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Posts by Max Gulker

Why Bigger is Not Always Better in Business

small biz owner flower shop

In my brief “Small Businesses Leverage Their Size” released today, I explore the benefits to businesses of being small, nimble and close to customer and market information on the ground. My discussion reflects a line of thinking in economics that touts the benefits of many small, decentralized entities as opposed to fewer larger ones. This point of view has been shared by many thinkers in the field, both classic and modern.

A look at economic thinkers who have advanced these ideas shows that free-market proponents are not necessarily advocates of “big business,” and free-market critics do not necessarily rely on “big government.”

Adam Smith’s classic conception of the free market and invisible hand is based fully on small, decentralized consumers and firms with the power to make their own decisions. Smith’s disdain for government laws that restrain these decisions is well known, but he also makes clear that such harmful meddling can come from big business:

“The pretense that corporations are necessary for the better government of the trade, is without any foundation.  The real and effectual discipline which is exercised over a workman is not that of his corporation, but that of his customers.  It is the fear of losing their employment which restrains his frauds and corrects his negligence.  An exclusive corporation necessarily weakens the force of this discipline.”

As noted in the brief, libertarian economist Friedrich Hayek also recognized the value of small, decentralized decision makers, especially as they pertain to gathering and responding to information that is also decentralized.

“Circumstances of time and place,” in Hayek’s view, cannot be fully understood by central planners, and decisions based on such information should be left to the “man on the spot.”

Economist E.F. Schumacher, author of the 1973 book “Small Is Beautiful,” (and namesake of AIER’s neighbor, the Schumacher Center for a New Economics) came from a vastly different point of view than Smith and Hayek, harshly criticizing the excesses of the unfettered free market and profit motive. But Schumacher’s view of social organization, like Smith and Hayek, hinged on small decentralized groups:

“There is no such thing as the viability of states or of nations, there is only a problem of viability of people: people, actual persons like you and me, are viable when they can stand on their own feet and earn their keep. You do not make non-viable people viable by putting large numbers of them into one huge community, and you do not make viable people non-viable by splitting a large community into a number of smaller, more intimate, more coherent and more manageable groups.” 

While Schumacher would emphasize motivations other than profit, there are notable parallels to Smith’s quote above: centralized, top-down organization impedes the positive outcomes that happen when people or small groups make their own decisions.

This view, along with the specific discussion of today’s small businesses in the brief, is echoed in today’s local movement. Restauranteur Judy Wicks, a pioneer in the use of ingredients from local farmers, touted the benefits of being small in nearly identical terms to the businesses owners with whom I spoke: “I realized that when we grow in physical size, we give up something very important-authentic relationships with the people around us and those we do business with,” she said during a lecture to the Schumacher Center. Such a small or local business is a modern embodiment of Hayek’s “man on the spot” or Schumacher’s more intimate and manageable group.

The thinkers discussed above focused mainly on how small and decentralized entities benefit society. In my new brief, I discuss how small businesses can leverage their size to reap the same benefits competitively for themselves against larger firms. Whether in politics, economics, or competitive strategy, bigger is not always better.

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Small Business Judo: Using Size to Your Advantage

The common narrative about small business usually goes in one of two directions. First, many predict doom for “mom and pop” firms in America, arguing small businesses must be protected from giants like Walmart, who can charge lower prices.

The second narrative focuses on the benefits these businesses bring to our economy and communities, stressing the need for consumers to “support” small and local business. Notably gigantic firm American Express, for example, sponsors Small Business Saturday every December, encouraging people to “rally their communities” to shop at local stores.

In reality, small businesses are profit-driven entities in our capitalist economy. While regulatory protection and goodwill from consumers may help on the margin, what small businesses need are working strategies to offer the market something of significant or unique value. In our upcoming July research brief, I will report the results of interviews with successful small business owners, focusing on the competitive advantages of their businesses being small.

We usually think of small size the other way around, focusing on the fact that larger firms can reap the benefits of economies of scale, and ultimately charge lower prices. But there are many things that small businesses often do better than large ones. Large firms must centralize a good deal of decision making, whereas those running small businesses may have a sharper understanding “on the ground” of customers and the workings of the firm.

The most commonly cited asset of small size, across diverse industries such as retail, manufacturing and professional services, is in the selection of the products themselves. All of the owners and managers with whom I spoke discussed the ability to either focus on high product quality or fill a market niche that isn’t served by larger firms. The second most common response was superior customer service—the ability to focus on the quality of long-term customer relationships, and not just the volume of business. Other common responses centered around the ability to be nimble (make fast decisions) and deeper knowledge about local market conditions.

The fact that being small carries some competitive advantages should not minimize the challenges small businesses face. Research has shown, for example, that when big box retailers enter a market, there is significant exit among smaller competing stores. Beyond price competition, owners with whom I spoke cited other drawbacks to small size, including the lack of resources to engage in extensive marketing and difficulties in complying with regulations and tax burdens. Still, it is useful to remember that large firms leave openings in markets that small businesses can successfully fill. Be sure to look for our next research brief in early July for a lot more discussion of how small businesses use their size to their advantage.

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Economic Wellness: Why We Struggle To Save Money

We often think of savings as putting money away for big long-term goals, such as a child’s education or our own retirement. But a lack of shorter-term “emergency” savings threatens many Americans’ abilities to make ends meet every year. Small-to-medium sized financial shocks (unexpected expenses such as medical bills or a car breaking down) happen regularly, but the majority of households do not plan as such. Much like the phenomenon of overspending we looked at last month, this lack of planning doesn’t stem from a single flaw in our economy or culture, but shows how human nature can lead many of us financially astray.

In an excellent three-part study, the Pew Charitable Trusts show how deeply entrenched this problem is. As defined above, 60 percent of American households experienced a financial shock last year, with a median cost of $2,000. 47 percent of households reported “struggling to make ends meet” after a shock. This is not surprising, given the median household earning less than $50,000 a year has less than two weeks’ income in liquid savings. It’s worth stepping back to wrap one’s head around that last statistic: more than half of these households would not be able to replace two weeks of income without taking greater measures such as going into more debt, selling possessions, or borrowing money from friends or family.

Publications and personal finance bloggers urge their readers to build resilience against these financial shocks by keeping a dedicated savings account with the equivalent of one, three, or even six months of household income. And households agree: over 90 percent of Pew’s respondents said people like them should have at least three months’ income available for emergencies.

Yet 80 percent of those same respondents didn’t have the level of savings they personally recommended. These respondents run the full gamut of income, so many of these people should have the means to figure this problem out. Why, then, haven’t they?

Simply put, households are trading savings and security later for more consumption now. As we covered last month, the desire for instant gratification is probably part of human nature, and the ability to buy more now makes it very hard to stick to a savings plan. Economists call this phenomenon “time-inconsistent preferences”: decisions we make in the moment often differ from those we would make if we could lock ourselves in when planning ahead. The idea has been used to explain why people join a gym and never go, or keep planning to quit smoking “tomorrow.”

The most telling result from the Pew report is that making a household budget had no significant effect on a household’s level of emergency savings. Even planning to put more away at the beginning of the month is no guarantee of success. That latte or extra dinner out doesn’t sound that great when you’re planning three weeks ahead, but when the day arrives…time-inconsistent preferences strike again.

While there aren’t easy answers, it might be helpful to educate people to expect the ways they’ll depart from a rational budget. A potential tool might ask people to plan a month’s worth of spending and saving and then go on about their business, tracking actual behavior not to adhere to the original budget but to demonstrate how real behavior departs from the plan due to day-to-day choices. Learning from these results, people might begin to anticipate their realistic behavior, and learn to fit in savings in more than just an idealized way.

These problems don’t have single quick fixes, and likely need more comprehensive solutions such as the economic wellness initiative we’re planning at AIER. But any understanding or solution to the problem must account for the types of “mistakes” that are likely as a result of human nature.

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It’s Who You Know: Networking and Economic Wellness

ten dollar bill

We usually think of human capital as knowledge: the education and training you need to complete a task on the job. But networks — “who you know” and how you interact with those people —  are also critical to economic wellbeing.

It’s easy to see the benefit of networks through big life events such as when you hear of a job opportunity through a friend. But there are numerous more subtle advantages to knowing a large number and variety of people, like exposure to new ideas, fresh perspectives and the psychological benefits of connection. When you connect with new people, you also indirectly connect with their networks and these connections incrementally add up to greater economic prosperity and a fuller life.

We often build networks while acquiring more traditional kinds of human capital in school. Most MBA’s will tell you that they could have learned the substance of their coursework on the job, and that the real benefits of that program came from collaborating and socializing with a diverse array of successful classmates. And while the models and techniques I learned getting a Ph.D. are essential to my work as an economist, what I learned from my community of colleagues in graduate school was at least as important.

Researchers agree that size is far from the only indicator of network strength. Ron Burt of the University of Chicago’s Booth Business School suggests that the most successful people have networks consisting of multiple “clusters,” groups bound together by career, training or life, who don’t always interact with each other. These networkers then move between clusters, connecting and recasting ideas for new audiences. This process is not always as comfortable as sticking with a single group of people like you, but can carry big rewards. Think about how often we talk about the need to “get out of a bubble.”

Strong networks also bring significant benefits to society. In his landmark 2001 book Bowling Alone, Robert Putnam demonstrated that changes in technology and a decline in civic organizations led to people being increasingly disconnected from each other. He tied this phenomenon to numerous economic and social problems we currently experience.

Perhaps one reason for perceived stagnation among our working and middle classes is this growing disconnection among people. Knowledge and skills are important for success, but connecting with others helps refine those skills and find the best places to put them to use. To foster economic and personal wellness, we might start thinking more about ways to help more people connect with each other.

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Working Class Americans Deserve a Retirement, Too

Just how high a mountain do working class millennials have to climb when it comes to planning for their future? Sometimes the act of thinking beyond this month’s bills can feel out of reach, as this New York Times article from 2013 – still very relevant today — discusses.

But economic wellness isn’t just for well-to-do Americans. It should be for everyone.

There are few financial wellness programs aimed at working class Americans, but they are precisely the group who would benefit the most from them. And younger workers of modest means often don’t know where to begin on the path to economic freedom and well-being.

The current body of financial wellness content, which often discusses how to invest your extra income, often fails to address the concerns of workers with modest means. This status quo is unacceptable as we talk about wage stagnation and Americans falling behind. Less than a third of U.S. adults have a four-year college degree; their economic concerns are often reported but seldom addressed. Many expect to never fully retire.

Although financial wellness content providers may see a lack of demand – or perhaps a lack of profits to be made — we see a great need for an economic wellness program. And as a not-for-profit institute, we are in a great position to provide such a program.

As I mentioned in yesterday’s blog, one difference between financial wellness and economic wellness is that economic wellness includes an understanding of the economy and one’s role in it. In this case a well-designed program would give the worker pessimistic on ever reaching retirement an understanding that it is indeed possible, and knowing what it will take to get there.

Against this backdrop, younger Americans of modest means are a particularly important audience for such programs. In that New York Times story, one common thread is the isolation the interview subjects feel.After working most of the hours in their day at unskilled jobs to support themselves,  and often paying down debt, they don’t feel they have the resources or time to embark on a path to a better future.

An economic wellness program geared to this population might begin by presenting questions and ideas to consider before diverting any money toward long term goals. It might also provide a way to connect with others going through similar struggles.

Here at AIER, we are working to build an economic wellness program that includes the needs of younger Americans of modest means. It is our hope that we can set some of these Americans on the path toward a more prosperous future, and that some of them will make up the next generation of our members.

Stay tuned in the coming months as we begin to unveil content from this initiative.

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Financial Wellness Isn’t Enough

Financial wellness is a term being used more and more these days, but a big piece of the puzzle is missing. As we at AIER have thought about how to help individuals make choices that safeguard their economic freedom and well-being, we’ve begun instead to use the term economic wellness.

What is the difference between financial wellness and economic wellness? It’s an important distinction.

First, let’s define financial wellness. A recent report by the Consumer Financial Protection Bureau offers two defining characteristics of financial wellness programs. First, they are comprehensive, focusing on a complete picture of an individual or household’s financial well-being, rather than a single goal or type of saving. Second, these programs are focused on behaviors rather than information.

It’s important, for example, to know what a 401(k) is, but the desired outcome is actually making monthly contributions that take advantage of tax benefits and help bring about a Read more

Inflation Hit Urban Renters Harder Last Year

urban apartment livingRecent changes in your cost of living depend greatly on where you are in your career, education and life.

That’s a key takeaway from my recent research, which we published today in a brief entitled “Average American’s Cost of Living Falls.” Americans’ wages grew faster on average than the Consumer Price Index in 2015 (1.9 percent versus 0.5 percent). But the economy is affecting different kinds of people in different ways.

In the brief, we look at the cost of living for different households by constructing three profiles: an urban renter, a young family, and a retired couple.

We arrive at these profiles by measuring the everyday expenses of these three groups using our Everyday Price Index, or EPI. Our index starts with the CPI, but we then exclude big-ticket items such as housing, cars, appliances, and electronics as well as infrequent purchases like clothes and legal services.

The results underscore the idea that inflation is far from constant across products and impacts different Americans in a variety of ways.

The urban renter’s cost of living rose 2.1 percent in 2015, as opposed to a 1.4 percent decline in the EPI. The main factor in that difference is gasoline and energy costs; the urban renter has far fewer of these expenses, and these items fell in price in 2015.

The retired couple (+0.3 percent) and young family (-1.0 percent) also outpaced the overall EPI due to the importance of healthcare and education in their respective budgets. A table providing a closer look at the weights we put on goods and services in the EPI and profiles used in the brief is available online.

We also take a deeper look at what’s happened to the price of specific goods and services, and find stark differences. Many Americans felt less cost pressure in 2015 from pronounced declines in energy costs, including gasoline (-24 percent) and heating oil (-31 Read more

Permanent Tax Cuts Pack a Bigger Punch

Congress recently renewed several tax breaks for households and businesses, which the president signed as part of the year-end budget deal. Whereas previous renewals generally expired after one year, Congress made many of the tax “extenders” it renewed in December permanent.

This can be helpful. When it comes to tax cuts, how long the cut remains in place, as well as whether they are offset by spending cuts, can be important in how effective the cuts are.

As we note in our January edition of Business Conditions Monthly, “There is something for everyone” in this package of tax cuts. For businesses, permanent extensions include deductions for research and development investment and acquisitions of certain assets.

For individuals, permanent extensions include tax credits for children and college education, and enhancements in the earned income tax credit. As the chart below shows, Read more

Small Businesses Can Outperform Big Competitors

small business pottery computerI’ve recently been talking to successful small business owners about what allows them to prosper when facing competition from larger firms or national chains.  In a diverse array of industries including retail, manufacturing and financial services, business owners tend to report three things they do better than larger competitors:

  • More attentive customer service
  • A deeper understanding of local market conditions
  • The ability to make and implement decisions more rapidly

Success in business often comes down to gathering information and making decisions in response.  In most large firms, there is a good deal of Read more

Seeking Generational Patterns? Don’t Be a Slacker

slackerGoldman Sachs, in a beautiful infographic titled “Millennials: Coming of Age,” tells us that 34 percent of millennials say advertising on social media has a positive impact their perception of a brand.  This is more than double the rate of the rest of the population (16 percent), and Goldman concludes that “millennials are turning to their online networks when making purchasing decisions.”

But we also just learned that two-thirds of millennials perceive no benefit from social advertising.  A better conclusion might be “Social media advertising is a growing phenomenon, but has not yet become a dominant form of advertising among millennials.”

Goldman isn’t intentionally misleading us.  Human beings love seeing patterns and making generalizations. Pattern seeking is one of the primary miscues that behavioral economists identify as a hurdle when interpreting the complexity of the real world. It is in our nature to try to identify patterns and draw conclusions Read more