
Why Corporations Could Get Higher Returns Than VCs - zabramow
http://rwrld.blogspot.com/2015/01/what-do-you-have-to-lose-why.html
======
Sealy
"These differences in how we value risk help to explain why the derivatives
and junk bond and future markets are worth trillions. Smart investors will buy
risk from people at a discount. Now that would just be interesting if it were
not for something really fascinating that it suggest about how corporations
could use behavioral psychology and the popularization of entrepreneurship to
earn returns that venture capitalists would envy.

The prime candidates for entrepreneurial ventures are actually people in their
30s and 40s. Their startups are less likely to fail and reasonably so. They
have more experience than people in their 20s and more drive than people in
their 50s. They learned about processes and products and people. But they have
one major disadvantage in comparison to the twenty-something crowd: they have
so much to lose."

An insightful piece into Daniel Kahneman's life work. I've always had a
fascination with his books and what he writes about socio-economics and the
paradoxes we see in the shops all around us. If anyone is ever interested in
how money is really made, I'd highly recommend reading his books.

Why else would his books be on the reading lists of so many intern / grad
banking jobs.

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duckingtest
>He had to pay, on average, $7 and some change to buy the mugs back from
people. By contrast, he had to sell the mug for about $3 and change to get
them to buy when they did not already own it. Kahneman’s conclusion was that
people put a higher price on loss than they do gain.

That's a weird conclusion. Let's say I value the mug at $5. Obviously I'm not
going to sell it for $5, because the transaction itself is an effort, so I
would lose! The opposite for buying, obviously I'm not going to buy a mug for
$5 if I think it's worth exactly $5.

The price a rational person is willing to accept for a thing he owns must
always be higher than what he values it at.

In a general case, probability of gain is obviously worth less than the same
probability of loss, because you need bigger relative return to make up for
the loss.

~~~
learnstats2
It's rare that I find fault with Kahneman but here - yes - also:

if someone is seeking to sell a mug to me, my perception of its value just
went down.

if someone is willing to buy a mug from me, my perception of its value just
went up. I might have been intending to throw the mug out before I knew that
someone would buy it.

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lifeisstillgood
There is a big problem with these artificial "behavioural economics" studies
(and it's a known issue that lab based decisions differ from real life).

But claiming that people have bad risk management (scenario : do you want the
blue pill (risk of death 1/1000 or the red pill (2/1000). People pay upto 200
extra for blue pill. Or will you take part in testing the red pill for FDA
(people refuse 50k to take part)

Here you are not comparing loss aversion to a 1/1000 chance - you are
comparing "safe and tested pills" versus joining a human drug trial. Even non
statisticians can tell we don't know that's a 1/1000 chance

So I do worry about basing predictions about VCs on poorly understood loss
aversion from reports of studies that leave much to be desired.

~~~
diminoten
I wish they would have picked a less dramatic consequence. Death as a
consequence forces me to mitigate risk to the highest degree I know how to,
which I think would skew the results, if folks are anything like me.

Death is just so final, and such a significantly different force in the lives
of humans, that it can't really be compared to anything else.

~~~
Falkon1313
The point is that people are told that the risk of death is the same in both
cases, and either way, they're deciding between the same chance of loss of
life, or certain loss of money, but they respond differently depending on how
it is phrased - whether they would be losing or gaining the money in exchange
for taking (or not taking) the risk.

What I see as the inequivalence is that in the first case, they're gaining a
cure either way (if it doesn't kill them). (Although it doesn't say what would
be cured - I wonder whether most people assumed a terminal illness vs. some
minor ailment?) But in the second scenario, they're not gaining anything but
the money. So it becomes a 99.9% chance of curing something that you want to
cure (possibly terminal) vs a 0.1% chance of dying for nothing but money when
you weren't even sick.

I wonder if death isn't the biggest skew though. When pharmaceuticals are
mentioned, I think of weight loss, impotence, and cosmetics industries. It
would be interesting to see the outcome of replicating the experiment for each
of those compared to actual industry profits of each. If a group of people pay
more to try to be attractive than they do to delay death, would their
experimental responses to risk match the observed facts of their actual
behavior? Are most people acting irrationally (in the Economics sense)? And if
so, what would that tell us about the risk studies?

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phkahler
Normal statistics don't really apply when losing puts you out of the game
permanently (like dying) or any other one-time risk. By definition statistics
are about expected or average results. A company, VC, or casino can take a lot
of risks and get close to the average results - an individual can't.

~~~
adwn
Exactly! The concept of "expected value" is pretty meaningless when it comes
to one-time events. For example, when insuring a 1 billion $ item with a loss
probability of 1 in 1,000,000 at a premium of 10,000 $, the expected value of
the profit is 9,000 $ – which is useless if the insurance case occurs and the
insurer is bankrupt afterwards.

Similarly in life: For some events in life, there's just no time to recover
afterwards.

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minthd
But all the money in a be portfolio is made in the extreme cases. I don't
think selecting risk averse entrepreneurs gets one there.

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therealdrag0
>"Countless employees who could be great entrepreneurs shy away from the
prospect because they have something to lose. What a corporation would have to
offer as a percentage of returns would be less – perhaps considerably less –
than what a venture capitalist or traditional banker would have to offer."

That's why companies like Google do 10% time right? And didn't someone
recently say Valve kinda does 100% time, everyone has the freedom to work on
the project they find interesting.

~~~
lnanek2
Google pretty much ended 20% time. It requires management approval now and
management is pushed hard re team productivity.

~~~
skj
It requires management approval in that it has to be something that Google
could use - needs not bear any relation to your team or product.

If a manager prevents you from doing a 20% project, we're instructed to get in
touch with... someone, I forget who but there is a route of escalation.

~~~
jjoonathan
If the manager is hurt when you take 20% time (and they will be if they are
competing on productivity metrics that don't take it into account) I am sure
they can find a way to retaliate (err, "communicate their priorities") that
can't be provably identified in the escalation process. Besides, they wouldn't
even have to be dishonest to say that you were underperforming on your primary
project.

"Google gets rid of 20% time" makes a good headline. "Google revises peer
evaluation incentive structure to effectively penalize employees for actually
using their 20% time" doesn't, but 20% time is just as dead either way.

~~~
encoderer
You don't work there? I just want to be sure I am reading it correctly.

It must be strange to work at Google. To have people who have never worked
there argue and disagree with your experience.

~~~
michaelochurch
I worked there. He got it right.

Some managers are supportive and want their reports to succeed and will
encourage them to direct their own work. Some are not. Google's great if you
get a good manager. It sucks if you don't. Not much of a different story than
in other companies.

"20% time" means that if you do a skunk-works project and it succeeds (which
is hard to do-- because Google places high demands in terms of reliability and
internationalization before it allows a launch, and for good reasons-- if
you're _only_ giving it 8 hours per week, so most people whose projects
succeed will "cheat" a little bit) that you don't have to apologize and won't
get fired for the mere fact of having a side project. That's important, but
the idea that average Googlers get 1/5 of their working time to devote to
anything that helps the company is a myth.

~~~
Rapzid
Yeah, sounds like every other large corp with deep pockets ever now in that
regard. I've had this experience at large-ish tech companies and have actually
ended moving cities to take a new position to work for a manager, and ended up
moving on(from the company) after that same manager was re-assigned later on.
Working with a great manager can be an awesome, motivational experience. It
can really accelerate your career growth too.

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graycat
Nearly always, a successful corporation has some expertise in some market.
Then, the corporation can, and sometimes does, use that expertise to conceive
of projects, evaluate them, and execute them. And the corporation can get the
financial rewards from a successful project.

However, in US information technology, from all I've been able to see from
looking at the biographies of hundreds of US VCs, only a few in the whole
country have much expertise in anything technical, in any market in business,
or anything beyond general management, marketing, legal, or finance.

So such VCs are not in a position to evaluate projects except in terms of
'traction' or accounting results or just a little of team or founder
personality.

To be more clear, large and crucial parts of US _culture_ are really good at
evaluating projects just on paper; such parts include Ph.D. committees,
editorial staffs of leading peer-reviewed journals of original research in
STEM fields, the NSF, NIH, and DARPA, and many corporations with their
expertise in their markets -- GM can evaluate essentially anything having to
do with cars and trucks; Exxon for oil; Boeing for airplanes; GE for airplane
engines; Intel for microelectronics; etc.

So, net, in information technology, generally corporations have much more
expertise to evaluate projects than do VCs.

For a more general reason, in recent years, on average the return on
investment (RoI) of US VCs has been poor, and evidence is in, say:

[http://www.avc.com/a_vc/2013/02/venture-capital-
returns.html...](http://www.avc.com/a_vc/2013/02/venture-capital-
returns.html#disqus_thread)

[http://www.kauffman.org/newsroom/2012/07/institutional-
limit...](http://www.kauffman.org/newsroom/2012/07/institutional-limited-
partners-must-accept-blame-for-poor-longterm-returns-from-venture-capital-
says-new-kauffman-report)

We have to suspect that, on pursuing new projects, generally corporations do
better than the record of VCs.

------
ojbyrne
Corporations already get higher returns than VCs

[http://avc.com/2013/02/venture-capital-
returns/](http://avc.com/2013/02/venture-capital-returns/)

~~~
tanzam75
Well, corporations are launching new products all the time. Each new product
can be thought of as a VC investment in a new startup.

However, the VC investors have to share the winnings with the founders, while
the large corporations get to keep basically all of it. Oh, sure, the
corporation might pay out bonuses and promotions, but this is a small fraction
compared to what startup founders get to keep.

Thus, VC investors start out with a built-in disadvantage that they have to
overcome: call it "founder drag." It's sort of like the race between active
funds and index funds. The actively-managed funds have to overcome their
higher expense ratio just to get back to even.

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LiweiZ
One quick point: No matter how different the sizes of different organizations
are, they come with different DNAs more or less. Normally, one organization
has very limited tolerance towards other DNAs. This alone will kill the new
comers. Or the container will fall apart.

Resources are basically not a big issue for big players. It's their DNA and
abilities derived that set what they are not able to achieve.

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iamjdg
The reason I would offer less for the pill that cures my ailment and has no
chance of killing me is because I also have the option to live with my
ailment. Anyway, I think agree with the article I just this analogy to valuing
loss greater than gain was bad.

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iamjdg
If this article is correct then corporations could also obtain higher returns
than ycombinator.

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michaelochurch
_Research suggests that the average person will not pay more than $200 for the
premium pill [over a pill with a 0.1% chance of killing them]._

I don't buy this. For a young person, a 0.1% chance of death is years' worth
of death risk. However, I think there's a way to "trick" people into a result
like this. Say that Pill A has a 99.9% chance of delivering a cure, and Pill B
has a 100% chance of curing them. First, "99.9%" sounds very good already, and
"100%" sets off our bullshit detectors because almost nothing in medicine
_always_ works. The 99.9 figure is more precise and therefore more impressive.

Furthermore, there's a difference between (a) the pill itself kills in 0.1% of
chances vs. (b) it's 99.9% efficacious. In (b), you can take the cheap
medicine and try the expensive one if the cheap one does work. As for (a),
that's not something we really face because no drug that kills 0.1% of
patients at normal doses would be on the market. If it were used at all, it'd
be restricted to hospitals and used only when the disease was severe enough to
merit it (e.g. cancer drugs).

 _The prime candidates for entrepreneurial ventures are actually people in
their 30s and 40s. Their startups are less likely to fail and reasonably so.
They have more experience than people in their 20s and more drive than people
in their 50s._

Adverse selection. Most 50+ who have their shit together don't want to deal
with VCs and their bullshit. There are plenty of driven, 50+ year old
entrepreneurs, but they're not interested in VC. Also, they aren't interested
in get-big-or-die gambits _in general_ because getting back into the careers
they left, at that age, is just much harder.

 _This suggests that corporations have a great deal to make by offering
entrepreneurial opportunities to their employees._

I don't think that the concept of an "intrapreneur"\-- except at a small
number of companies like Valve (which only has a few hundred employees)-- has
legs. Would Google or Microsoft or Citibank allow it if everyone wanted to be
an "intrapreneur"?

While the intrapreneur path will involve a lower risk of financial loss
(because it requires no capital investment, except opportunity cost in the
willingness to take a lower salary and a more interesting job) it probably has
a higher per-month job-loss risk. Employees can avoid behaviors that will make
them enemies. They can choose not to give a fuck when it isn't their turn to
give a fuck. Intrapreneurs don't have that liberty. They have to fight
battles, work hard enough that they lose social polish, and (if their managers
aren't supportive) navigate a conflict of interest between their personal
project and their assigned work. They can easily turn into overperformers and
get themselves fired. Moreover, I don't think that the sociological issues
that are in play here are going to go away easily.

None of this refutes the title itself, as presented:

 _Why Corporations Could Get Higher Returns Than VCs_

In fact, they already do. But that's another story entirely.

