Thursday, April 9, 2009

The Dao of Strategic Assessment (11): Assess, Never Assume

/// Have been sitting in the archives. Forgot to post it.

I am a big fan of Tom Friedman. Enjoyed most of his books. However, this is one time Mr. Tom believed his press report of "everything he say is perfect."

In his Feb article on risk-takers, Mr. Friedman did not know about the low success rate of launching a startup. For every Google, there are many startups like Profusion. Interestingly, he also did not stated the ratio between successful startups and failed startups.

Many years ago, I read an article on the success rate of VC investment. It stated that 10 out of every 100 startups succeed within the first year. From those 10 startups, about 50% succeeds in surviving the second year. By the third year, 50% of that number survives. The road to success is never easy for the VC and the entrepreneur

Mr. Friedman's poor assumption means that he did not assess the grand picture of venture capital properly.


Another Reason Friedman's Wrong: Most Startups Bomb
Joe Weisenthal| Feb. 23, 2009, 1:23 PM|

Earlier, John Carney pointed out a major flaw in Tom Friedman's plan to subsidize the VC industry and startups. Top investors aren't wanting for cash, so any government money would flow towards lower tier investors, and lower tier companies, likely leading to a big mis-allocation of wealth.

Here's another big problem. Innovative startups aren't the cure-all they're made out to be.

Sure, it'd be great to plant the seeds of another 100 Googles, but alas, most startups aren't Google. Actually, most startups crash and burn. Just look over the last few years. Even in the absence of extra government money -- just a normal market scenario -- investors seeded way too many trash companies. Companies got funding despite ideas that were so half-baked you knew they were DOA the moment you heard of them. They still are, even today. And the data bears this out.

The American magazine looked at the 'startup myth' in a piece from January: To get more economic growth by having more start-ups, new companies would need to be more productive than existing companies. But they’re not.

A study by economists John Haltiwanger, Julia Lane, and James Spletzer, published in the American Economic Review Papers and Proceedings, combined data from the U.S. Census and other sources to look at the relationship between firm productivity and firm age. The results showed that firm productivity increases with firm age. This means that the average new firm makes worse use of resources than the average existing firm, which is not what you would expect if economic growth benefits more from the creation of new firms than from the expansion of existing ones. And you shouldn’t think that the typical start-up makes up for its poor productivity when it gets older, because the typical start-up is dead in five years.

This is not to say that we don't need startups. Obviously we do, and some of our most significant quality-of-life enhancements come from innovative startups. But we suffer from mental selection bias, because we think of startups as though they're all potential Googles (a rare startup winner), rather than their most likely outcome, which is a total time and capital sink that should never have gotten off the napkin.

Here is a link to Thomas Friedman's article on startups

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