Archive for the ‘SME’ Category

The Virtues of Local Ownership

There’s plenty in the news these days about the supposed virtues of “buying local.” Buying local usually means buying from small businesses. As I’ve argued before, in at least some cases buying local also means opting for small-scale, inefficient production processes. And in other cases, it means an unhealthy kind of insulation from the outside world.

But what about the virtues of specifically local ownership, when the ownership in question is ownership of what is otherwise a standard-issue department store, replete with goods ‘Made in China,’ as the stereotype goes?

The New York Times recently reported on an effort by a small town in upstate New York to ensure its residents have access to some sort of local department store. When the local Ames department store went out of business a few years back, residents of Saranac Lake — pop. 5,041 — took matters into their own hands. They raised the capital, at $100/share, to open their own department store.

It’s a charming story, and an interesting experiment, but we ought to exercise some caution before attaching too much significance to it.

First, it will be tempting to see this as radical re-visioning of modern capitalism. To see examples of such a temptation, see the 2004 Avi Lewis and Naomi Klein documentary, The Take, about the takeover of a defunct Argentinian factory by its former employees. Lewis and Klein portray that takeover as an example of the pursuit of a real alternative to capitalism — despite the fact that the cooperatively-run factory is still buying inputs on the open market, selling goods on the open market, and so on.

Were it not for movies like The Take, it might go without saying that innovations in ownership structure don’t eliminate the fundamental challenges of capitalism, and certainly don’t eliminate the standard ethical issues that face all businesses. The department store in Saranac Lake is — setting aside a few nods to local sourcing — just a regular department store. It’s got employees, so it will face questions about how those employees are treated. It’s smaller than your typical Walmart, but it will still face questions (or at least it should) about where its products come from, the conditions under which they’re manufactured, and so on. And its managers will still face questions about how to balance the good of the community as a whole with their obligation to be fiscally responsible. And so on.

Not that we need to be entirely cynical about the Saranac Lake experiment, and others like it. There’s at least a prima facie case to make for the significance of local ownership. Managers of a locally-owned store have at least some sense of what kinds of things shareholders would want them to do, and hence seem less likely to violate the trust placed in them. When you know your shareholders by name, you can ask them what they want, and they can tell you what obligations they feel to the community, and they can then ask you, their representative, to make good on those obligations.

In the end, I think experiments in capitalism are good. Indeed, the way it fosters experimentation is one of the great virtues of capitalism. We ought to keep a careful eye on such experiments, both for what we can learn about their particular virtues, and for what we can learn about the nature and structure of capitalism more generally.

Walmart & Free Shipping: Who Will Suffer?

Once again, Walmart is making headlines with a business practice that will be good for its customers, and bad for its competitors. Here’s the story, by Stephanie Clifford for the NYT: Wal-Mart Says ‘Try This On’: Free Shipping

For years, Wal-Mart has used its clout as the nation’s largest retailer to squeeze competitors with rock-bottom prices in its stores. Now it is trying to throw a holiday knockout punch online.

Starting Thursday, Wal-Mart Stores plans to offer free shipping on its Web site, with no minimum purchase, on almost 60,000 gift items, including many toys and electronics. The offer will run through Dec. 20, when Wal-Mart said it might consider other free-shipping deals….

Not surprisingly, Walmart’s competitors are alarmed. Smaller on-line businesses don’t get the kinds of sweet shipping rates that Walmart gets from UPS and FedEx, and they don’t have the regional distribution centres that allow Walmart to keep its shipping costs low. It’s pretty clear that this move by Walmart is going to put serious pressure — maybe even fatal pressure — on some of its competitors.

Just 2 quick points to make:

1) It’s worth noting (for the benefit of those who don’t know) that Walmart’s profit margins are already razor-thin. Yes, the make big profits overall, but that’s due to their mind-bogglingly huge volume of sales. On a per-sale basis, their profit is very small. So the money for shipping a given product (for free) isn’t coming out of the profits on sales of that product — the profits just aren’t there. Something has to give. One possibility is that it really is a short-term gimmick, perhaps intended precisely to drive competitors out of business. That would potentially count as an instance of predatory pricing, which would be at least arguably unethical and potentially illegal — in spite of the short-term benefits to consumers.

2) Normally when we think about Walmart’s effect on competitors, we think about its effect on its very small competitors, the ‘mom & pop’ operations. But I wonder whether that’s the case here. I’m no expert on the structure of the industry, but it seems that the companies most likely to be hurt are Walmart’s large and mid-sized competitors, i.e., companies that occupy roughly the same strategy space as Walmart. It seems to me (and it’s just a hypothesis) that most small retailers will have significantly different business strategies than Walmart, and hence won’t be competing directly with Walmart in ways that would let them fall victim to this latest maneuver. If I’m right, then if Walmart really can sustain this free shipping policy (and they haven’t claimed they’ll even try to) it would be very bad for its medium-sized and large competitors. If that’s the case, will people have the same kinds objections as they tend to have when Walmart’s consumer-friendly strategies are instead bad for small businesses?

Venture Capital: Lessons for Business Ethics (part 2)

Yesterday I posted the first of two blog entries on Ethics in Venture Capital. This is the second.

I noted yesterday that the relationship between venture capital (VC) firms and entrepreneurs is fraught with ethical challenges related to bargaining, information, control, and short term-ism. Those worries tell us something about the world of venture capital; but what do they tell us about business ethics more generally?

The key lesson, I think, is one I learned from Gary Pisano’s book, Science Business, though it isn’t a major theme of that book. The lesson is this: a funding model is also typically a governance model. This insight is at a very coarse level summed up by the old aphorism that “he who pays the piper calls the tune.” In business terms, providing financing means paying the piper. Governance is about getting to call the tune.

This is closely linked to the core lesson from another favourite book of mine, Henry Hansmann’s The Ownership of Enterprise. Hansmann’s book is an attempt to explain the patterns of ownership and control we observe when we look at the range of business firms that populate a market economy. When you look around at complex organizations like modern corporations, most of them tend to be owned by shareholders but managed by professional managers. What is it that explains how pervasive that particular setup is? Lots of other models are possible — partnerships, employee co-operatives, consumer co-ops, and so on. Law and even tax policy in most modern economies both permit and sometimes even encourage these other models, yet the shareholder-driven corporation dominates in most industries. Why? To make a long story short, Hansmann’s thesis is basically that the patterns of ownership we see can best be explained in terms of different stakeholders a) interest in, and b) ability efficiently to accomplish, effective oversight of managers.

So, back to VC. When VCs invest in firms, they often essentially assume ownership: they buy an equity stake in the firm and exercise control (via Board membership, among other mechanisms). But why are VCs involved at all, rather than other sources of funding, like employees or banks or non-expert shareholders? Basically, in Hansmannian terms, because VCs are better able to a) bear the risk involved in ownership of a startup company, and b) exercise the kind of knowledgeable control over the company (via supervision & sometimes appointment of managers) to make the risky investment worthwhile. But as I noted yesterday, the specific kind of (short-term) interest that VCs have in the firms they invest in raises a special set of ethical issues that look somewhat different from the issues faced in firms funded in other ways.

The lesson: if we want to understand the ethical challenges firms face, and why they do the things they do, we need to think in a detailed way about who owns them, the goals those owners have, and the extent to which the owners are exercising effective control.

Ethics in Venture Capital

This is the first of two blog entries on ethical issues in venture capital.

Venture capitalists are investment companies that specialize in careful investment in high-risk ventures that provide the possibility of exceptionally high returns, typically in specialized technology-driven industries like biotech and information technology. Venture capitalists (VCs) are a source of funding for small companies that need a serious infusion of cash (typically from a few hundred thousand dollars to a few million dollars) but that are too small (and with too little short-term promise of profit) to raise money via the stock market. In addition to providing funding, VCs typically provide startup companies with mentoring, providing advice, business connections and management expertise that might otherwise be lacking.

The relationship between VCs and the entrepreneurs they provide funding to raises some special ethical challenges. Here are just a few:

1) Bargaining power. VCs typically provide funding to companies that are fairly desperate for money. Add to that the fact that VCs are typically seasoned industry insiders, whereas the entrepreneurs seeking funding may never have been in business before at all. He or she might, for example, be a university scientist who knows a lot about cancer drugs, but nothing at all about the world of business and finance. As a result, there’s a worry that VCs will often be able to impose conditions that are highly advantageous to themselves, and much less good for the entrepreneur. Whether that imbalance ends up being unfair is a matter for debate.

2) Information. The companies VCs invest in are typically recent start-ups; often all they’ve got going for them are a few smart people and what they take to be a great idea. In order to justify investing, VCs engage in an intensive process of due diligence, essentially insisting on a level of access to information otherwise reserved for insiders. Sometimes they sign non-disclosure agreements, but sometimes they don’t. The result is that VCs end up with inside information not just about the companies they actually invest in, but also about the companies they consider investing in — and some VCs will look at proposals from several hundred companies per year. This raises obvious risks related to confidentiality, insider trading, and the protection of intellectual property.

3. Control. Because their investments are so risky, they typically insist on being given considerable control in exchange for their investment. For example, VCs may insist on being given seats on the company’s Board of Directors. This raises questions of loyalty and conflict of interest. VCs seek Board seats in order to protect their interests; but Board members have fiduciary obligations to promote the interests of the company as a whole, which may at times be different from the interests of the VCs.

4. Short Term-ism. The time-horizon for VCs is relatively short. Their investments typically take the form of cash in exchange for shares (often preferred shares) in the company. The idea is generally to nurture the company through early-stage growing pains, help it grow into a company that can either go public (via IPO) or be bought out by a bigger, wealthier company. Typically VCs cash out in 3-5 years; if things have gone well, they reap a very significant profit. The result is that VCs have a pretty short-term interest in the companies they invest in. They care about growing the company, making a profit, and getting out. They are typically seen as having very little interest in the long-term interests of employees or other stakeholders. This is the source of the common joke that “VC” actually stands for “vulture capital.”

In my next blog entry, I’ll consider what we can learn about business ethics more generally by thinking about ethical issues that arise in the world of venture capital.

Here’s the Wikipedia page on venture capital.
One of the few scholarly works on VC ethics: Yves Fassin, “Risks in Business Ethics and Venture Capital,” in Business Ethics: A European Review, Volume 2, Issue 3, pages 124–131, July 1993

Addendum (Aug. 12, 2010)
A friend of mine who is a venture capitalist suggested the following excellent clarifications regarding timelines. First, the 3-year time horizon mentioned above is mostly for later stage deals. VCs that invest at earlier stages usually have 5+ year time frames. VCs that invest in start-ups have 7-9 year time frames. Second, even the 3-year time horizon for later-stage deals is not all that short — not compared to the even shorter time horizons of stockholders in publicly-traded companies, which are typically under pressure from Wall Street to produce quarterly results.

Ethics and the SME

Here’s a very nice short article on business ethics, with a particular focus on SMEs (small and medium enterprises).

By Hendri Pelser, writing for Times Live (South Africa), Play fair and you will win:

With the effects of the global credit crunch still with us, it is pertinent to consider business ethics – the lack thereof helped create the recession.

But how does one approach business ethics? In the academic world, it is a philosophical discipline. For companies, it’s often a large volume of rules and regulations.

In the arena of small and medium enterprises, however, it simply comes down to the way you and your business behave – and decision makers face a myriad ethical challenges every day. These range from the way the tea lady is treated to the non-payment of suppliers or even bribes and kickbacks….

This piece is nice in a number of ways. Too little has been written, generally, about ethical challenges faced by SMEs, and this article says a lot of smart things about that. But the article really is a good brief primer on business ethics, and an interesting read throughout.

My one quibble is with the title of the article, which is misleading (but which probably wasn’t chosen by Pelser, so it’s not his fault). Nothing in the article actually implies that if you play fair, you’ll win. Certainly there’s a suggestion that good ethics leads to a good reputation, which in turn can help a business achieve success. But the relationship between ethics and business success is clearly complicated. In some cases, success is what gives a business a bit of leeway to engage in the kind of overt ethical behaviour that will build its reputation. In such cases, the truth is closer to “win, and you can afford to play fair.” Also, it just cannot be denied that in at least some cases, you’ll play fair and lose. Or, more generally, there are situations in which you’ll lose no matter how you play — perhaps because other companies have better products, better staff, better marketing, economies of scale, whatever. That complexity, of course, is precisely what makes ethics in business a challenge. If acting ethically were a straightforward recipe for business success (and if it were uncontroversial just what counted as acting ethically), we’d see a lot less unethical stuff going on in the world of commerce.

Boycotting BP is Futile and Unethical

Do not boycott BP.

I know you’re mad. I am too. But a boycott won’t accomplish any of the things you’re trying to accomplish. And it’s unethical.

The push to boycott BP (as a punitive response to the Deepwater Horizon oil spill, obviously) comes from the advocacy group Public Citizen, which encourages you to: “Boycott BP: Take the Beyond BP Pledge today!” There’s also the inevitable Facebook group, Boycott BP.

This move is well-intentioned, but entirely wrong-headed, for a number of reasons.

The first reason has to do with alternatives. Sharon Begley at Newsweek, with the sarcastic title “Boycott BP! Because it’s much better to give your money to Exxon.” It’s highly unlikely that those who participate in this boycott are going to eschew gas purchases altogether. With a few exceptions, they’re much more likely to simply start buying their gas at the non-BP station down the street. And, as Begley points out, as far as the oil companies providing the oil go, good luck finding one that meets your high ethical standards — or even minimally decent ones. Every oil company you can name is in roughly the same moral category. So boycotting BP just means jumping out of the frying pan and into the fire.

Second, there’s the fact that a boycott of BP gas stations won’t actually hurt the organization you’re trying to hurt. In practice, “boycotting BP” means boycotting BP-branded retail outlets. And as an editorial in the LA Times pointed out, “BP stations are independently owned, so a boycott hurts individual retailers more than London-based BP.” So, sure, boycott BP stations — that is, if your goal is to hurt a bunch of small businesses already operating on razor-thin profit margins. Put a few minimum-wage gas jockeys and cashiers out of work. The difference simply will not be felt at BP’s head office. (The same naturally goes for vandalism of BP stations, which is both unethical and criminal.)

Finally, there’s the question of tokenism. Buying gas for your car is far from the only way many of us indirectly buy from BP on a regular basis. As “DanH” points out in the Comments section of this blog entry, (see comment at June 3rd, 2010 2:52 pm) BP also makes home-heating fuel, airline fuel, ingredients for plastics, and the natural gas from which much electricity is generated. Oh, and solar panels — BP makes those, too. If you want to make this boycott real (which you shouldn’t) you’ve got to boycott those things, too.

Can consumers take action? Sure they can, by doing things — long-term things — to reduce their reliance on fossil fuels. They can also write their elected representatives to encourage tougher regulation of risky practices like deep-water drilling. And so on. I know, I know: in the immortal words of Homer Simpson, “But I’m mad now! Well, then direct the righteous indignation you’re feeling now toward change that will make the world better for the future.

It’s fine to be angry about this disastrous oil-spill. Being angry is entirely appropriate. And it’s good to want to do something. But do the right thing, not the first thing that comes to mind.

(Tip of the hat to AP.)

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