My professional life revolves around entrepreneurship in its many forms, the Fourth Industrial Revolution--4IR (that the World Economic Forum correctly started heralding a few years ago) and how these two themes intersect around opportunity, wealth creation and social innovation. One of the devices to understand the 4IR is what I call the Trilogy, which was written about by Daniel C. Wahl in the very good article, "Facing Complexity: Wicked Design Problems". The Trilogy, which is a device to simplify the 4IR, is that this revolution can be understood as the convergence of nature-design-technology. Until today I would have said go away and study complexity science, artificial intelligence, bio-mimicry, slime mold, design thinking and 10-20 other concepts and then the Trilogy is obvious. Today I had a realization.
Fashion represents the Trilogy. Please remember my twenty years in retail and retail consulting. Now one might argue that fashion has existed from before we left the caves (all of intellectual history beginning from the first drawing on a cave wall) and you would be correct. Remember, it could be that all of human history can be understood through the lens of the Trilogy-nature-design-technology (see this article on the Krebs Cycle of Creativity). Now back to explaining the Trilogy in terms of fashion.
Now almost everyone can understand fashion in terms of design, at least it is superficially obvious. Technology is much the same, with different fabrics and colors being the result of technology. Where it becomes interesting is when we consider the role of nature in fashion. Of course, nature is where we introduce the human-centric focus and that leads us to the drape of the clothing on the body, the equally important emotional engagement of the wearer and most importantly to the question of customer self-esteem. What the fashion example makes clear is that every consumer opportunity, product or solution should be considered in the terms of the trilogy, whether you were sitting outside a cave or a modern design studio. As you venture forth in the 4IR remember one does not understand fully until one can explain the issue or opportunity in terms of nature-design and technology.
Note: The Krebs Creativity Cycle is not obvious and takes awhile for people to appreciate its utility. I will do a followup post to explain its utility in more detail.
The quote below is from Paul Heyne‘s 1982 speech “What Is the Responsibility of Business Under Democratic Capitalism?”
"The primary problem that modern, industrialized economic systems must solve is the problem posed by the scarcity of information. We are inclined to overlook these difficulties and to take their resolution for granted, because we take for granted the remarkable mechanism of social coordination through which we gather and disseminate the knowledge that is essential to the system’s functioning. In overlooking the knowledge or information problem, we focus undue attention on a different scarcity, the scarcity of goodwill. We erroneously suppose that goodwill can resolve problems that can in fact be resolved only through the accumulation of additional information. Moreover, many of our proposals for increasing the amount of goodwill in the economy fail completely to attain their objectives, but do manage to subvert the crucial information system."
Increasingly I come to the conclusion that social problems are caused by the asymmetry of information. Rarely do I see approaches that take this idea into consideration.
This morning somebody asked me for a list of talks and workshops that I do. A current list is below.
The Secret to Successful Entrepreneurship. 4 hours, 8 hours, or 3 days. Entrepreneurship is a popular topic in the media, schools and the workplace. It is also critically important to individuals looking to manage their economic well-being in this new century. However, there are three key concepts in entrepreneurship that get little attention: fear, assumptions and opportunity. Fear holds one back but where does this fear come from. Assumptions are the land mInes that blow up most companies. Picking the opportunity is where one lays the foundation for the scalable business. These topics can be presented individually in half-day or full-day seminars or all together in a comprehensive 3-day workshop. Everyone will need to be an entrepreneur to successfully function in the new era of the 21st Century. This talk is where one can learn the fundamentals.
The Five Step Process to Convert Passions into Innovation. 4 hours, 8 hours, or 3 days. Innovation is perhaps the most popular word that no one defines correctly and consistently creating innovative solutions is always more challenging than it should be. Using the five step approach taught in this program, anyone can create innovations. This approach is not based on design thinking or the other traditional approaches to creativity, but rather draws its inspiration from early childhood development—1-Passion, 2-Discovery, 3-Creativity, 4-Invention, 5-Innovation. Depending on the depth of understanding desired, this topic can be presented in half-day or full-day seminars or in a comprehensive 3-day workshop. If you are interested to learn the lessons every genius throughout history has taught us, this is the event for you.
The Five Themes of the Fourth Industrial Revolution. 4 hours, 8 hours, or 3 days. Klaus Schwab, Chairman of the World Economic Forum, coined the phrase the “Fourth Industrial Revolution” to describe the current period of technological innovation and the resultant massive social, economical and political changes we can expect. While it is important to understand the underlying technologies, the social consequences are more dramatic than any period in history. Whether in half-day or full-day seminar or a 3-day workshop format, this presentation explores the technologies and five major themes that explain the Fourth Industrial Revolution. Anyone trying to prepare and educate people for the 21st Century should attend this event.
Social Entrepreneurship: Capitalism Redefined. 4 hours, 8 hours, or 3 days. Capitalism came under attack on many fronts as a result of the Financial Crisis of 2007-2008. In simple terms it might be said that the corporates forgot their responsibility to society. On the other hand capitalism is the most efficient way to address social issues at scale, as evidenced by the over 1.5 billion people who have escaped poverty in recent times. To blend this efficiency of capitalism with an integrated approach to solve the most pressing social problems, that challenge is what gave rise to social entrepreneurship. Whether in half-day or full-day seminar or a 3-day workshop format, this presentation defines social entrepreneurship, outlines the special features of its business model and showcases how existing companies can use social entrepreneurship and how non-profit organizations can convert to social entrepreneurship. How to start a social entrepreneurship venture is covered in the 3-day format.
Much of the content for these talks has been put together over the last 12-18 months from lectures I have given at various universities. Many people have heard me teach or speak on these topics at StartUP FIU. Many of my colleagues at StartUP FIU can also speak on these topics, if you wish.
Yesterday's reading discovered some excellent articles:
Esko Klipi on Medium, "It is only a few network connections away". He points out that networking is growing increasingly important as the Internet shrinks the world. Makes one realize that networks created by people could be more powerful than 20th century forms of organization.
Evonomics.com on inequality, "The Science of Flow Says Extreme Inequality Causes Economic Collapse". What caught my attention was a quote from Robert Reich, "But in The Work of Nations (2010), Robert Reich also points out that the companies that are flourishing through globalization and technology are ones pursuing what he calls high-value capitalism, the high-quality customization of goods and services that can’t be duplicated by mass-produced uniformity at cheap places around the world." I rarely agree with Robert Reich, but I think he is correct this time. I think that corporate governance has enforced too narrow a set of objectives and the executives have opted for the easiest path. BTW, Evonomics is doing an excellent job of trying to redefine how we look at government economic policy with a particular emphasis on complexity economics.
Stanford Social Innovation Review on corporate social responsibility, "Corporate Social Responsibility for a Data Age". In managing disasters much valuable data is behind corporate firewalls and not normally available to the government. The article suggests that the data be made available after the disaster, but it appears more logical to me to pre-position the data.
At 25iq two great articles on entrepreneurship, "A Dozen Lessons on Growth" and "A Dozen Lessons About Product/Market Fit". Just simply one of the best blogs around on entrepreneurship. Step-by-step type detail on understanding subjects that most people misunderstand.
In another of my favorite blogs on economics, Marginal Revolution, "Online Education and Personalized Learning". The article makes the point that in any class there are students performing at many different grade levels. Online learning provides one way for students to follow their own pace of learning. Pace of learning is a big issue that I see rarely addressed. (See image above.)
Aswath Damodaran on ValueWalk, "My Snap Story: Valuing Snap Ahead Of It’s IPO!". Damodaran is a leading academic authority on valuation and Snap will be one of the biggest IPOs of 2017, if it gets away. Sorry, got confused and included a finance article
For the last seven years I have taught an IAP course at MIT on social entrepreneurship. The early years focused on my experience at One Laptop per Child (OLPC). OLPC started at MIT and was one of the largest social entrepreneurship ventures (SEV) at the time. In recent years I have focused the course more on scaling an SEV and use three different models to develop an understanding of the key concepts for scaling. This week I am at MIT.
Coincident with this year's course I have been reading the writings of Ludwig von Mises. Von Mises is considered by some to be the leading thinker in the Austrian School of economics. I prefer Hayek for the wide range of his writings, which arguably included complexity, information theory, behavioral economics, psychology, political theory and economics. Von Mises is however the better writer with a lucidity and logic that is both compelling and original.
One of the points von Mises makes clear is the importance of capitalism and markets in allocating capital. He wrote at a time in the 20th century when socialism and communism were being actively advocated for as better alternatives than capitalism. In class one of the students was advocating for government subsidies to support certain social initiatives. I asked why he thought the government was better at allocating this capital than the individual taxpayers. Silence followed, and then he said that a small group in Washington was better able than the public to make decisions about the future. I replied that small group decision making was the same model used by dictatorships. Deafening silence. In fairness to the student, everyone has problems with decision making about the future, but let's continue to explore von Mises point.
Suppose the government announces that they are raising taxes to subsidize a lunch program for students. Sounds good, research shows that children learn better when not hungry. However, this tax revenue will now prevent the next Google from raising its first round of venture capital because certain people will not have the capital to invest. Setting aside the question of financial return, what if the next Google cures cancer! Now it may not be so obvious that we should let the government use our money to subsidize school lunches.
The point of this post is that when you look at government investment and social projects one should always consider the allocation of capital. Such an approach probably reduces the role of government and raises the bar for social projects, which I assume here will nearly all be social entrepreneurship. The bar is raised because now the social project needs to focus equally on impact and capital efficiency. One could argue that such an approach prevents certain worthwhile projects from being funded. Perhaps, but there are so many good social projects now, why not pick one that is capital efficient. It is not for me to decide whether clean drinking water or childhood education is more important, so I have no concern picking the capital efficient one amongst the two. When both projects are capital efficient I am willing to consider other factors. This paper from SSIR, Across the returns continum, offers a logic for such trade offs from Omidyar Network. If the project were a platform to facilitate additional social projects, that would probably be a deciding factor for me.
Personally I find nothing inconsistent with combining the thinking of the Austrian School of economics with social entrepreneurship. I think it brings an added discipline to the practice of social entrepreneurship. In the end the Austrians always come back to the concept of individual empowerment, whether it be in economic development or capital allocation. I am always very comfortable looking at social entrepreneurship through the lenses of individual empowerment.
The economic disparity will be exaggerated by the increasing use of AI. AI requires massive processing power and storage for the required data to power the "learning". If you cannot afford such resources one will not be able to use AI to create competitive advantage and will fall further behind.
In considering disparity one must create solutions that anticipate the future, particularly in the current period of paradigm shift. See 1 above.
Multiplicative systems are systems where each part of a system must function correctly for the system to produce the desired result. Additive systems are such that when one part of a system breaks down, the result changes but the end product still has a value. 8*2*0*7=0, 8+2+0+7=17. Modern computer program design uses an additive approach, but historically used a multiplicative approach.
I think that social problems are generally multiplicative. One has to get all parts correct. Usually one needs to both change a behavior and act in a way that supports the behavior change. For example, the abstains alcoholic needs to stay out of bars.
SSIR has an article in the latest edition, "Is It Time to Ditch the Word “Nonprofit”?", which suggests we need a new term to replace "non-profits". An alternative approach might be to stop creating non-profit organizations. Why do we have 1.5 million such organizations in the U.S., or roughly 1 for every 4 for-profits?
The obvious solution is to convert non-profits to social entrepreneurship. This was not an alternative considered in the SSIR article. Of course, the writer has a startup that raises capital online for non-profits. Except for some human rights issues, I think all the UN Sustainable Development Goals could be achieved by entrepreneurship.
To quote a saying I like, "non-profit is a tax status and not a mindset". Your social entrepreneurship venture can be a non-profit, although I would not recommend it. There is better capital access in a for-profit business model and business approaches are a much faster way to solve social problems. The more important issue is to make more business people realize their for-profit models can be used to address social problems. That would be a better article from SSIR than an article on the terminology of non-profits.
A recent post, "The Business Model to Downsize Government", talked about how the private sector could lead social change. I wanted to come back to this theme when I had more evidence than some research from HBS. I now have several confirmations that show that Tulane University was the local leader in rebuilding New Orleans after Hurricane Wilma. Local government was apparently so corrupt and inept that a group of people, including the leadership at Tulane, took into their own hands to plan and execute a recovery.
Perhaps we have a data point where the private sector addressed and solved a large, complex social problem.
Also, interesting to note that one of the multiple networks of Tulane University (the Trustees) engaged in the project and then energized the other networks to support. Successful organizations have multiple effective networks, but it only takes one network to capture the attention of the other networks and bring to bear the full resources of the organization.
A reader wrote to correct me. The hurricane was Katrina.
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."
Today the AVC blog has a story about their portfolio company Kickstarter joining President Obama and the UN to fund raise for Middle East refugee relief. This is an interesting "partnership" for several reasons:
The U.S. Government believes that significant capital can be raised for traditional government activities through private sector crowd funding.
The Government believes that a private sector crowd funding is faster and less expensive than a legislative effort
My takeaways from this:
The Obama presidency does not believe they can pass refugee fundraising legislature and have opted to use their expertise in social media instead. Effectively the President has become a moral authority like the Pope without the resources to act.
This initiative could have happened without the U.S. Government and the UN involved. If Kickstarter had initiated the campaign they could have chosen their own execution partners. I hope Kickstarter learns how to do these campaigns without government and multilateral partners. The challenge is in the execution in country and picking the right partners.
This example is further proof that the private sector can disrupt government and reduce its scope.
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 become something of a collector of different models of social entrepreneurship. For the purposes of being accepted as an example of a different model of social entrepreneurship, the company must be for-profit and have a unique way of delivering measurable social impact. The examples I have collected are not necessarily the first such companies. The only distinction I make is I do not accept CSR projects.
Two examples recently caught my eye:
The Miami Heraldreports that Carnival Cruise Lines is forming a new division/company where the onshore excursions will be to work with local people on socially beneficial projects (instead of going off to see sharks or polar bears). If Carnival were to develop multiple ships and cruises for this purpose I would applaud them for their social impact. If they need a local social entrepreneurship professor to help them plan their impact and projects, please let me know.
Norton Sound Corporation is one of many native-owned corporations established for the benefit of indigenous people at the time of Alaska statehood. Norton Sound operates Norton Sound Seafood and Norton Sound Seafood Restaurants. All of the seafood is caught by members of a particular indigenous group near Nome, Alaska. Sale of the seafood to the corporation provides much of the livelihood for the natives. The creation of a branded product and metropolitan outlets for a product provided by indigenous people is a model I like.
Wonder how much seafood, if any, Carnival buys from Norton Sound or any other native corporation in Alaska. The new division should consider such questions.
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
Today Nancy Dahlberg has a nice recap at Starting Gate of the Miami Herald Business Plan Challenge, which I judged. Noteworthy was this year's winner in the high school category, Teenography. I very much like the idea of teaching entrepreneurship to high school and junior high school students--not checkbook management or accounting, but real business concept development and go to market strategies.
Teenography operates an exchange/marketplace/platform (pick the word you like) that enables young (high school) photographers to offer their services to clients in need of photos for events, marketing materials, etc. Average charge rate is $40/hour compared to professionals who charge $100/ hour in South Florida. Why the difference of $60/hour. You might say professionals versus amateurs but the real reason is what economists call asymmetry of information. Information on photographers used to be difficult to find and incomplete, the asymmetry, because there was no easy way to find out about amateur photographers. When information on amateurs becomes available through Teenography and more complete information is the norm, the price per hour of photographic services drops by $60/hour. Reducing the premium created by the asymmetry represents the business opportunity.
In markets where there is an asymmetry of information, there are two new business development strategies:
Exploit the asymmetry and earn abnormal returns (hospitals), or
Eliminate the asymmetry, e.g. Teenography, Etsy, CarFax
As is obvious, the Internet and ubiquitous information make it possible to profitably eliminate the asymmetry. A trend I see emerging is for such exchanges to bridge service providers in developing countries with clients in developed countries. One example of this is Behance, which enables third world graphic artists, web developers and designers to showcase their work to the world. The site allows for the service provider to be contacted but not for a contract to be consummated...yet. Customer service from India is not so far from the exchange model nor is artesans in Africa posting their wares on a web-based exchange where socially motivated buyers can pick what they want to purchase.
This business model of the exchange that bridges the developed and developing world ('bridging marketplaces") I think will become very common. The timing is excellent because low skill jobs for immigrants in the U.S. are being taken over by robots. Fruit picking and nursery work is now done by robots, according to this post in Marginal Revolution. If there are no jobs in the U.S. to attract immigrants, then I hope these workers find bridging marketplaces that provide local employment.
If someone had good open source exchange software, one group of socially motivated people could focus to organize the local service providers and another socially motivated group could focus on marketing the exchange products or services. A little imagination and we crowd source to fund the marketing.
For more on the relationship between developed and developing markets, read this excellent article from the Washington Post, The Great Unraveling of Globalization.
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.
This January, teaching at MIT, I think I had an important realization about social entrepreneurship. In simple terms I think of social entrepreneurship as entrepreneurship directed at solving a social problem. (The sophisticated, academic definition I like is here.) "Social" is just a comment on the type of problem one selects to solve. Nothing more.
So, if social entrepreneurship is just entrepreneurship then why cannot we just use Osterwalder or Bill Aulet or BCG or my own concept of business model to think through scaling a social entrepreneurship venture. (That was the realization.) So, why do we need a special business model for social entrepreneurship. There are three reasons:
The market conditions in much of the developing world are so tough that almost everybody needs partners to handle distribution, sales and marketing.
To get the proper resources, one frequently has to find private sector partners where there is a match between market forces and social objectives
If you can satisfy 1. by 2. then you can avoid the shortfall likely in qualified staff to pursue the social objective; if not revisit 1 and 2.
When one starts a new company in the U.S. one chooses the distribution channel(s), but one hardly worries about how to get product to Des Moines. In Honduras, for example, the complexity of distribution to remote cities can not be described. The best hope is to find an existing distributor knowledgeable in your product category who has the capital to finance more inventory of your product. Should one fail to secure this distributor (lack of matching between market forces and social objective), the alternative may be a donkey train at best. Repeat story for sales channels, marketing, customer education, after sales service.....
In conclusion, the difference between business models for entrepreneurship and social entrepreneurship is that one needs to find the partners and construct the matching between market forces and social objective in social entrepreneurship. In entrepreneurship, particularly in advanced countries, it is more a matching of market forces at all times and markets are efficient about allocating the necessary resources
Note (1): In determining 1 and 2, please pay attention that the business model can be replicated from country to country to continent.
Note (2): Some would argue that "becoming a movement" is a requirement of a scaleable business model in social entrepreneurship. I would agree it makes it much easier, but one needs a very special set of circumstances to pull it off.
"The Miami Service Jam is the local chapter of the Global Service Jam (GSJ) community. The GSJ is an annual 48 hour event where people in over 100+ cities get together to apply design thinking and prototype solutions for a common design challenge. Participants from all over the world interact over social media and upload videos of their prototypes to the GSJ website.
This is a fun, volunteer run event open to anyone who wants to learn more about design thinking, connect with interesting people and build their creative confidence.
This is an excerpt from an article on AVC about enterprise-oriented networks:
“C2FO is a network of businesses and their suppliers that solves a working capital problem for the suppliers and provides a better return on capital to large enterprises. Here is how it works: C2FO has a sales force that calls on large enterprises and shows them how they can use their capital to earn a better return while solving a working capital problem for their suppliers. They bring these large enterprises onto their platform and, using C2FO, they recruit their supplier base onto the platform. They also bring all the accounts payable for the large enterprise onto the platform. Once the network and the payables are on the platform, the suppliers can bid for accelerated payment of their receivables. When these bids are accepted by the large enterprise, the suppliers get their cash more quickly and the large enterprise earns a return on the form of a discount on their accounts payable. C2FO takes a small transaction fee for facilitating this market.”
What caught my eye is that the C2F0 model is an excellent way for F500 companies to share value with smaller suppliers in less developed countries where capital is scarce. If a F500 company were to adopt the C2FO model worldwide for small suppliers, I think that would be a major social program consistent with social entrepreneurship. In fact, maybe it should be a requirement for all companies applying for B Corp status (above a certain size).
A shortage of capital is a major issue in the developing world and the C2FO model helps to organize capital to solve the problem. Perhaps World Bank or Inter-American Development Bank could provide a similar service discounting F500 accounts receivables for small suppliers or partner with C2FO to expand internationally.
I think if I was the CEO of C2FO I would build my brand and value proposition around helping small businesses around the world solve their capital problems and not around "delivering efficient cash flow and bold returns". Package the pitch to F500companies around social responsibility with a return. I might also consider changing the strategy and provide technical infrastructure for a fee to organizations like World Bank or Qatar Foundation (and no longer need a direct sales force).
I just completed my fifth year teaching an IAP course at MIT Sloan on social entrepreneurship. The first two years the course focused on telling the One Laptop per Child story, the third year focused on better defining social entrepreneurship and year four and this year (5) focused on "scaling" social entrepreneurship. To some degree these courses have documented the evolution of my thinking on social entrepreneurship.
The approach to social entrepreneurship that I prefer is to ignore all of the normative hype and merely focus on solving the "social" problems. My cocktail party definition of social entrepreneurship is now:
"A commercially sustainable, scalable solution to a social problem"
In this definition, the selection of the problem the entrepreneur addresses will define them as a social entrepreneur or a traditional entrepreneur. I define sustainability simply in terms of cashflow and not in the alternative usage that includes social, economic and environmental benefits. I am not against a wider range of benefits, but I believe many social ventures fail because they define their mission too broadly to achieve all three types of benefits. Such a broader mission is more difficult to manage, more expensive to execute and more expensive to the disadvantaged person one is trying to help.
In one economist's definition, social entrepreneurship can be defined using the value creation-value capture model of resource-based theory. In this model social entrepreneurship "maximizes value creation and satisfices for value capture" (sufficient to stay in business). Value is defined as "utility". Originally I thought of this transfer of value as exclusively between the provider of product/service and the customer or user of a product or service. This limited definition of "value creation" has bothered me for awhile now because I think it ruled out organizations that are social entrepreneurs. The issue came up in class at MIT and a vigorous debate ensued.
I now believe that the social entrepreneur could transfer value to other stakeholders in addition to the customer. For example, selecting to work with new indigenous people to become suppliers would be a value transfer to the indigenous farmers. Paying above market wages would be value creation for local workers. Providing stock ownership to employees might be creating value for employees. Effectively, value creation can benefit any stakeholder of an organization provided enough value is transferred to the customer or end user to have an exchange (purchase). The exchange is required to meet the requirement for entrepreneurship.
Two additional themes were stressed for the last two years:
Social entrepreneurship offers the opportunity to redefine the role of government
Value proposition is just as important, or more important, in social entrepreneurship because the disadvantaged person may need more assistance to recognize and use a solution to a problem.
My lecture slides from MIT 2015 are available through this link. Download SCALING SE MIT 2015. I very much like the Scaler Model for scaling social entrepreneurship, which is explained in the slides.
Note: The original definition of social entrepreneurship using value creation and value capture was developed by Felipe Santos in an INSEAD Working Paper. He did not consider value transfer to all possible stakeholders in the article, "A Positive Theory of Social Entrepreneurship".