I have only taken one (undergrad microecon) course in econ—would really appreciate if some one more familiar with business and economics could go through my ramblings below and point out errors/make corrections in my understanding.
Picture the sell and buy side of business. The people on a given side compete against each other to be more favorable to the people on the other side. So more buyers ⇒ sellers capture more value. More sellers-> buyers capture more value. If you are selling a commodity, you don’t capture much value at all. The price that buyers are going to pay for your good is not really based on the value that they’ll receive from it, since the choice they face is not (buy and get value) OR (don’t buy and don’t get value). They also have the choice to buy from any of the other sellers, and will take that if they can pay less. So sellers cut, cut, cut prices until they can’t cut any more (they race to the bottom), where price = cost of production (including wages, etc) + enough of a return for it to be “worth it” for them. (What rate of return sellers will stop undercutting each other probably relies on macro...ask someone on LW maybe. This is an important piece but I think I can get by without it for now.)
If you’re a seller and there are no other sellers (monopoly), they buyer only has the choices (buy and get value) OR (don’t buy and don’t get value). So they will (more or less) pay anything up to the value that they will get from the good. This may be much, much more than the cost of production + “acceptable” return, so monopolists can win huge.
Your job is probably a commodity. Engineer, baker, tailor, data scientist, statistician...it’s a commodity unless you can make buyers believe that other sellers are not selling the same thing that you are—basically, that they can’t approach other sellers and get a price from them for the same good. So even if you are creating lots of value...because other people could do so as well, you can’t capture nearly as much of that value. (So basically it sounds like you want to make a very different type of value than other people can provide, and lots of it. It seems like a decent place to look would be what different experiences, skills, etc that you have that others don’t—even though much of your training might have been geared towards increasing your ability to produce a commodity, see above.)
The above applies to wages, to businesses, etc. Keep in mind that the skilled labor market on the sellers side is not efficient, meaning that people aren’t necessarily making the most money that they could be. This is at least partially because there are lots of other constraints on sellers choices and behavior, which may be family, upbringing, social situation, other terminal values that they can’t really maximize with more marginal money, etc.
I think that large companies likely have quite a bit of inertia, meaning that they may not be making “efficient” decisions either. The people working at those companies have TVs that are probably risk-averse with respect to money. Firm capital (if publicly traded) depends on shareholders transient judgment...which may be to SELL due to their own risk aversion if the firm makes a radical move. So I would expect firms to be not efficient in the strict sense, and also risk averse. So it looks like there is a tradeoff as firms get bigger (as revenue increases and costs increase). They likely get some smoother processes, less hiccups, economies of scale etc, but they also possibly give away expected utility through risk aversion. It seems like firms have an incentive to get bigger for these reasons (and if they are getting revenue based on value generated instead of cost of production, this incentive may even be bigger in terms of executive salaries), but future losses through risk aversion may be undervalued, or simply discounted because they are far in the future (and execs may have cashed out by then anyways so have reason to strongly discount the future.) So there may be room in the market for a new, smaller firm that creates value in a way that established players can’t, since the established companies’ incentives will punish them for taking advantage of the opportunity.
there may be room in the market for a new, smaller firm that creates value in a way that established players can’t
Maybe this is what startups are about. When a few people start a company and invent a product… well, hypothetically you could have a big company like Microsoft select a few employees, give them salary and complete freedom, and let them invent a new product for the company… but for various reasons that rarely happens. So it is better to wait until someone outside of the company develops the stuff and then try to buy it.
An alternative explanation is that by buying external startups that succeed, you save money by not having to finance all those other startups that failed, so for a big company buying a startup is cheaper than trying to create one at home. But I feel this explanation is probably wrong. -- You could do some preselection about whom you allow to try making an “internal startup”. And if one in a hundred succeeds, the price of a successful startup is probably higher than salaries for a few hundred employees; and a sufficiently big company has enough resources to play this game. To sufficiently motivate people, you could promise half or maybe even 10% of the “internal startup” profits to the employees who created it, and the company would still be profitable.
Sounds partially correct, although, I am a self-taught “economist” mostly.
However, in my experience, this kind of “basic incentive structure analysis” type of economics does not really predict the real world so well. I had to actually un-learn a lot of it in real life. (Or maybe I should have learned more advanced kinds of economics.)
Basic Econ can be understood as more normative than descriptive. That is, if you had these kinds of markets, then things would be really great and efficient. But in real life everything from old-boys networks to political corruption to cognitive biases screwing this up. The more you live in a place that works like Basic Econ the closer you are to an optimum. If you see lots of poverty around you, someone, something is throwing big monkey wrenches into this mechanism.
So in the real life you can see well-paid employees who are just nephews of the CEO or have an excellent sales pitch (interview skills). It does not always work out the textbook way. It should, just doesn’t.
Your job is probably a commodity. Engineer, baker, tailor, data scientist, statistician...it’s a commodity unless you can make buyers believe that other sellers are not selling the same thing that you are—basically, that they can’t approach other sellers and get a price from them for the same good.
But most people are specialists today. When was the last time you saw a General IT Guy in a big city? 1990? Today it is being some kind of an Enterprise Network Bullshit Bingo Database Architect. Or more realistically, simply based on what kinds of products or technologies they know. For example being an Oracle Financials expert is a world on its own. Or SAP, Navision...
But if you become a specialist, there is one trade-off. You must live in a city. Rural areas need generalists. This is simply based on density. In the country, there may not be more than 5 doctors or IT folks within 100km so they better know it all.
I think that large companies likely have quite a bit of inertia, meaning that they may not be making “efficient” decisions either. The people working at those companies have TVs that are probably risk-averse with respect to money. Firm capital (if publicly traded) depends on shareholders transient judgment...which may be to SELL due to their own risk aversion if the firm makes a radical move. So I would expect firms to be not efficient in the strict sense, and also risk averse. So it looks like there is a tradeoff as firms get bigger (as revenue increases and costs increase). They likely get some smoother processes, less hiccups, economies of scale etc, but they also possibly give away expected utility through risk aversion.
The big issue is not even risk aversion. After all a truly large firm can risk a tiny fraction of its revenue on an experiment and that tiny fraction can still be large. The issue is plain simply the incentive chains. There is a long hierarchy with everybody on higher than you trying to use rewards and punishments to get you work the way they want you to. After several steps down in this chain, this naturally gets corrupted. Like a game of telephone. People who are 4-5 level removed from shareholders they don’t want the same things shareholders want to. If they are rewarded for number of calls taken, they will find any excuse to drop calls and take another one.
I have only taken one (undergrad microecon) course in econ—would really appreciate if some one more familiar with business and economics could go through my ramblings below and point out errors/make corrections in my understanding.
Picture the sell and buy side of business. The people on a given side compete against each other to be more favorable to the people on the other side. So more buyers ⇒ sellers capture more value. More sellers-> buyers capture more value. If you are selling a commodity, you don’t capture much value at all. The price that buyers are going to pay for your good is not really based on the value that they’ll receive from it, since the choice they face is not (buy and get value) OR (don’t buy and don’t get value). They also have the choice to buy from any of the other sellers, and will take that if they can pay less. So sellers cut, cut, cut prices until they can’t cut any more (they race to the bottom), where price = cost of production (including wages, etc) + enough of a return for it to be “worth it” for them. (What rate of return sellers will stop undercutting each other probably relies on macro...ask someone on LW maybe. This is an important piece but I think I can get by without it for now.)
If you’re a seller and there are no other sellers (monopoly), they buyer only has the choices (buy and get value) OR (don’t buy and don’t get value). So they will (more or less) pay anything up to the value that they will get from the good. This may be much, much more than the cost of production + “acceptable” return, so monopolists can win huge.
Your job is probably a commodity. Engineer, baker, tailor, data scientist, statistician...it’s a commodity unless you can make buyers believe that other sellers are not selling the same thing that you are—basically, that they can’t approach other sellers and get a price from them for the same good. So even if you are creating lots of value...because other people could do so as well, you can’t capture nearly as much of that value. (So basically it sounds like you want to make a very different type of value than other people can provide, and lots of it. It seems like a decent place to look would be what different experiences, skills, etc that you have that others don’t—even though much of your training might have been geared towards increasing your ability to produce a commodity, see above.)
The above applies to wages, to businesses, etc. Keep in mind that the skilled labor market on the sellers side is not efficient, meaning that people aren’t necessarily making the most money that they could be. This is at least partially because there are lots of other constraints on sellers choices and behavior, which may be family, upbringing, social situation, other terminal values that they can’t really maximize with more marginal money, etc.
I think that large companies likely have quite a bit of inertia, meaning that they may not be making “efficient” decisions either. The people working at those companies have TVs that are probably risk-averse with respect to money. Firm capital (if publicly traded) depends on shareholders transient judgment...which may be to SELL due to their own risk aversion if the firm makes a radical move. So I would expect firms to be not efficient in the strict sense, and also risk averse. So it looks like there is a tradeoff as firms get bigger (as revenue increases and costs increase). They likely get some smoother processes, less hiccups, economies of scale etc, but they also possibly give away expected utility through risk aversion. It seems like firms have an incentive to get bigger for these reasons (and if they are getting revenue based on value generated instead of cost of production, this incentive may even be bigger in terms of executive salaries), but future losses through risk aversion may be undervalued, or simply discounted because they are far in the future (and execs may have cashed out by then anyways so have reason to strongly discount the future.) So there may be room in the market for a new, smaller firm that creates value in a way that established players can’t, since the established companies’ incentives will punish them for taking advantage of the opportunity.
Maybe this is what startups are about. When a few people start a company and invent a product… well, hypothetically you could have a big company like Microsoft select a few employees, give them salary and complete freedom, and let them invent a new product for the company… but for various reasons that rarely happens. So it is better to wait until someone outside of the company develops the stuff and then try to buy it.
An alternative explanation is that by buying external startups that succeed, you save money by not having to finance all those other startups that failed, so for a big company buying a startup is cheaper than trying to create one at home. But I feel this explanation is probably wrong. -- You could do some preselection about whom you allow to try making an “internal startup”. And if one in a hundred succeeds, the price of a successful startup is probably higher than salaries for a few hundred employees; and a sufficiently big company has enough resources to play this game. To sufficiently motivate people, you could promise half or maybe even 10% of the “internal startup” profits to the employees who created it, and the company would still be profitable.
Sounds partially correct, although, I am a self-taught “economist” mostly.
However, in my experience, this kind of “basic incentive structure analysis” type of economics does not really predict the real world so well. I had to actually un-learn a lot of it in real life. (Or maybe I should have learned more advanced kinds of economics.)
Basic Econ can be understood as more normative than descriptive. That is, if you had these kinds of markets, then things would be really great and efficient. But in real life everything from old-boys networks to political corruption to cognitive biases screwing this up. The more you live in a place that works like Basic Econ the closer you are to an optimum. If you see lots of poverty around you, someone, something is throwing big monkey wrenches into this mechanism.
So in the real life you can see well-paid employees who are just nephews of the CEO or have an excellent sales pitch (interview skills). It does not always work out the textbook way. It should, just doesn’t.
But most people are specialists today. When was the last time you saw a General IT Guy in a big city? 1990? Today it is being some kind of an Enterprise Network Bullshit Bingo Database Architect. Or more realistically, simply based on what kinds of products or technologies they know. For example being an Oracle Financials expert is a world on its own. Or SAP, Navision...
But if you become a specialist, there is one trade-off. You must live in a city. Rural areas need generalists. This is simply based on density. In the country, there may not be more than 5 doctors or IT folks within 100km so they better know it all.
The big issue is not even risk aversion. After all a truly large firm can risk a tiny fraction of its revenue on an experiment and that tiny fraction can still be large. The issue is plain simply the incentive chains. There is a long hierarchy with everybody on higher than you trying to use rewards and punishments to get you work the way they want you to. After several steps down in this chain, this naturally gets corrupted. Like a game of telephone. People who are 4-5 level removed from shareholders they don’t want the same things shareholders want to. If they are rewarded for number of calls taken, they will find any excuse to drop calls and take another one.