Some clear thinking about the uncertainty of the times

Justin Fox in his must-read blog revives Frank Knight’s Risk, Uncertainty, and Profit (one of my favorite books on economics) to give us all a much-needed pep talk about the current economy. Money quote:

Knight argued that making decisions was the job of an entrepreneur, and that business profit was the reward for for [sic] being willing to act in the face of uncertainty. This means, I think, that some people who aren’t sticking all their money into mattresses or Treasuries right now are going to make an awful lot of money over the next few years.

Even in this recession, I’m running a thriving small business and start-up consultancy. For almost everyone I’ve dealt with, the first question out of their mouth is, “Should I hunker down and wait this out or should I invest in growing?” I’ve had small business owners plausibly ask if they should reduce everything – lay off employees, advertising, everything, and just ride out the recession with the profits built over the years.

I almost never go that route. I believe that recessions are about reorienting your strategy, revamping and rehabilitating your relationship to your customers, and investing in your business to take all the customers your rivals are shedding.

The most relevant aspect of recessions for start-ups is this: the big players don’t have their eyes on the ball. Small businesses and start-ups, no matter what the business climate, face their stiffest obstacles from the biggest players who are not always willing to play fair to keep you from making a beachhead. Stealing patents, slash-and-burn pricing, threatening distributors – all of these are usable and successful tools in the big players’ toolboxes.

The response of big players is to business downturns is to cut back. Almost to a person, the folks at the big companies are laying off, cutting investments, cutting back distribution channels, and ignoring the little guys. They stop paying attention to the start-ups (after all, what silly billy would start a business in this economy?).

I’ve actually done considerable quantitative work on this in a study I did last year measuring competitive response by major players in three different industries across business cycles. While business upturns produce the greatest number of successful start-ups, successful competitor response goes way, way down during downturns. Whatever else is working against you in a recession, your competitors aren’t. The competitive barriers to entry go significantly down, which is why business cycle shake-outs often end up with more new players on the board.

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