Why Founders Should Learn Economics

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With the genius of Elon Musk and other bright sparks of Silicon Valley flaunting their intellect on the world stage, you could…

Elon Musk – aka the smartest man in the room – might be an outlier / AFP / ERIC PIERMONT (Photo credit should read ERIC PIERMONT/AFP/Getty Images)

With the genius of Elon Musk and other bright sparks of Silicon Valley flaunting their intellect on the world stage, you could be forgiven for thinking that all the most successful entrepreneurs are pantologists – that is, experts in just about everything. In truth, however, the world of entrepreneurship is a broad intellectual church, with some evidence suggesting that successful entrepreneurs have a lower IQ than their contemporaries at university who don’t go onto start businesses.

Whatever the case, the difference between success and failure is about more than luck, and contained in the vast expanse of human knowledge there’s got to be information that can help entrepreneurs do better in business. If I had to suggest a modern subject that would be of most use to founders it would be economics (in the broadest sense). That’s why I caught up with Anthony J. Evans, Associate Professor of Economics at ESCP Europe Business School, and author of the excellent textbook Markets for Managers. He makes the case for why managers should have a grounding in the-not-so dismal science.

Philip Salter: What are the broad advantages of company founders understanding economics?

Anthony J. Evans: We tend to think of economics as being a way to understand the economy, but it is really a way to understand markets. It is the basis upon which we understand hidden costs and what constitutes value in the minds of our customers. So it helps us to make internal choices about the best use of our resources, but also the prices that are generated by market exchange provides valuable feedback on the wider industry.

Salter: Are the lessons of your book best absorbed by the CFO?

Evans: The book covers concepts such as Economic Value Added and internal markets, and these work well when implemented at the CFO level and applied throughout the organization. However in many cases this is unfeasible. So the book also explains how the concepts can be internalized and used on a daily basis – for example, having stand up meetings to become more sensitive to costs and betting on beliefs to incentivize sensible opinions.

Salter: What do you think are the most useful things managers should know about microeconomics?

Evans: Whenever I teach at the Executive MBA level I am surprised at how much scope there is to return to basics. Concepts such as consumer surplus (the difference between how much consumers are willing to pay, and the price that you actually charge) are often neglected and yet a good understanding of this is the basis for any effective price discrimination technique. I also think that traditional textbooks downplay the importance of microeconomics to the real word because they present concepts such as asymmetric information (when one party has better quality information than the other) as an example of market failure. I see information asymmetries as a market opportunity, and the book provides examples of how companies find creative ways to combat them.

Salter: What about macroeconomics?

Evans: One section of the book explicitly argues that entrepreneurs should ignore macroeconomic indicators and focus more on their “microclimate”. But, having said this, policy decisions can make a big impact on planning decisions and it is important to step inside the mindset of central bankers and government officials to understand why they make the decisions they do. Fortunately, a lot of macroeconomic wisdom can be contained in a few relatively simple models.

Salter: Do you think there would be a better survival rate among startup if founders had a better grasp of economics?

Evans: Yes, I do. I think a lot of startups chase funding and give up too much control. This makes them focus exclusively on growth, as opposed to the creation of real economic value. Start ups should expose themselves quickly to a market test as a feedback mechanism and take good management seriously. It is better to take a large cut of a meaningful project than an ever diminishing cut of a vanity project.

Salter: Isn’t there a case to be made for entrepreneurs going into it with a certain amount of ignorance though? After all, if they knew business survival rates isn’t it likely that they wouldn’t take the personal risk?

Evans: Indeed. One of the chapters focuses on behavioural economics and discusses things like the optimism bias and overconfidence bias. While many economists treat these as signs of irrationality an alternative way is to consider them as part of a broader collection of biases and heuristics that serve an important purpose. In many individual cases it is important to recognise the tendency for excessive optimism. But optimism can be important. We need optimistic entrepreneurs but they need to find ways to stack the odds in their favour as much as possible. A sound understanding of economics can help with that!

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