network of book readers where they can interact directly with the readers. Readmill, acquired by Dropbox in 2014, offered this feature. Perhaps the advertising revenue model of Google search is another example of a successful network with an identifiable emergent characteristic. Perhaps a greater focus on the emergent characteristic would have enabled Readmill to survive as a standalone company. Building networks to foster symbiotic emergent characteristics such as platform effect may be a large market opportunity. The platform effect at both Google and Facebook was an after thought, as would be expected based on complexity theory, but in fact a key to success in both cases. At Google it provided the means to monetize search and at Facebook it accelerated the network effect for Facebook (and probably drew the world’s attention to social media). A business based on a network without an emergent characteristic is by definition a failure as a network. Fostering emergent qualities in networks should be a big opportunity given that the number of potential networks will only increase with the proliferation of digital technology. Such opportunities could involve network design or perhaps services to encourage the emergent characteristic.
Another interesting opportunity related to the network effect is Bitcoin and the underlying Blockchain infrastructure. Originally I was totally enamored of the idea that Bitcoin would replace government as the monetary authority by eliminating the need for government–issued currency. (The notion of eliminating government control of monetary affairs is almost irresistible.) With more thought on the subject I think Blockchain is a potentially bigger opportunity. Blockchain allows the members of a network to collectively authenticate data, replacing the role of a central authority. The MIT Media Lab Enigma project, according to Fast Company, uses the Blockchain technology to “enable a marketplace where users can sell the rights to use encrypted data in bulk computations and statistics without giving raw access to the underlying data itself”. For example, personal health record data could be shared without revealing individual identities. Effectively the Blockchain technology creates trust, verifies the data and reduces the cost to a network of processing information. With the increased size, versatility and resources of current networks with support from Blockchain, perhaps the biggest opportunity should be to use the newfound power of networks to replace government.
Note: The Edward Snowden affair may demonstrate that we have more confidence in Google than the U.S. government, these two being the largest collectors in the world of personal information. Now if we could only convince the Communist party in China and the Republicans and Democrats in the U.S. to go along, we could let individuals combined with network and AI technology manage global affairs. Ever the idealist!
The last opportunity that may emerge is in services to networks. For example, a university wants to start offering educational tours in Africa to alumni as a means to add value to the alumni network (and hopefully increase donations). The university will need a wide range of services to execute a strategy outside classroom education. Another example comes from Blackrock, the asset management behemoth. Any company that Blackrock invests in can purchase travel through Blackrock’s travel supplier[s] and take advantage of the volume discounts. An interesting example comes from my hometown Miami Marlins. They have created a network to share business between their corporate ticket holders. Both Blackrock and the Marlins need services for the network to exploit this additional opportunity to create value. As network becomes a better understood method to add value to an existing business model, the need for network services should increase."
For the last six years I have taught at MIT Sloan School of Management in January. Always the theme of the course is social entrepreneurship. Over the years the emphasis on entrepreneurship and scalability has increased and the thought of the government as a partner is now discouraged. My version of social entrepreneurship--"using entrepreneurship to solve a social problem" ........is probably toward one end of the range of definitions of social entrepreneurship. However, it appears the students appreciate the simplicity of approaching the social problem as simply a new business venture. I think they find it simpler than wrestling with the hundreds of social issues that one might consider in other approaches.
So what did I learn:
Students no longer are just trying to understand what social entrepreneurship is but rather are looking for tools that they can apply to their own social ventures
Students are coming to realize that a business can relax the profit constraint in order to share value with customers, suppliers, employees and other stakeholders. Milton Friedman's "maximize shareholder wealth" was a formidable obstacle but it looks like capitalism may be mellowing to consider a wider group of beneficiaries. (According to a 2011 Harvard study of 180 large U.S. companies, the stock price of companies with robust [Corporate Social Responsibility] programs outperformed those with a low CSR commitment by 65 percent over an 18-year period (1992-2010.)
Talking about social entrepreneurship in terms of business model appears to help the creativity of the students. Breaking the business down into parts makes it easier to see opportunities for innovation and value creation.
We can teach entrepreneurship to younger and younger students. The undergrad students in my class had no business background and did just as well as the graduate students.
This post reflects some of my thinking for a new book on a framework to identify the large market opportunities that have consistently repeated themselves over the last 4000 years.
"The last 40 years have seen an explosive adoption of new technologies (social media, telecom, life sciences, etc.) and the emergence of new industries, markets and customers. Not only are the number of new technologies and entrants growing, but also increasing is the rate at which technology is disrupting existing companies. As a result, while companies are facing continuous disruption, current corporate organizational strategies and structures have failed to keep pace with the rapid pace of innovation."
Much of the article is devoted to the evolution of organization structure as technology fostered changes in society. Small family firms evolved into specialized corporations that then became geographically disbursed to serve multiple markets. This very interesting history supports Simoudis' point that corporate organizations change in both strategy and structure. What Simoudis does not explain is why these organizational changes take place. The answer lies in the amount of information that an organization needs to process.
Has information increased or decreased since the Industrial Revolution began around 1770? Of course, the answer is that information has increased dramatically and since the 1960s the rate of increase has accelerated. Ronald Coase the Nobel Laureate helps us to understand why increased information causes organizational change. Coase showed that firms were organized to reduce transaction costs. Firms internalized functions when it was economically beneficial compared with buying the service. This insight defined the line between the firm and the market. Now if firms are organized to efficiently use external resources, one might logically expect that firms also organize to use their internal resources in the most efficient way. What are the internal resources? Coase described these resources as legal rights.Effectively, what Coase meant by rights is information--knowledge in workers, contracts, intellectual property, business processes, business models, etc. As JR Galbraith makes clear in "Organizational Design Information Processing”, organization form and structure is updated to process information more efficiently. This, of course, is the same behavior that complexity theory would predict. Organisms are constantly trying to organize information in order to reduce the amount of energy required for search and organizing.
proposing one way to look at the problem. The five key takeaways from Brainspace about how corporations should deal with information (in the future) are:
Identify subject matter experts
Information will be captured for reuse
Access to information in context creates value
Open, collaborative workflows and processes will be required
Leaders need to gain a real-time view into the knowledge network
Brainspace identifies correctly the need for a corporation to totally redefine how they think about information and how they create it and manage it to achieve knowledge (meaning derived from information). The most important point is No. 4, where Brainspace tries to articulate the new role of the individual employee. However I think that words like collaboration, workflow and processes, Twentieth Century words, do not accurately capture the new environment. I think ants, as famous in complexity theory as ducks, may be a better way to describe this new organization. Individual ants, with no directions or orders seek out food sources, independently capture information about food and report back (through pheromone trails), which may trigger exploration by additional ants who also report back until sufficient information through pheromone confirms a good food source. Workers in the future will capture information that will be available to everyone in an organization, which will prompt various other employees to investigate.. some in more detail. A significant portion of the information will be in real time, captured by IOT sensors.
I expect that corporations in the future will:
Assign a portion of each employee day to information management--search, analysis and curation--in order to keep up the larger volumes of constantly changing information
Use some form of Evernote designed as an enterprise-wide app, with equal attention to the future and current environment
Use AI to organize and re-organize information in enterprise systems, based in part on the results from individual employees doing information management
Adopt more analytics for decision making, but realize that information capture to feed the analytics is the priority
I think that when artificial intelligence can re-organizes the information for a company’s employees to better reflect their evolving understanding of a subject, then organizations will look like ant colonies with a large number of integrated but autonomous information gathers. Some might call this holacracy, but I think "ant colonies" better captures the idea.
On November 13 I will be teaching 3rd graders at a school in Hialeah. I will be teaching the Marshmallow Challenge, an international design challenge where children typically outperform adults. As part of this event I am trying to raise $1000 in donations, of which 50% will go to my class in Hialeah and the remainder goes to other classes.
I will be in Boston this week, a city I have grown to like very much. Usually I am at one university campus or another and rarely get to center city. This week is no exception:
Lecturing with a team from Demeter at the Fletcher School at Tufts University. (Demeter is a group that started at MIT and offers advisors and a network of experts for entrepreneurs in developing countries. My entrepreneur is working in the medical device space in Nigeria and currently raising a seed round (which is still open).)
Visiting friends at MIT
Happy to meet up with other people in the area. My contact info is on the "Profile" tab.
Today marks the start of my tenth year at FIU. I taught one semester in the business school, then moved on to the highly rated hospitality school for five years, found a home at the Engineering School three years ago and got to teach what is now my specialty--social entrepreneurship--at the Honors College two years ago. Teaching is now the most enjoyable thing I do and I also teach at MIT Sloan, University of Miami and for the Goldman Sachs 10KSB program in Miami and at Babson College.
What have I learned from ten years of teaching:
There is still a lot for me to learn about entrepreneurship
The smartest person in the classroom is always a student
Teaching university students is done best by using the learning techniques for adults (hands on, peer-to-peer, small groups, etc.)
Focus on developing student creativity, critical thinking, collaboration and communications and the course content will take care of itself.
Students all come to entrepreneurship with many preconceived ideas
I don't feel guilty anymore for having so much fun
In my classes this semester about 25 percent of the students will have taken a course with me before, but in Engineering it will be closer to 70%. I appreciate their confidence in me.
Special thanks to CC and JC for all their support over the last few years and to the TAs in the Honors College who do a great job.
The following is the third chapter in my new book "Scaling Social Entrepreneurship: Lessons learned from One Laptop per Child". The book is available in paperback and e-book versions on Amazon.
Chapter III- Non-profit Foundations and Their Influence on Social Entrepreneurship
While government’s ability to serve the public good and provide social services should probably always have been in question, one response to the underserved needs of society was met in part through non-profit foundations. Non-profit organizations for social purposes date back several centuries. One of the first efforts to legally codify such matters was in England in 1602[i]. An historian might cite earlier efforts to formalize non-profit activities, perhaps looking at collectives, guilds or buying groups. The long history of foundations and the provision of social services also had a profound effect on how people think about social entrepreneurship and many SEVs elect non-profit status as their legal form of organization. Whether or not that is the best choice will be discussed in this and later chapters.
We return to Hansmann (1980) for a comprehensive definition of the non-profit foundation. To summarize Hansmann, non-profits typically have four characteristics:
They do not distribute excess cash flow to stakeholders
They serve the “public good”
They subsidize the consumption of others
They maintain a “trust” in the non-distribution constraint
Hansmann’s first characteristic of a non-profit is that by their selection of a particular form of organization under the tax code (in the U.S.), they are barred from returning any excess cash flow to individuals who exercise control such as officers, directors or trustees. Any excess cash flow must be re-invested in assets to provide the services of the non-profit or in the operating activities of the organization.
Hansmann's second characteristic, the definition of the public good, was explained in the last chapter.
Non-profits are traditionally subsidy providers, lowering the cost of a product or service or offering them for free to those who cannot pay market prices. By not having the motivation and contractual obligation to provide a return to shareholders, non-profits are free to lower margins or provide the goods and services at below cost (including for free), thereby using their funding to provide the subsidy to the presumed less fortunate. Non-profits as subsidy providers also explain funding for certain performing arts, where the demand for performances is too small to justify a for-profit company providing the service. Another example may be donations to educational institutions where the donations subsidize scholarships that cannot be made from the educational institution’s cash flow or from government support.
Hansmann’s last characteristic of a non-profit is perhaps the most insightful and provides an understanding of a real service provided by non-profits. Non-profits serve as “trustees” for their donors. Much of serving the public good is difficult to monitor, particularly when the activities are across the world in Asia or Africa. Non-profits have no incentive not to provide their service and no incentive except to provide their product or service at the lowest cost possible. A for profit company seeking return for shareholders might not send all the food to the needy children in Africa or might overstate the cost of the food to enrich shareholders, but Hansmann believes that non-profits have no such self-interest.
While many would laud non-profits for their lack of self-interest, I think the professed absence of self-interest is the shortcoming in non-profits and perhaps one of the reasons that the social entrepreneurship venture has emerged as a viable alternative to execute social projects.
The absence of self-interest in non-profits causes two problems for non-profits:
There is no incentive for non-profits to be efficient. It is widely recognized in economic theory that every exchange of a product or service is based on each party believing that the exchange serves their self-interest. The provider of the product or service achieves this end by operating as efficiently as possible and by charging as much as the purchaser will bear. However, the non-profit is subsidizing the purchaser price and thereby distorting the market determination of price. With the market price distorted the incentive to be an efficient producer becomes distorted as well and may lead to less attention to operating efficiency. Hansmann makes the same point differently: “It is almost certainly true that nonprofit firms are productively inefficient in the sense that…they will generally produce any good or service at a higher cost than would a for-profit firm. If it were otherwise, we would expect to find non-profits operating in a much broader range of industries than is actually the case.” Complaints over the last several years about the high percentage of administrative costs in non-profit foundations might support this conclusion.
There is no incentive for non-profits to scale their operations. There are approximately 1.5 million non-profit organizations in the U.S., roughly one for every four tax paying corporations. The average non-profit had annual revenues in 2011 of $1.1 million and two percent have revenues over $10 million[iii]. Why are the non-profits so small in terms of scale? Non-profits do not have the incentive of self-interest from the derived economic benefits of scaling. In fact, I believe self-interest leads to the proliferation of small non-profits. Many people do not want to “anonymously” contribute to a large foundation like the Gates Foundation that is tackling the large problems on a worldwide scale. People apparently prefer to get the personal recognition of establishing their own small non-profit foundation. In certain communities it has become a status symbol to say you have a foundation. While personally satisfying, small foundations typically provide only incremental solutions and rarely address the big social problems that require scale of operations. Some would argue that there is a place for small foundations and that in some communities they aggregate resources in order to achieve economies of scale, etc. However, foundations aggregating resources are rare. Many small, stand alone foundations effectively duplicate overhead where such financial resources could be more efficiently deployed to address the actual social problems. When we examine the industries in which non-profits operate we recognize that they are generally similar to small business industries, industries that can achieve positive cash flow without any significant scaling. Otherwise, non-profits might be operating steel mills and building automobiles or conducting mining operations in Chile. The industries of small business and non-profits are typically also less capital intensive and therefore do not need access to capital markets to fund investment in new facilities or significant working capital requirements. A recent trend is for non-profit hospitals to convert to for-profit tax status or be acquired by for-profit hospital chains. Such moves are prompted by the need to expand their facilities or locations and achieve better economies of scale. These moves also give the organizations better access to expansion capital, which demonstrates a shortcoming in non-profit status.
Foundations require capital or expansion capital when they address large-scale worldwide problems. While historically foundations have operated with the characteristics of small businesses, as described earlier, tackling worldwide problems requires large amounts of capital to build international partnerships and distribution, to fund working capital and to fund continued innovation in product or service. In my experience commercial banks and investment banks will not finance a non-profit regardless of the scale of its revenues and cash flow. For example, almost every leading bank in the world I approached to commercially finance OLPC, despite annual revenues approaching $100 million and positive cash flow, turned me down. If the objective is to address large, worldwide social problems, access to commercial capital markets is required and the organization should elect to be a for-profit corporation rather than a non-profit foundation.
It may be noted at this point that there has been no mention of the word “donations”. It should also be pointed out that Hansmann made no use of donations in his definition at the beginning of this discussion of non-profit foundations. Foundations that rely principally on donations are called “donative foundations”. Foundations that rely on sales of product for cash flow may in certain cases be described as SEVs, as later explained in the discussion of the three forms of social entrepreneurship. Interestingly, at a recent speech to over 100 executives from non-profit organizations, when I asked them why they were non-profits they all answered, “to receive tax deductible donations”. This is what I call the “default” answer for a social organization. If you do not think about it, your social venture defaults to being a non-profit and accepts donations.
There are four possible reasons to actively select non-profit status:
Access to capital not available in commercial markets Certain projects cannot easily be financed in the commercial financial markets. Museums and performing art centers would be the two most common examples. These types of projects cannot create sufficient cash flow to attract loans and equity investors. Therefore, they can only be created and funded through donations to non-profit foundations.
Lower costs through volunteer communities Certain projects need to use the free labor of volunteers in order to be self-sustaining on a cash flow basis. For example, OLPC probably would have needed $20-30 million in additional donations to develop Sugar, the educational software on the OLPC laptop. A worldwide community of volunteers has created over 300 educational Sugar apps.
Partnering with NGOs, governments, multi-laterals and universities Certain social projects believe that they need to partner with NGOs (non-governmental organizations), governments, multi-laterals and universities in order to achieve their social objectives. The large NGOs and multi-lateral organizations have a wealth of experience in social issues, staff across the globe with local knowledge and resources that can be leveraged to achieve more effective operations. These types of organizations are all non-profit friendly and share concerns to differing degrees about the “self-interest” of the private sector. Therefore, it may be easier to partner with multi-laterals and NGOs if the organization is a non-profit foundation.
Branding Branding, defined as, “product positioning and messaging in order to achieve emotional engagement with the user for eventual economic benefit to the seller”, can be enhanced by non-profit status. For example, if the social venture is communicating a “low cost” solution, non-profit status implicitly communicates lower margins and prices.
While these four benefits to non-profit status may be attractive, a for-profit company can also achieve all of these benefits. A deliberate review of a new organization’s social mission and strategy should include a methodical analysis of whether the organization’s objectives are better served by non-profit or for-profit status. Unless the social project cannot generate sufficient cash flow to access capital markets, such as museums and performing arts centers, I recommend for-profit social entrepreneurship rather than a non-profit foundation.
I have been teaching social entrepreneurship for five years at FIU in the Honors College and at MIT Sloan, which was made possible in part by my 3+ years as CFO of One Laptop per Child (OLPC). OLPC was started by Nicholas Negroponte and faculty at the MIT Media Labs to provide every child in the developing world with a connected laptop. OLPC started as a donative non-profit but converted to a social entrepreneurship model in 2009. I joined to carry out this change in business model at OLPC.
Steven Weinberg, Nobel laureate physicist, says he teaches a new course to learn a subject. I do the same thing, but courses are better for organizing conceptual thinking and writing books I think is a better method to organize practical thinking. So when I think I understand the practical side of a subject, I write a book to confirm it to myself.
Social entrepreneurship is a better model to solve social problems than the traditional ways and increasing in popularity
Properly taught and modeled, over time entrepreneurship should not need the modifier "social" and the debate about the morality of capitalism can be put to rest
Organizing a social project is not particularly challenging, but organizing something that can scale to multi-country or Google scale is very challenging. In attempting such an effort one has to plan for worldwide coverage from the beginning. In traditional entrepreneurship, one gradually reaches the point of scaling after product/market fit and commercialization. In social entrepreneurship, early on one needs to find the model because lower operating returns and less startup capital do not give you the flexibility to iterate. This fact is even more true if you operate as a non-profit.
The second half of the book is devoted to the business model to scale a social venture. I strongly recommend in favor of for-profit companies in order to have better access to capital markets. I believe evaluation needs to be baked in from the beginning because access to social impact funds is becoming increasingly competitive. I advocate that one try to establish a movement to support the social objective, something akin to Gandhi, Mandela and King. That may look like a difficult undertaking, but OLPC achieved that objective--worldwide 1:1 computing for children. Lastly, I cannot say enough about the importance of partners to a social entrepreneurship venture and I recommend private sector partners.
The book is available in both paperback and Kindle versions on Amazon. I would be happy to sign a copy of the book that you give as a gift. I also think it makes a fine introduction to social entrepreneurship for a corporation looking to transform its corporate responsibility program into something more substantive.
I have just returned from vacation in Alaska. Most majestic landscape I have seen anywhere in the world. As is my custom, I read some books about Alaska and the indigenous population. The indigenous people have been in Alaska for 16,000 years and have survived two ice ages. After 16,000 years in the same place a people develop a comparatively advanced culture very suited to the surroundings. All was bliss and comparative harmony until the Russian explorers arrived in the 1700s.
These early explorers were charged with determining whether a colony should be established. With the abundance of furs, Alaska was a natural location for a colony. In keeping with the "business model" of the time, to establish a successful colony one maximized financial return with complete disregard (exploitation) of the local population. The Russians improved on run of the mill exploitation by kidnapping the natives' wives and children until a ransom was paid in pelts. As the fur trade grew in monetary terms the Russians looked to change the business model from exploitive to sustainable. The Russians were never able to achieve sustainable colonies in Alaska, which prompted them to sell Alaska to the U.S. government for a mere $15 million. The Russians failed because they never engaged the self-interest of the locals and the local market forces to support the colony.
The errors by the Russians are the mistakes I see frequently in social entrepreneurship:
They committed to a strategy (kidnapping) which made it difficult to execute a second or iterative approach to strategy
Their arrogance blinded them to understand the self-interest of the local people
They did not make use of the local market forces, which in the case of Alaska had been developing (albeit primitive) for thousands of years
In all my entrepreneurship classes I try to have an early stage entrepreneur serve as the course project. Effectively, the students develop the go to market strategy for an early stage company (or an idea) within the resource constraints of real entrepreneurs. This semester I have three projects running with three different entrepreneurs. One entrepreneur is ecstatic with the results, one entrepreneur is very pleased to have access to the resources of the university and the third project is struggling because we cannot find a customer/market for the product. This is the big unstated secret in Project 3, we do not know who to sell the product to--until yesterday.
Yesterday we were going over the fourth round of research on different possible customers. We were looking at interviews with the disabled that the students conducted and also learning about whether the product would be approved by Medicare. A discussion of pivoting to robotic wheelchairs prompted a student to relate a story from her home country of Sweden about the launch of a specialized elevator. As soon as she told the story six people all knew what the market for the product was. I have never seen six people all have the same insight at the same time, but it was very obvious that this was a high quality idea and the answer to the unstated problem. Of course more study and thinking is required, but the whole class felt better that we now had a good working hypothesis. Very pleased that collaboration produced the idea. Very pleased that so many students were relieved we finally had found a good hypothesis. Didn't think they took these projects so seriously and personally.
Takeaway: It is true that you know a good idea when you see it. You just have to keep working on the problem until you have a breakthrough. This article is a nice compilation of techniques for more creative thought, "The Myths We All Believe About Breakthrough Thinking". Particularly valuable article for engineers.
In September I will need two entrepreneurs/startups for my new classes. Would prefer one consumer products company and one tech company (any field). If you or someone you know is interested to go through 12 weeks of analysis, consulting and development for an idea or early stage company...to go to market or develop a growth plan, please contact me.
Sometimes defining words drives me crazy for years. As yesterday's post might indicate "risk" is one of those words. I really like the concept of equating risk with "variance in cash flow" in business usage.
"Social" is another such word that perplexes and annoys me. I cannot understand why this word should have implied normative value, as in social benefits. Social is derived from "society". Social is a characteristic of a group of people. A group of people is a "society". So, society is the sum of the individuals.
Ostensibly capitalism allocates the resources to satisfy individuals and their needs. What capitalism cannot allocate resources to, probably because such a thing cannot attract investment capital, might just be a social benefit. For example, no performing arts center can attract investment capital so maybe such a project is a social benefit.
Social benefit looks a lot like a public good. My rather detailed thinking on the subject is in this post, "Public Good". Until further notice, this capitalist is defining "social benefit" as public good.
Every year I write a few posts on leadership. Much of my thinking on leadership is influenced by the writings of the U.S. military. This morning I am lecturing to the ROTC student body at FIU. This is a summary of what I plan to say.
The three functions of leadership are:
Determine the mission
Provide resources necessary to accomplish the mission
Motivate people to perform effectively and efficiently
I plan to illustrate each point by an example from military history. Napoleon, Wedemeyer and Cortez respectively illustrate the three points. The common theme in each of their approaches is that they "redefined the problem" in order to properly perform one of the three functions of leadership.
My opinion of the best book on leadership is in this post from 2009, Team.
