Rita Gunther Mcgrath | Blog | The Discipline of Strategic Growth

Brilliant reflections on skunkworks

Ah, skunkworks. Those small, agile units beloved of large organizations looking for the Next New Idea. I've written about them in the past - and outlined some of the pitfalls of setting them up and expecting great things to happen without having some way of re-integrating them back to the core business.

I ran across this really interesting blog post this morning that adds a lot of rich texture to the subject of skunkworks and pulls together some really interesting examples. For instance, I didn't know that the originator of "let a thousand flowers bloom" idea was Chairman Mao! Definitely worth a look.

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Posted Rita McGrath on July 31, 2010

Top Ten Reasons Not to go Public

A reporter recently asked me about the downsides of a firm going public - why might it not be the best course of action for them? Here are my "top ten":

It is a major distraction from the business of serving customers and meeting customer needs.
Leadership teams today have to ‘recruit’ the right kinds of shareholders – activity which has nothing to do with actual business wealth creation but everything to do with staying alive in the stock markets.
Being publicly traded means you will tend to overpay your executives.
Executive (particularly CEO) tenure will tend to shorten as public company pressures make any slip up intolerable.
It depresses the interest in long term innovations that are good for the company.
You need a whole bureaucracy to manage the relationships with the Street.
You can’t dispose of assets or businesses which still generate cash without huge stock price hits, so you tend to stay in things far longer than you should.
Great people with somewhat tarnished reputations would never be able to use their talents in a public company (I can give examples).
It depresses flexibility because of the pressure to meet expectations.
It is manifestly unrealistic – only 8% of companies from 2004-2009 were able to grow by 5% top line each year and only 4% of companies in the same period were able to grow bottom line during the same period, and yet the investing community looks for double digit growth??? (data from a study I recently conducted with Accenture)

Food for t hought, no?

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Posted Rita McGrath on July 21, 2010

Pricing advice for new entrepreneurs

Make sure you’re getting enough margin to account for your time - Advice I suggested on this blog aimed at helping people earn a little more pocket change by starting their own business.

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Posted Rita McGrath on November 28, 2009

How decisions made under uncertainty can cast a long shadow - Internet Pricing

The reality of having to make decisions under uncertainty is that quite often, you'll get things wrong. Unfortunately, sometimes those wrong things have very long and path-dependent consequences. I'm thinking in particular of two decisions that were made virtually industry-wide as the Internet evolved: 1) the decisions that content should be 'free'; and 2) the decision to sell Internet access on a flat-fee for unlimited access basis. As a recent article in the Wall Street Journal points out, in the early days of the Internet (remember dial-up access?) consumers were perfectly happy to pay by the amount of connection time they used. If you cast your mind back to the old AOL business model, you paid a basic access fee to get your ID and password, and that covered a certain amount of usage. Then, if you went over that, you paid more. This kind of pricing makes a lot of sense when you have a resource that is vulnerable to overuse, and you want to encourage investment in the infrastructure to support it. Then, along came a bunch of bright sparks with the idea of offering 'always on' unlimited access to the Internet at high-speeds for a fixed, flat rate. I'm sure the original idea was to try to undermine the AOL model both in terms of speed and in terms of ease of use. What was apparently not anticipated was that the amount of traffic that would eventually begin flowing through the networks as our lives become increasingly digital and on-line. Now, those who offer network services are in a pickle: How do you backtrack on that business model, once you have trained customers that your services should essentially be available in unlimited quantities for one flat price? I think it's rather analogous to the problem news organizations and content providers are up against as well - how do you convince people to pay for content after spending over a decade providing the news for free? There are a few examples in which companies have been able to get customers to pay for something they used to get for free - cable TV and (to some extent) Satellite radio might be cases in point. But it isn't easy, and requires some kind of barrier to competition. It will be interesting to see how the net neutrality legislation now making its way through the legislature will play into this. While I do agee that you don't want network provides making decisions about which services customers can and can't get, it doesn't seem to honor basic fairness to me to dictate that they have to offer their services to any comer on an unlimited basis. After all, nobody is telling the electricity company that they can't charge more to those who use more. And in telephony, interestingly enough, the operators seem to have avoided the seduction of giving their network minutes away for free. We have a strong interest in making sure that networks are capable of handling the traffic of the Internet future. And someone has to pay for that. Let's hope that some reasonable compromise can emerge, in which network providers have an incentive to provide great service, while charging fair prices for the access they provide.

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Posted Rita McGrath on October 24, 2009

Taxes, the structure of incentives, and why I’m worried about the plan for health reform funding

When I was a Ph.D. student studying entrepreneurship, one of the most influential articles I read was by economist William J. Baumol. Entitled “Entrepreneurship: Productive, Unproductive and Destructive”, it basically suggested that a nation gets the type of entrepreneurship it rewards. Countries that reward productivity-enhancing risk-taking richly encourage those with entrepreneurial inclinations to pursue those activities. Countries, in contrast, that reward other kinds of activities, such as politicking, status-seeking through religion or study, or worst of all, counterproductive activities like drug dealing and other forms of corruption—tend to encourage those with entrepreneurial talents to pursue those sorts of activities, to the detriment of more productive entrepreneurship.

Baumol’s observation haunts me as I peruse the extensive coverage of the frantically rushed efforts to overhaul 17% of the nation’s economy in one fell swoop in the form of a major change in how medical care is allocated and paid for. Without examining the merits of the health aspects of the plan, I wish to express grave concern with this wholesale and ill-considered redistributive move. Perhaps without intending to (or more likely, without having ever given it a thought), the plan currently being sped along by the House Democrats is going to fundamentally alter what Baumol called the ‘structure of incentives’ that shape how entrepreneurs allocate their energies.

Let’s start with the basics: Under the House plan, medical care would be paid for by a surtax on those families with household income above $350,000 in 2011, a surtax which can go to as high as 5.4%, in addition to the tax increases already scheduled to kick in in 2011. Further, the plan would impose mandatory health insurance coverage for employees on all businesses with more than 25 of them, or a fine of 8% of payroll. Employers with more than $400,000 in payroll would basically have to pay at least 25% above salary to hire an additional person. Research suggests that a great many Americans with incomes above $350,000 are entrepreneurs and small business owners - in many cases, they operate sub-chapter S corporations in which profits are cashed out at the end of each year and taxed at the individual rate. That money, which looks like discretionary income to headline-hungry politicians, is often plowed back into the business. It’s not going for luxuries - in many cases, it’s going for working capital, inventory, marketing, and other unglamorous business necessities.

So what does Baumol’s theory tell us is likely to happen? Well, the first predictable consequence is that an awful lot of entrepreneurial energy is going to be spent, not productively, but unproductively, as small business people and those falling into the higher-tax categories spend their time not producing new innovations but figuring out how not to fall into the maws of increased tax and regulatory burdens. Following right on that as a predictable consequence is that those who are able to do so will do business in such a way that they don’t fall into the higher-taxed categories. Rather than pay individual rates, small businesses will incorporate and pay the lower 35% corporate rate. Further, get ready for the new conglomerates - thousands of businesses employing exactly 24.5 people, all interconnectedly doing business with one another rather than falling foul of the over 25 employee stricture. And with small business growth having led us out of most recessions in the past, get ready for this sector to add jobs far more slowly and with far greater caution than it had previously - a big blow to an economy that desperately needs a vibrant and growing small business sector.

At a more macro level, a huge body of research points to the same conclusion (remarkably, for academic research). The effects of higher individual taxes on rates of entrepreneurship are without an exception, negative. It is well accepted, and has been for decades, that the desire to have a vibrant entrepreneurial economy is at odds with the desire to operate a welfare state, due in large part to the way in which welfare states allocate resources – when the upside to undertaking the risks of entrepreneurship decrease, while the downside of not doing much at all are limited, it becomes hard to justify making the effort. If it is possible to live quite a comfortable life without too much bother, why take on the long hours, the worry and the headaches of small business ownership? You don’t need to take my word for this – the following excerpt is from an academic study, looking at the structure of incentives for entrepreneurship in Sweden, probably the worlds’ best known welfare state. Here is what the author concludes:

Sweden, allegedly the most extensive of all welfare states, is the object of the empirical analysis. It is shown how key welfare state institutions tend to reduce economic incentives both for opportunity-based and necessity entrepreneurship. Both aggregate economic performance and data on firm growth and direct measures of entrepreneurial activity are broadly consistent with the identified structure of payoffs. A number of measures can be implemented to strengthen entrepreneurial incentives within extensive welfare states, but the fact still remains that an entrepreneurial culture and a welfare state are very remotely related. As a result, the respective cultures are unlikely to be promoted by a similar set of institutions (Magnus, 2005, p. 437).

So here is the really chilling part about the proposed tax hikes. The Wall Street Journal on July 17 (“A Reckless Congress” page A14), citing research by the OECD and the Heritage Foundation found that the top average US tax rate (combined state federal marginal tax rate) would hit 52% should the Obama budget and House health-care plan become law. In some states, such as New York and New Jersey, the rate would be 56.92% and 57.07%, respectively. What’s the marginal tax rate in Sweden? 56.44%.

All this and the US taxpayer would not enjoy the benefits of a true welfare state - excellent, inexpensive, state-funded universities, ample unemployment benefits, child assistance benefits and, yes, government funded universal health care.

Those of us, myself included, who believe that it is entrepreneurship that drives economic vibrancy should be doing everything in our power to persuade the stewards of our country’s well-being to stop this train wreck in the making. Or perhaps the Journal editorial writers said it best:

The world is looking on, agog, and wondering why the United States seems intent on jumping off this cliff.

REFERENCES:

Baumol, W. J. 1990. Entrepreneurship: Productive, Unproductive, and Destructive. Journal of Political Economy, 98(5): 893-921.

Magnus, H. 2005. Entrepreneurship: a weak link in the welfare state? Industrial and Corporate Change, 14(3): 437.