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The Illusions of Entrepreneurship Professors

Picture of professor in front of studentsLate last year, I posted a couple of essays that defended Thomas Stanley’s Millionaire Next Door theory: Defending the Millionaire Next Door Theory and the Millionaire Next Door Business Plan.

As part of the reading I did for those posts, I stumbled on and read business school professor Scott Shane’s book “The Illusions of Entrepreneurs.”

Then, oddly enough, a friend who carefully reads my posts sent me a private message. That message? I needed to read Shane’s book.

In this post, I want to provide a very brief review of Shane’s book. Some find Shane a good counterbalance to Stanley.

But then, inspired by Shane’s book and its title, I want discuss the possibility that some business school professors may themselves “labor under illusions” concerning entrepreneurship.

My Short Review of Illusions of Entrepreneurs

Here’s my short review. Shane presents a “glass-half-full” assessment of small business ownership.

That’s too bad. Shane appears to see self-employment and small business ownership as “mundane,” “boring,” and in many cases a reflection of people misunderstanding reality.

Nevertheless, I give the professor’s book a “B” grade.

A prospective small business owner benefits from a sober assessment of the risks and costs.

Professor Shane provides such an assessment. And no long-lasting harm comes from someone criticizing (constructively) your or my business plan.

But those points made, I see some flaws in the logic and between the lines of Shane’s book. This blog post comments on those flaws.

Flaw #1: Conventional Wisdom about Small Business Owner Income Wrong

A first quick flaw to point out and get out of the way. Contrary to Shane’s book, the data actually suggest small business ownership jacks up people’s income.

In fact, on average, the good longitudinal survey data about small business ownership and self-employment says these folks earn a chunk more money than the average person. Maybe 40% more according to one good survey: $72,000 per year for the average self-employed person versus about $53,000 per year for the average traditional employee.

You and I can’t look just at the money. But the money matters. And we should explicitly calculate and consider the extra income self-employment brings.

Note: The data sources and calculations for the above statement and the next statement appear in first Millionaire Next Door post I did.

Flaw #2: Conventional Wisdom about Small Business Wealth Wrong

Another quick flaw: Small business ownership contributes mightily to people accumulating wealth.

Someone who owns their own business for 30 years, for example, on average accumulates about an extra $360,000 of wealth as compared to someone holding a traditional job.

Shane’s book, I think, misses this important point.

This omission possibly highlights an understandable flaw that exists in much of the literature on entrepreneurship. People look at ventures rather than at individuals. That seems incomplete.

Someone who starts three ventures only to close down two of them for poor profitability may look like a failure. But this sequence of ventures may mean an entrepreneur moves from a first unprofitable venture to a second marginally profitable venture to a third strikingly profitable venture.

Flaw #3: Blindness to the Entrepreneurs’ Lottery

A subtle flaw I worry I see in Shane’s thinking? He seems to see only one form of entrepreneurship as truly making sense: Entrepreneurship that pursues giant opportunities and which, if everything goes to plan, delivers windfall results.

Yeah, no, I get it. Those sorts of entrepreneurial outcomes make for great stories. And probably MBA students won’t want to pay $50,000 a year for a program that prepares them to run a dry cleaners or a teriyaki take-out

But don’t the swing-for-the-fence entrepreneurial opportunities, more than anything else, resemble a Power Ball lottery?

I think so. Many play. But practically speaking nobody wins at that level.

Roughly half million businesses start each year in the U.S. Only a tiny handful experience a windfall.

For example, a couple of dozen people become billionaires each year through entrepreneurship (often after two or three decades of hard work and outstanding good luck), at least according to Forbes magazine write-ups (see here and here, for example).  That puts your or my odds of becoming a billionaire through entrepreneurship at roughly 1 in 20,000.

Another example? Well, what about an initial public offering where you have founders stock? Good question. Initial Public Offerings (IPOs) in the U.S. run from 100 to 150 companies a year according to Statista. That seems to put your or my odds of reaping an IPO-type harvest through entrepreneurship roughly run 1 in 3,000.

A final back-of-the-envelope calculation and example. What about venture capital startups? Well, the average venture capital fund looks at maybe 100 startups to find one worth investing in (Source: Wikipedia reporting on a Stanford University study.) The chance one of those investments will turn into a game-changing success is about one in twenty accordingly to knowledgeable observers. Link those two percentages together and your or my odds run 1 in 2000. Roughly.

And so here’s the point: Betting on those odds whether as an entrepreneur or public policy maker doesn’t make sense. Playing the odds a few times in a row when you have a 1 in 2000 chance or 1 in 3000 chance of success? Gosh, most every serial entrepreneur shooting for the stars fails.

Note: In comparison, playing the odds a few times in a row when the odds are 1 in 2? That should work for most people.

Flaw #4: Counting Too Much on Cleverness

Can I point out something else that I think you can see in Shane’s work and the work of some other business school professors? (And probably, quite honestly, in stuff I was writing two or three decades ago…Sorry.)

I think you regularly see people believing that if some entrepreneur is just smart enough or just sophisticated enough, that cleverness makes the difference.

This fact: Good research from economist Jay Zagorsky suggests something like IQ makes a modestly positive difference in terms of your or my income. Roughly $234 to $616 per IQ point. (As compared to the average person with a 100 IQ, someone with a 130 IQ earns roughly an extra $6,000 to $18,000 a year.)

But that same research indicates that IQ makes almost no difference in terms of your or my wealth. Zagorsky, in fact, calculates that each extra IQ point adds maybe $83 of wealth. Which he says basically counts the same as zero.

In any case, connect that dot to the sort of wealth-creating entrepreneurship that some business school professors like to focus on, and you see the problem. One struggles mightily to argue that clever matters much in terms of wealth creation whether through entrepreneurship or some other wealth creation activity.

Flaw #5: Missing Benefits of Low Competition Environment

A final niggle: My sense is Shane sees many small business owners simply as bunglers running unsophisticated operations.

I’m not sure that’s fair or even true. But ironically that caricature of the “Millionaire Next Door” small business owner hints at something useful: These businesses often operate in an environment with a much lower level of competitive pressure.

As a result, developing a winning strategy and maintaining a competitive advantage works more easily in the small business arena.

You and I probably need only a modest advantage to compete against the guys down the street or across town: a little better website… one or two more talented team members… or maybe just a slight head start.

In comparison, big firms need big competitive advantages. Tesla Motors and anyone else wanting to start a car manufacturing company, for example, needs a giant competitive advantage to successfully battle with Toyota, General Motors and Mercedes Benz.

That easier-to-achieve competitive advantage eases the requirements for your firm’s success.

Closing Comments

Let me share two comments to close.

First, the small business ownership flavor of the Millionaire Next Door theory doesn’t work for everybody. (Shane, I absolutely must acknowledge, does a good job of rebutting this type of thinking.)

You therefore want to consider small business ownership when your current job doesn’t deliver the income or experience you want. And then keep in mind, of course, that no job is perfect just as no small business is perfect.

A second comment: Some wealth-building strategies and some career plans let you follow simple recipes for success. But small business ownership doesn’t work that way.

We’ve got a free, downloadable retirement planning guide, for example, that explains how you can easily prepare for financial independence  (Grab a free copy of that guide here: Download Thirteen Word Retirement Plan.)

Similarly, some career plans (like “go to law school and join a big law firm”) essentially require a person follow a clear-cut credentialing process and then apply for a job. That’s another example of a pretty formulaic approach. (These paths may be easier to describe than they are to follow, something highlighted here.)

Small business ownership, frustratingly, doesn’t work like that. The process burdens you with more complexity, uncertainty and stress in terms of your planning and the execution. (In the bargain, of course, you probably bump your income and get a practical way to build wealth.)

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