Growthology

What’s the Best Way to Hire Employees?

New research by Stephen V. Burks, Bo Cowgill, Mitchell Hoffman, and Michael Gene Housman (paper available here) looks at the performance of employees hired as a result of a referral vs. those hired from other sources. They knew from previous research that referred employees often performed better, but couldn't explain why.

Through their research, they found that, relative to non-referred workers, referred workers are a better deal, even though both groups have similar characteristics and score similarly on standard productivity measures. Referred workers:

• Are less likely to quit
• Are more innovative
• Have fewer accidents

The graphs below shows worker likelihood of quitting based on referral status:
Referrals result in employees who are better suited for the job at hand, which, their research found, makes them 25 percent more profitable than non-referred workers. (See the math in Table 16 below.) Also of note, is that "people tend to refer others like themselves, making referrals from high productivity workers especially valuable."



The practical take-away here for entrepreneurs? If you can find employees through referrals from trusted sources, do so. If you don’t have one already, start an official employee referral program to find the best-fit candidates. If you already have such a program, you’re good to go for now. The authors are planning future research to explore the benefits of expanding existing employee referral programs.

Signaling and Investor Preferences

I mentioned last week a paper by Jing Chen on serial small business owners. From the same special issue of the Journal of Economics & Management Strategy is another paper, "Show Me the Right Stuff: Signals for High-Tech Startups" by Annamaria Conti, Marie Thursby, and Frank T. Rothaermel (available online here [gated]).

The authors construct a theoretical model to examine the influence that (i) obtaining patents and (ii) receiving financing from founders, friends, and family (FFF) have on follow-on investments by angel capitalists and venture capitalists in high-tech startups. They then analyze data from 226 startups that went through the Advanced Technology Development Center at Georgia Tech (ATDC).

Conceptually speaking, patents and FFF investments serve as signals of quality to outside investors: willing to invest time and money in procuring a patent; willing to commit your own money and the money of close connections. What Conti, Thursby, and Rothaermal's analysis of the ATDC startups suggests is that angel investors and venture capitalists do not value these quality signals the same way: VCs put more weight on patents, while angels put more weight on FFF funding. That is, VCs appear to care more about the underlying quality of the startup's technology while angels care more about the commitment of the founders to the startup.

The implication for founders is that you should consider which signal to invest in depending on who you want to target for follow on funding; or if you have already invested in one versus the other, know which audience to target going forward. Both patents and FFF funding represent different costs and appear to have significantly different values to different types of investors.

Serial Small Business Ownership

Serial entrepreneurs generally do better with their subsequent businesses than first-time entrepreneurs do with their first business.This has led to the belief that serial entrepreneurs' previous business experience sets them up for greater success with their subsequent ventures. However, it is also possible that serial entrepreneurs simply have better ability at the start.

A forthcoming paper, "Selection and Serial Entrepreneurs" by Jing Chen (available online here [gated]), looks at this issue among small business owners and the self-employed and finds that natural ability of serial business owners is the dominant factor for why they do they better; that is, their success is independent of previous venture experience.

Chen looks at self-employment and serial business ownership data from the National Longitudinal Survey of Youth 1979 dataset from 1981 to 2008. There are a lot of caveats about the data used, which focus on self-employment and small businesses, so to the extent findings extrapolate to growth-oriented startups is debatable. For example, 43 percent of the serial entrepreneurs changed industries with their subsequent businesses. So when Chen finds that entrepreneurial experience does contribute to improved outcomes when those entrepreneurs start a subsequent business in a familiar industry (rather than changing industries), it casts some doubt in my mind about the degree to which experience is or isn't influential. Regardless, the study highlights the role of innate entrepreneurial ability, specifically for small business owners and the self-employed--natural ability appears to have a dominant effect on firm performance.That is, the generalized implication is that innate ability perhaps matters more than experience.

Disclosure: The Kauffman Foundation is supporting a data module being added to the National Longitudinal Survey of Youth 1979 (NLSY79), the author's source data for this study, and the special issue of the journal this paper is published.

Is starting a business in your home area a good thing?

The Kauffman Foundation is interested in how geography affects entrepreneurs these days (here, here, and here), so when I came across a paper about entrepreneurs’ location choice, it piqued my interest.

"Home sweet home: Entrepreneurs' location choices and the performance of their ventures," a fascinating paper by Michael S. Dahl and Olav Sorenson (available here), looks at Danish data to determine if where entrepreneurs choose to start their businesses affects how well the new business performs.

Entrepreneurs, more so than employees, tend to live in the area of their birth, or to start companies in places they have lived for a long time. As we might expect, Dahl and Sorenson discover that "Ventures perform better – survive longer and generate greater annual profits and cash flows – when located in regions in which their founders have lived longer." Logically, as they know the area well and have numerous connections that help their new businesses, most importantly with raising capital and staffing the venture.

There were a few additional findings also of interest that arose from the examined data. Companies tended to perform better when founders were:

• Male
• Married
• Had higher levels of education
• Had wealthier parents
• Around the peak age of 42

Founders’ prior experience in the industry also adds to the odds of greater success for the business, especially if they are already familiar with the region as well. The authors note:

That fact raises interesting implications for the understanding of agglomeration. In general, the literature on agglomeration has assumed that firms must cluster to benefit from collocation. Our results, however, suggest that rational entrepreneurs would enter the industries in which they have employment experience and locate their businesses in the regions in which they have lived. Since acquiring experience at some existing firm in the industry generally implies living in close proximity to it, the implication of these constraints is that entrants in an industry will disproportionately emerge in regions that already have dense populations of firms in the same industry even if co-location itself offers no advantages [author emphasis] (Sorenson and Audia 2000).

So yes, start your business wherever "home" is for you. Being well-educated and having prior experience in your company’s industry would also help.

Search Engine Marketing - Worth It?

I am reading a very interesting paper by Thomas Blake, Chris Nosko, and Steven Tadelis about eBay and search engine marketing. They find through an experimental design that there is virtually no significant effect on eBay sales when they stop paid keyword search placements. One of the critical factors was using Google’s ability to tweak keywords for different geographies. They find that while new or infrequent users are drawn in by the search ads, their sales are minimal compared to the swath of repeat customers who don't need the ads to direct them to eBay. There is a discussion of implications about the (lack of) value of search engine marketing for large, established companies in the paper.

But startups are far from your typical large, established companies. I’m not sure how effective search engine marketing is for startups, and this paper doesn’t speak to that audience. What this paper does offer is some general evidence about organic versus paid search traffic, which is relevant to startups, particularly if one becomes more widely known. And it critically cautions against the pitfalls of a straightforward return on investment calculation (bold is my emphasis):

Not only do most consulting firms who provide marketing analytics services use observational data, recommendations from Google offer analytical advice that is not consistent with true causal estimates of ad effectiveness. As an example, consider the advice that Google offers its customers to calculate ROI:

“Determining your AdWords ROI can be a very straightforward process if your

business goal is web-based sales. You’ll already have the advertising costs for

a specific time period for your AdWords account in the statistics from your

Campaigns tab. The net profit for your business can then be calculated based

on your company’s revenue from sales made via your AdWords advertising,

minus the cost of your advertising. Divide your net profit by the advertising

costs to get your AdWords ROI for that time period.” [a footnote cites this quote to here].

This advice is very much akin to running a regression of sales on adwords [sic] expenditures, which is not too different from the approach that result in the inflated ROIs that we report in columns 1 and 2 of Table 5. It does not, however account for the endogeneity concern that our study highlights where consumers who use paid search advertising on their way to a purchase may have completed that purchase even without the paid search ads.

There’s nothing stopping from you conducting your own experiment if you wanted to go down that route.

Lessons for Entrepreneurs from Crowdfunding Redux

A couple of weeks ago, Mindee Forman highlighted some key findings from Ethan Mollick's research on crowdfunding. I'm seeing more and more papers crop up on this topic, including what I will be highlighting today, "Crowdfunding Creative Ideas: The Dynamics of Project Backers in Kickstarter," a working paper from Venkat Kuppuswamy and Barry L. Bayus (available here). The paper is interesting throughout and has some factoids about Kickstarter projects that I will not call attention to here.

This paper corroborates many of the findings that Mindee wrote about--that being featured on Kickstarter, having a video, and having a shorter project duration increases the chances of having a successful fund raise. While this may seem redudant, it's important in terms of research for different analysis to draw the same conclusions. We also learn some new information from Kuppuswamy and Bayus about attracting backers:

1. Smaller goals are more successful at being funded.
2. Many reward categories increases the chances for being funded.
3. A project with a colon in the title is correlated with successful projects [amusing, I wish they spent more time theorizing on this one].
4. Prior Kickstarter experience helps a little.

They also investigate donations along the funding cycle. They find that after initial backers sign on, an average project experiences a lull in attracting new backers, but makes a comeback once the deadline nears.

The authors interpret this in terms of the buzz or excitement a project intially generates, followed by a decrease in interest, followed by a pickup when the deadline approaches. Alternatively, to me this sounds like it could be a good samaritan dilemma--I see that someone else is already helping, so I don't need to contribute here; oh wait, this is more urgent than I thought, I should help!

In any event, Kuppuswamy and Bayus find that posting private and public updates as the funding deadline approaches helps quite a bit, which is significant because this is something under the project creator's control.

Lessons for Entrepreneurs from Crowdfunding

There is a lot of buzz out there these days about crowdfunding. As Kauffman Dissertation Fellow Ethan Mollick at the University of Pennsylvania’s Wharton School puts it, "Crowdfunding has been drawing substantial attention from policy makers, managers, and entrepreneurs, but relatively little notice from academics, even though it touches on many topics of importance to scholars of entrepreneurship."

His paper from last July, "The Dynamics of Crowdfunding: Determinants of Success and Failure" (available here), examined almost 47,000 projects on Kickstarter that raised a combined revenue of $198 million. Mollick concluded that several factors influence whether a project will succeed or not:

1. The greater the size of the founder's social network, the greater the chance for success (particularly Facebook in this case; this is also known as the 'be popular' strategy).
2. The underlying quality of the projects – those with high-quality, polished pitches are more likely to be funded (e.g., use a video; as Kickstarter's website states, "Projects with videos succeed at a much higher rate than those without.").
3. A strong geographic component tie-in seems to increase success (pitching country music in Nashville, film in Los Angeles, etc.).
4. A shorter Kickstarter duration is better (35 percent chance of success for 30-day pitches, 29 percent for 60-day pitches). Mollick noted that a longer duration implies a lack of confidence in the project’s success.
5. Being highlighted on the Kickstarter website is hugely beneficial (89 percent chance of success vs. 30 percent for unfeatured projects).
6. A large number of creative individuals in the city where the project is based is associated with greater success (target these kinds of people).

Geographic Distribution of Projects by Success

The circles on this map represent counts of Kickstarter projects by city; the larger the circle, the more projects based in that area. The shading within the circle reflects the portion that were successful—dark green represents successfully funded projects while light green indicates the project was not funded. Based on Mollick's research, odds are that the successfully funded projects in given cities were a good fit culture-wise for that city.

The Kauffman Foundation will be writing some papers on crowdfunding in the near future – stay tuned!

Venture Capitalists Prefer Vegetables

Very quickly before I start, I want to point out this research would conceivably extend to all investors that take a sizable chunk of preferred stock in a startup, not just venture capitalist (my opinion, not stated by the authors).

VCs have to work with founding teams and other common stock shareholders when they want to exit their investment, and as initial public offerings have decreased, trade sales, which were already common occurrence, have become even more prevalent in recent years. In a new paper, "Carrots & Sticks: How VCs Induce Entrepreneurial Teams to Sell Startups," (available here) Brian J. Broughman and Jesse M. Fried analyze 50 trade sales of VC-backed startups located in Silicon Valley.

Broughman and Fried investigate how VCs choose to persuade the entrepreneurial teams and common stockholders to make the sale—either through bonuses or carve-outs to common shareholders (carrots), or through force by terminating the entrepreneurial team, professionally blacklisting the founders, or trying to manipulate shareholder voting (sticks).  They find that VCs rarely overtly use sticks but do use carrots with some frequency—at least one carrot was provided to the entrepreneurial team in 45 percent of sales, and on average amounted to 9 percent of the deal value.

The practical application here is that you can hold out on a sale. The infrequent overt use of sticks suggests that VCs don’t want to hurt their reputation by being forceful. There are a couple of other discussion points in the paper you can check out for yourself. I give credit to the authors for writing in an understandable and non-technical manner.

Hat tip to Robert Strom for pointing out this paper.

Entrepreneurs Matter to Firm Growth

How much do individual entrepreneurs really matter to their firm’s performance? We intuitively suspect and anecdotally hear about how hugely important the individual entrepreneur is to a firm. A working paper by Sascha O. Becker and Hans K. Hvide, “Do Entrepreneurs Matter?” (available here) puts some numbers and analysis behind intuition.

Becker and Hvide look at roughly 65,000 Norwegian firms established between 1999 and 2007, in particular studying firms where the entrepreneur dies before 2009 (so firms are between zero and eleven years old in this sample). In this case, an entrepreneur is defined as an owner with at least 50 percent ownership, though most of the analysis focuses on entrepreneurs with more than 50 percent ownership (341 instances).

They find that firm performance drops significantly after an entrepreneur’s death relative to other similar firms that do not experience a death event: on average, four years after an entrepreneur’s death, sales drop by about 60 percent, employment drops by about 17 percent, and firms have 20 percent lower survival rates two years after the entrepreneur’s death. The effects appear to be long lasting and firms show no signs of recovering from them.

We can say with some certainty that there is causality here—that the entrepreneurs have a causal effect on the growth of the firm—because the authors conduct a series of robustness checks to address many potential questions about the strength of their findings.

No significant differences:

• Are the negative effects of an entrepreneur’s death only for firms that were performing poorly and would have had poor performance anyways? No, the effects occur for firms across all levels of pre-death performance.

• Are the negative effects of an entrepreneur’s death temporary (i.e. a period of turbulence and then return to normal)? No, the immediate effects are small relative to sustained effects that accrue over time.

• Do more mature firms fare better; does the age of firm matter? No, the negative effects are largely independent of the age of the firm, although more mature firms fare slightly better with survival rates.

• Does the age or gender of the founder matter; does the death of an older founder (60 years or older at founding) have less of effect? No significant differences are found.

• Do family firms fare better or worse; does it matter if the entrepreneur was married? No significant differences are found.

• Do firms in urban areas, with a greater and denser supply of entrepreneurs, which could serve as replacements, differ from firms in rural areas? No.

• Does the size of the firm matter? Only minor differences are found for small firms relative to large firms.

• Is the reverse happening: does poor firm performance lead to the entrepreneur’s death? The authors do not have data about the health of the entrepreneur or cause of death. However, they can compare the pre-death performance between firms that experience a death and those that do not and find there are no pre-death differences in performance. This suggests that death comes unexpected or that health issues are not significant enough to affect firm performance.

Some differences:

• Does the firm having team ownership matter? Yes, negative effects of the death of an entrepreneur still occur but are lessened. When Becker and Hvide lower look at owners with just a 50 percent share (204 instances) or a less than 50 percent share (495 instances), they find similar negative effects, but just less severe. For 50 percent owners, the effects are about half as large relative to greater than 50 percent owners (majority owners; the main analysis); for less than 50 percent minority owners, the effects are quarter the size of the case of majority owners.

• The loss of greater levels of human capital has a more pronounced negative effect. The death of entrepreneurs that are highly educated (more than 12 years of formal education) have greater negative effects relative to other entrepreneurs; firms that are in sectors that have on average a higher education level experience greater negative effects from a death event relative to firms in other sectors.

Getting back to the main findings, the authors do not know why there is such a stark difference between the drops in sales (60 percent) versus employment (only 17 percent). They suggest as one possibility that the entrepreneur has spillover effects on employee productivity which would hurt sales proportionately more (i.e. leadership in sales, or was a great salesperson), but don’t have strong evidence to present. This will be an area for future research.

I think this research serves as a precautionary tale to startups that will unfortunately face unexpected life events. Besides an entrepreneur’s death, other unexpected life events could see an entrepreneur suddenly removed from their firms. I am not convinced this research extrapolates to founder removal due to internal firm conflicts where a decision is made (either by majority of co-founders or investors), because those decisions are made by choice.

Following Fads: Evidence from Software Firms

Elizabeth G. Pontikes and William P. Barnett have a working paper about "salient events" and entrepreneurial entry, "When to Be a Nonconformist Entrepreneur? Organizational Responses to Vital Events" (available here). I don't have much additional commentary to offer on this as the authors do a good job of giving the practical implications in the abstract (bold is my emphasis):

Salient successes and failures among organizations, such as spectacular venture capital investments or agonizing bankruptcies, affect consensus beliefs about the viability of particular markets. We argue that such vital events lead to over-reactions in the organizational entry process, with new firms flooding the market after salient successes and a dearth of entries after salient failures. Particularly notable are the implications of nonconformity under these conditions. An entrepreneur who bucks the consensus and enters a market after salient failures must endure considerable scrutiny, and so is likely have a strong fit to that market. Such a nonconformist will be spared from a passing fad, whereas an entrepreneur that follows trends is more likely to enter markets that are not a good fit for the organization. So we propose that in the wake of salient vital events nonconformity is a preferable approach. We find support for this idea in an analysis of software firms: Organizations that enter a software “market space” after salient bankruptcies are especially likely to remain, while those that enter a space after high-profile venture capital funding events are especially likely to leave.

Don't follow the crowd--I would imagine a comforting research finding for many entrepreneurs and startups out there facing headwinds.

But do you trust me?

Last week for Practically Friday, Jared examined conflict resolution looking at evidence from married couples. This week for Valentine's Day, we look at something essential to any successful relationship, whether business or personal: trust.

Just as there are many reasons a person chooses a spouse, numerous factors determine whether or not venture capitalists or angel investors will fund a company. The traditional and most frequently studied reasons include market size, past performance, and the company's future projections. But that's not everything. "This approach, widespread though it is, fails to consider that an investment in an early-stage company is a decision to commit to a business idea and, just as importantly, to an entrepreneur who will lead the business idea," says Kauffman Dissertation Fellow Lakshmi Balachandra, an assistant professor at Babson College. In her Ph.D. dissertation (abstract and executive summary here) she examined two research questions regarding the role an entrepreneur's perceived trustworthiness has in an investor’s decision to provide capital:

1. How does the assessment of an entrepreneur's trustworthiness impact an early-stage investor’s interest in investing? For example, will entrepreneurs with economically viable/sound business models be considered for investment even if they seem untrustworthy? and
2. To what extent do behaviors and cues presented by the entrepreneur influence the investor to trust them and decide to invest in them, as opposed to economic aspects of the business?

To determine how trustworthiness played a role in funding, Balachandra looked at 101 videos of entrepreneurs pitching to angel investors and analyzed them based on the ultimate investment decision, post-pitch survey results, and the demographic information of the involved parties, as well as third-party ratings regarding the behavior of the entrepreneurs during their pitch. Her results were as anticipated:

Investors’ assessment of the entrepreneur’s trustworthiness following the pitch directly impacts and moderates any interest in investing that they had from evaluating the economic factors of the business. I found that, as hypothesized, the economic factors of the venture are the primary consideration for angel investors. However, the investors' evaluation of the trustworthiness of the entrepreneur directly influences the way the investors then assessed the economic factors of the business. That is, when investors found the entrepreneur to be trustworthy, they rated the economic factors as more attractive as well.

The difference? A full 10 percent: "when entrepreneurs 'pitch' more trustworthiness, they are 10% more likely to have investors interest[ed] in investing in their business." So what qualities made an entrepreneur appear more trustworthy? Coachability or character (who a person is) mattered three times more to investors than competency (aptitude at a point in time and prior experience).

In considering if they can trust the entrepreneur from his/her pitch, investors must believe they can make up for any lack of competency of the entrepreneur. For example, if an entrepreneur doesn’t know financial accounting, a professional accountant can be hired to fill this knowledge gap. This is in stark contrast with character: there is no way for an investor to compensate for differences in character which I measured as coachability in my study. This quality is critical to the investor since if the investor invests, the investor will be working with the entrepreneur for the foreseeable future.

So what did these entrepreneurs actually do to appear trustworthy? (Since this is Practically Friday and all.) Most importantly, they:

1. Had a higher level of speaking skills and presentation ability (character and competency).
2. Had a greater number of social network connections, indicated by name-dropping (character and competency).
3. Were open and accepting of suggestions, feedback, and critiques (character).
4. Had a similar background/experience to the investor (character).
5. Tended to be younger (character).
6. Laughed more often (character).

While some of these cannot be changed (age and similarity to the investor, for example), others are in your direct control as an entrepreneur. So take a public speaking/presentation class, get out there and meet people, and make sure to relax and laugh during your pitch to investors. It just might make the difference between getting funded and not. Appearing (and being) more trustworthy can only help with those pesky romantic relationships, too.

Conflict Resolution: Evidence from Married Couples

Founders are kind of like married couples in terms of the intensity and importance attributed to arguments, right? If you follow me on that point, then the forthcoming paper (working paper available here) “A Brief Intervention to Promote Conflict Reappraisal Preserves Marital Quality Over Time” by Finkel et al. could help you with conflict resolution.

Married couples that were tasked with reappraising a recent significant argument from a third party perspective reported significantly greater marital satisfaction than those that did not receive in the intervention.

The intriguing aspect is that the intervention was very brief—devoting just seven minutes once every four months. Additionally, the authors find the intervention was just as effective for newlyweds as it was for long-married couples, so it appears the intervention would be effective regardless of your business’s development stage.

Does sitting down to think about your feelings sound silly? Depends on the person. More importantly, does it work? It was highly effective in this study. I’ve adapted the prompts in the paper (pages 6-7), substituting startup terminology for original references to marriage.

Write down your most significant conflict from the past four months, or more specifically, provide a “fact-based summary of the most significant disagreement… focusing on behavior, not on thoughts or feelings.” Now, think about it again:

1. Think about the specific disagreement that you just wrote about having with your business partner. Think about this disagreement with your business partner from the perspective of a neutral third party who wants the best for all involved; a person who sees things from a neutral point of view. How might this person think about the disagreement? How might he or she find the good that could come from it?
2. Some people find it helpful to take this third party perspective during their interactions with their business partner. However, almost everybody finds it challenging to take this third party perspective at all times. In your relationship with your partner, what obstacles do you face in trying to take this third partner perspective, especially when you’re having a disagreement with your partner?
3. Despite the obstacles to taking a third party perspective, people can be successful in doing so. Over the next four months, please try your best to take this third party perspective during interactions with your business partner, especially during disagreements. How might you be most successful in taking this perspective in your interactions with your partner over the next four months? How might taking this perspective help you make the best of disagreements in your relationship?

These directions really stress the importance and difficulty of taking on the third party perspective. It’s hard to do. We’re first person viewpoint people by nature. But if you can work on taking on that viewpoint, you could have much less conflict-induced stress.

Video Streaming Quality and Viewer Behavior

Startups and businesses that offer video on their website or on a mobile platform face a fickle audience. If videos don’t load or are frequently interrupted with buffering, viewers are more likely to abandon the video and not return to the site. These are the finding of study by S. Shunmuga Krishnan and Ramesh K. Sitaraman, “Video Stream Quality Impacts Viewer Behavior: Inferring Causality Using Quasi-Experimental Designs,” who analyzed 23 million video views from 6.7 million unique viewers (paper available here).

I am not terribly surprised by the results. We might intuitively expect video failing to stream smoothly or quickly would lead to viewers giving up on watching the video. But the authors importantly establish a causal link and offer some nuanced findings that I think are informative. My high-level takeaway is that as internet speeds increase, consumers become more impatient and expect better quality from video providers. Here are some selected highlights from the paper:

• If a video fails to start up within two seconds, viewers start to abandon the video, and the drop off is steep. However, abandonment varies by internet speed. Viewers with faster internet connections have less patience and abandon sooner. Mobile connections give a lot more slack.

• Longer videos get more slack to startup (lesser abandonment rate from delays in starting up) than shorter clips.
• Viewers who dealt with rebuffering interruptions and delays viewed the videos for less time.
• Viewers who have difficulties are less likely to return to the site, and this is persistent for at least a week.

Knowing this is important because abandonment rate, how long videos are viewed, and return viewers are all factors for generating revenue.

 

Band Camp, Judges, and Interviews

My overall point in this post is to say that interview timing and order matters a lot. Perhaps the early bird does get the worm after all. More nuanced explanations follow below after I present some stories and evidence. Now, onwards to the text…

Growing up, I played alto saxophone for a number of years. I played on my own and took lessons while also playing in the official school bands in middle school and for most of high school. And like many band members, I attended band camp—specifically for me, Midwestern Music Camp at the University of Kansas for an entire week (you stay at the KU dorms; you rehearse in Murphy Hall and perform at the Lied Center; very cool for a band kid etc.). I think I did this for four or five summers.

KU runs a very large camp, so they split campers into multiple bands depending on skill level. My recollection is that to decide skill level and chairs,¹ you audition with the department head of your instrument at KU. I’m foggy about the exact process, but I remember signing up for an audition time and spending hours in agony practicing and waiting before being able to get the audition over with. Don’t quote me on this, but I want to say that you could check-in and audition in the morning and afternoons over a two-day period (perhaps it was only one day; I can't remember).

I was not even the best saxophonist at my own high school, but overall I was fairly good. One of the later years I attended band camp, I made 2^nd chair in the top flight band, which I was estatic about. What displeased me, and to the best of my recollection the rest of the saxophonists in the band as well, was the skill level of the individual who was given 1^st chair. Frankly, this person was very mediocre. They misplayed all week long and at multiple points just dropped out of sections of songs entirely because they could not keep up with the music. I was very annoyed that this person was given 1^st chair ahead of me.

Perhaps it had something to do with the audition timing.

I’ve been a longtime reader of Ed Yong, who a couple of years ago highlighted a paper by Shai Danzigera, Jonathan Levavb, and Liora Avnaim-Pessoa that documents an odd trend in judge parole rulings (Ed Yong’s summary here; full paper here). Here is the most relevant chart from the paper:

What this shows is the proportion of parole rulings that favor the prisoner over an average day of rulings (tick marks on the x-axis note every third case). Data were collected from 1,112 hearings over a 10-month period. The dotted lines represent food breaks and effectively creates three ruling sessions each day. The chart shows that prisoners at the beginning of each session have a much greater likelihood of receiving a favorable ruling than those at the end of each session. This holds across the entire sample of judges and rulings (more controls for other variables and explanation are available in the full paper). What Danzigia and his co-authors theorize is that the judges' mental resources are used up early in each session, so they are sticking with the easier status quo decision as they tire out; the food breaks help judges reset. Whatever the interpretation, there is clearly some unfortunate bias against prisoners who receive rulings scheduled later in each session.

A recent paper by Uri Simonsohn and Francesca Gino analyzed thousands of interview timings of MBA students (gated full paper here; earlier working paper version here; press release summary here). They find that interview position matters here too. Over multiple days of interviews, what does an interviewer do if the best applicants all come on the same day, or even all on the same day right next to each other? Simonsohn and Gino find that an interviewer expects to recommend the same number of applications each day and that this constrains their ratings. Once they near this subconscious daily quota on each day, they are hesitant to approve additional applications from that day regardless of their overall merit. This means that interviews early in the day have a negative impact on interviews later in the day; if early interviews are given high scores, the subsequent applicants are more likely to receive lower scores regardless of the applicant’s characteristics. This effect grew even stronger as the day wore on.

I cannot remember what time of day I auditioned at band camp so many years ago. However, knowing myself, I would have been sleeping in and saved a couple of hours to practice at KU before the audition, so there is no way that I auditioned in the morning. If we assume I am objectively able to rate and compare my saxophone skills, I can say that I am now disappointed to now find out years later that logically it looks like my audition timing helped seal my second-best chair position. I perhaps did not look as strong in the afternoon as I might have in the morning.

I think the research I’ve summarized here extrapolates well to startups—who have to interview, pitch, and audition to various parties all the time—particularly the interpretation from the MBA interview paper that high scoring early on creates a bias against later candidates. This is particularly important to consider in the context of startup competitions or submission of competitive bids. I will weakly suggest that if you have an option, perhaps going early in a competitive scenario is better than waiting. The more powerful interpretation is something you have no control over—hope that your strongest competition isn’t interviewed or reviewed around the same time you are? Yikes, that’s depressing. Perhaps judges and reviewers should make sure to take plenty of breaks when they are reviewing and scoring pools of applicants.

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¹ Chair is music terminology referring to skill and seating position within a band or orchestra. The best player of a given instrument is 1^st chair of their section and second-best is 2^nd chair, and so on and so forth.

Negative Press, Boards, and Strategic Directions

To me, that bad press can be a catalyst for strategic change in a business is not a surprising research finding. That bad press can have no influence when a business is doing well is again not terribly surprising. These are some of the conclusions in a forthcoming paper, “Burr Under the Saddle: How Media Coverage Influences Strategic Change,” by Michael K. Bednar, Steven Boivie, and Nicholas R. Prince. The authors look at 40,000 articles covering 250 firms over the course of five years, analyzing how boards react to negative media coverage (abstract and gated copy of paper here; press summary here).

What I find a more interesting finding is that bad press has a greater effect on strategic change when a businesses’s board of directors is comprised of outsiders—independent board members with no previous ties to the firm’s management (such as being family, friends, or former business relationships).

I’m wary to post blasé “practical” advice like “be aware of the outside/insider composition of your startup’s board of directors.” I don’t find this kind of messaging particularly helpful, and I’ve sat through infinite numbers of talks/presentations with the bullet point “choose board wisely,” so I’m pretty sure people are hearing this message already. But when I read things such as Wasserman’s The Founder’s Dilemmas and see all the instances of founders being replaced at their startups (for various reasons), and then I see this research about insider and outsider dynamics in boards, I’m inclined to add some nuance to board composition and “choosing wisely.”

As your startup grows, it seems very likely that a board would grow to include both ‘insiders’ and ‘outsiders.’ These groups will have different behavioral characteristics, with one of them being the interpretation of bad news. Perhaps you can extrapolate this bad news sensitivity to a broader behavioral characteristic: outsiders place more weight on outsider information. That is, they are more willing to take cues from outsiders, for better or for worse. So as the composition of your board changes, perhaps adding more outsiders as the startup grows, be more prepared to deal with reactionary changes from any bad press. The struggle over strategy will be harder than it was in the beginning.

Downsides to Failure Tolerance

Ramana Nanda and Matthew Rhodes-Kropf have a working paper out titled “Innovation and the Financial Guillotine” (where guillotine refers to investors’ willingness to kill an investment). Having your startup choose a strategy of high tolerance for failure in theory helps your startup and your employees feel like they can take risks to try something very innovative. The same goes for investors (and governments)—choose to tolerate failure to promote innovation. When Nanda and Rhodes-Kropf modeled investment choice decisions and their interaction with failure tolerance, they find that choosing a broad strategy of failure tolerance leads to funding less radical innovation and more incremental innovation. The issue is that by promoting failure tolerance, you make it harder to kill projects. Not being able to kill projects is a risky proposition.

My interpretation is that simplifying your startup or investment choices by employing a broad strategy of failure tolerance is not a good replacement for project-by-project considerations (the authors sort of get at this but don’t say it directly, so I could be wrong).

Learning from business failure

There is a substantial body of research on the failure of new businesses. Among other topics, researchers have explored the causes of firm failure, the jobs destroyed by these business closings, and the impact of this churning on our economy more generally. In this post, we consider research that highlights a silver lining to the failure of a new business:  the benefits of this experience for a serial entrepreneur’s next endeavor. Yongwook Paik, a 2008 Kauffman Dissertation Fellow, examines the effects of prior firm-founding experience on subsequent firm performance in a paper based on research for his PhD dissertation in Economics (see executive summary here). 

Paik hypothesizes that prior firm founding experience increases both the human capital and social capital of serial entrepreneurs, allowing them to build the skills they need for greater success in their next endeavor. Using data from U.S. venture-capital-financed semiconductor firms that entered the market during 1995-1999, Paik analyzes the effect of founders’ prior firm-founding experiences on the survival rate and the annualized rate of return on investment in subsequent ventures.  He also takes into account selection effect of serial entrepreneurs and the role venture capitalists play by selecting the most promising new businesses and mentoring new companies. Comparing “serial entrepreneurs” (those who have founded a company previously) to “novice entrepreneurs (first-time founders), he finds that the survival rate of firms founded by serial entrepreneurs is substantially higher than that of firms founded by novice entrepreneurs, but that serial entrepreneurs do not see a greater annualized return on their investments.  Firm-founding experience, it seems, allows entrepreneurs to build the skills needed for early-stage firm survival, but not necessarily those that lead to greater financial success. In addition, he finds that the mentoring of venture capitalists helps a young firm survive in its early phases and results in a higher rate of return on investment.

This study offers significant insight into the way that entrepreneurs build the skills they need for later success and serves as an important reminder to venture capitalists and other funders of new businesses that serial entrepreneurs’ previous failures are not indicators of future failure.  In fact, these experiences may lead to greater future success.

Influences of Founder or Joiner Mindsets

Today we’re going to look at a working paper by Michael Roach and Henry Sauermann (disclosure: the Kauffman Foundation partially funded this research). The paper, “Founder or Joiner? - The Role of Preferences and Context in Shaping Entrepreneurial Orientations” can be accessed here. Personally speaking I am interested in emerging lines of research like this that shed more light on the employees of startups.

I think you should take away three primary things from this—(1) more PhD students report having a joiner orientation than a founder orientation, (2) social influences don’t appear to matter to forming a founder orientation, but they do for forming a joiner orientation (would have happened anyways), and (3) without individual preferences that relate to entrepreneurial job characteristics, social influence alone may not be enough to form founder and joiner orientations.

Survey work and descriptive statistics

The authors conducted a survey of 4,282 Science & Engineering PhD students at U.S. universities and asked them a number of questions about their interest in entrepreneurship. They coupled the survey with 50 qualitative interviews.

They categorize students into either having a “founder orientation” or “joiner orientation:”

• Founder orientation: Those who responded ‘definitely will’ or ‘likely will’ to “How likely are you to start your own company?”

• Joiner orientation: Those who responded ‘extremely attractive or ‘attractive’ to “Putting job availability aside, how attractive do you personally find a career in a startup with an emphasis on research or development?”

Based on responses to these questions, 11 percent of the students are categorized as having an orientation to being a founder, and 45 percent as having an orientation to joining a startup.

The authors then asked respondents to look back to when they first began their PhD program and rate their pre-existing orientation to entrepreneurship. As they note, this can be a little problematic. Anyone who likes entrepreneurship at the time of the survey could say “oh yeah, I liked it back then too” even if they did not. Nevertheless, they do find 73 percent of those with a founder orientation reported having pre-existing inclinations to entrepreneurship while only 50 percent of those with a joiner orientation did. This is interesting because it means that a founder orientation may be more likely to form earlier in life than a joiner orientation.

Additionally, these students with a pre-existing inclination are actually more likely to report their current orientation as joiner (65 percent) rather than founder (24 percent). The authors offer this potential reason “[this suggests] a longstanding interest in joining a startup may be more pervasive than a longstanding interest in founding one’s own company.” They find suggestive (i.e. not as clear as other findings in the paper) that those with pre-existing inclination are more likely to sort into schools or projects that are more entrepreneurial, but have little evidence that they match with faculty that have prior entrepreneurial experience.

Factors that influence founder and joiner orientation

Roach and Sauermann compared these founders and joiners to students who signaled orientation to working for an established firm, comparing individual preferences and social influences.

I’ve created these summary tables (all errors are my own). A plus sign (+) signals a significant difference and a minus sign (-) no difference. Two plus signs (++) means that there is significance and that the preference is stronger between either the founder or joiner.¹

Individual Preferences	Founders	Joiners
Autonomy	++	+
career advancement	+	+
risk tolerance	++	+
Money	-	-
desire for basic research	+	++
desire managerial activities	+	-

 

Social-Contextual Influences	Founders	Joiners
Department supportive of entrepreneurship	-	+
Advisor with entrepreneurial experience (mentors)	+	-
Their research perceived to have commercial value	++	+

The above tables include those individuals who reported having a pre-existing inclination to entrepreneurship. How do these orientations form for those who did not report a pre-existing desire to be entrepreneurs?

For these individuals, Roach and Sauermann find individual preferences as listed in the table above matter to forming both founder and joiner orientations, but the same cannot be said for social-contextual influences. A founder orientation is likely to emerge even in the absence of social influences (having an advisor with prior entrepreneurial experience and conducting research with perceived commercial value), whereas some social factors (supportive department and perceived commercial value of research) do appear to affect the emergence of a joiner orientation.

All in all, I think this is an inteesting line of research and am particularly curious to see the authors follow these students and find out how orientation translates to actual startup activity.

 

¹ E.g. Both founders and joiners have significant preferences for autonomy relative to those who have established firm orientations, but the difference is even stronger for founders.

Cracking the Code: How Successful Entrepreneurs Build High-Growth Companies

A recent paper from Ernst & Young and the Kauffman Foundation looks at the cadre of 636 E&Y Entrepreneur Of The Year finalists from 2012 to see what makes them tick. These companies are high-growth and tend to produce disruptive innovations. They’re also not small – in the U.S. 95 percent of firms have fewer than 50 employees, while in this group only 18.2 percent fell into that size range.

In looking at these finalists for the Entrepreneur Of The Year (EOY) awards, eight key findings on why these companies succeed came to light that could be of use to other entrepreneurs and to would-be entrepreneurs. Here they are for this week's installment of Practically Friday:

1. Have a unique perspective on risk

   As Magnus International Group founder Eric Lofquist put it, "It's funny – looking back, I never thought any of it was risky. Feeling so strongly about something: I didn't consider it a risk." That type of attitude drives the EOY entrepreneurs to meet unmet needs and solve problems with their businesses instead of sitting back and letting someone else do it.

2. Communicate vision and instill passion in great teams.

   Finalists overwhelmingly stated that people were their leading priority, as opposed to more established companies worldwide, many of whom have been more concerned lately with efficiency and productivity increases (read: headcount losses) than developing their teams.

   
   

   
   

3. Demonstrate resilience and rapid recovery.

   As Liberty Global president Mike Fries stated, "I don’t think you can really be successful without staring into the abyss at least for a little bit. Every entrepreneur has that moment, and your goal in life is to not have it a second time." Mistakes in high-growth companies are the price of progress, while in more-established companies they often just lead to the blame game.

4. Embrace innovation.

   Established companies are often resistant to radical innovations that may benefit them in the long term but harm their revenue streams in the short term. Successful entrepreneurs know that innovation is the lifeblood of company survival and economic growth.

5. Pursue what you do best.

   Partner with existing corporations to handle infrastructure and technology needs, sales channels, administrative functions, regulatory compliance, or manufacturing and distribution (to name a few) so your high-growth company can focus on what it does best and scale more rapidly and cost effectively.

6. Pursue geographic expansion.

   The majority of the EOY finalists surveyed included geographic expansion in domestic and international markets as part of their growth strategies.

7. Secure the right capital at the right time.

   Funding sources differed by companies' level of revenue, and EOY entrepreneurs accessed a wide range of finance options to grow their businesses.

8. Preserve what you've built.

   As these high-growth companies grow and mature, EOY finalists were most concerned with preserving their company culture, attracting and retaining top talent, protecting and enhancing their company’s brand and reputation, and retaining their best customers.

While the Ernst & Young EOY finalists tended to own companies on the larger side, the findings of this survey apply more broadly to any entrepreneur wishing to grow a company. Mega-entrepreneur Richard Branson has similar advice for small businesses (it's all about the team, do what you do best…), as does entrepreneur Rosalind Resnick for home-based businesses (do what you do best, have some kind of support team, geographically expand, embrace innovation…).

As Bryan Pearce, director of Entrepreneur Of The Year put it, "Our Entrepreneur Of The Year finalists and winners have 'cracked the code' for achieving extraordinary growth in challenging economic times. Their exemplary way of doing business creates jobs and enriches communities while demonstrating how it is possible to defy the gravitational undertow of economic stagnation."

Complementing Your Startup

This week in Practically Friday we're looking at a forthcoming study in the Journal of Consumer Research by University of Chicago professors Ryan Rahinel and Joseph P. Redden. It is about Tostitos, and it could have applications to your startup: if you sell two products that are consumed together, you could have an advantage over rivals that don’t. The study is not published yet, but there are press release summaries e.g. here and here.

Rahinel and Redden examine consumer preferences surrounding complementary goods—products that go together, like peanut butter and jelly, mashed potatoes and gravy, or if you are me, balsamic vinegar and anything. Rahinel and Redden specifically looked at Tostitos brand chips & salsa. In one study, they gave consumers various Tostitos chips & salsa products but gave the products fictional names. If consumers were told the foods were from the same brand, they reported liking the chips & salsa more. In a second study, consumers ate various Tostitos chips & salsa products but were told the products were from separate Brand A and Brand B. If told the brands worked together on product research and design, consumers reported enjoying them more. The bottom line is that consumers appear to want matching brands.

You might already have enough trouble developing a single product or service. But you have to differentiate yourself from your competitors, and there’s only so much you can do by specializing with one product. You could be leaving money on the table by ignoring a good or service that naturally pairs with what you are doing already. If we think outside of food/consumable products, for example, Nike started selling running shoes that paired with iPods. Lark is expanding their sleep monitoring product into a general health and well-being product. It might not be enough to just be aware of what your product or service complements; developing that complementary good could be the key to success.