Not long ago, I needed the help of a plumber to fix a leaking bury hydrant on my property. While I could probably dig the hole and then, thanks to the glorious Internet, figure out how to fix it myself, it would hardly be a valuable use of my time. I am better at researching and teaching, and then spending some of my earnings to get other things done. So, I relied on the specialization offered through the division of labor in the market.
Using a well-known referral service to separate the wheat from the chaff, and thus find a reliable and reputed plumber, I was able to get an appointment the next morning. Long story short, the plumber shows up, looks at the bury hydrant, says something about “oh, you have one of those” followed by “I didn’t bring tools for that kind of job,” and gets in his van and drives off.
Four hours later, the leak is fixed. I am presented with the bill, payable immediately (“cash or check”), for a total of four hours of work: two hours of driving, most of it for the trip back and forth for the tools this plumber didn’t bring, and two hours of digging and fixing. When I make clear that it’s not my responsibility to make sure the plumber brings the appropriate tools for the job, and that I’m therefore opposed to paying the outrageous $85 per hour for him to drive his car, the response is simply that I’m being charged for his “time.”
I ended up having to pay the ludicrous amount, half of it for nothing of value to me. But the point is not that another licensed (state-sanctioned and protected) plumber over-charged yet another customer. The point is that this plumber didn’t work for a larger business, but was self-employed—and failed completely to understand what it means to run a business.
It’s about Creating Value
This failure among entrepreneurs to understand entrepreneurship is ridiculously common, and we’re all worse off because of this fact. The problem is that even though they would have a whole lot to gain from taking just a small step in the right direction, they fail to do so. While one cannot blame them for being ignorant (entrepreneurs have “better” things to do than study entrepreneurship theory, for example), it is a sad fact that many entrepreneurs think of their businesses as their employment. That’s exactly the wrong assumption.
Entrepreneurship is not employment, and calling owner-managers of very small businesses “self-employed” is doing all of society a disservice. It only causes confusion. Employment is the assignment to carry out specific tasks (or produce a set of fairly standardized outcomes) within an existing business. When you are employed, your time and effort are introduced into a larger and tightly knit production process that is centrally coordinated (see my book, The Problem of Production: A New Theory of the Firm, on this).
This is nothing like starting your own business, which does not have a set framework and not pre-existing production process. The thing with entrepreneurship is: you can offer whatever service you like in whatever way you like. You certainly cannot do that if you are employed in an existing business. These roles are actually more different that many might realize.
To put this in economic terms, entrepreneurship is about creating new value: to do this, one must first find out what consumers value and how you, the entrepreneur, can satisfy those wants. You make money by making consumers happy—solve their problems, satisfy their wants, make their lives more comfortable, etc. Whether you are successful is completely on the consumer’s terms (and relative to what others offer).
Not about Cutting Costs
Within an existing business, the value is already established. Existing businesses have already figured out some type of market position where they can make money – a niche where the value they offer to consumers is higher than the price they charge, which in turn is higher than the costs of production at the relevant production quantities. Your role as employee in a business is thus to contribute to the production process by carrying out the assigned tasks (or your part of the process) and do so as effectively and as cheaply as possible. Your role, and the role of management too, is to cut or keep down costs.
See the difference? While you as employee (or manager, for that matter) is to keep costs down so that the business can continue to sell goods and services at a profit (at the already determined market prices), the role of the entrepreneur is to figure out how to provide value to consumers and how much to charge for it. (I elaborate on this non-cost perspective in Dr. Matthew McCaffrey’s recent anthology, The Economic Theory of Cost: Foundations and New Directions . )
An entrepreneur who focuses on cost is in effect acting as the manager and not entrepreneur of his or her business. This works if there is already a production process with given beginning and end as well as known prices. But if you are “self-employed,” you do not have the luxury of focusing on keeping down or cutting (your) costs instead of creating value.
The aforementioned plumber, for instance, charged for “time” (his cost) rather than the value provided (stopping the leak). Leaving destructive incentives aside (“forgetting” tools is a great way of getting paid for not doing much work at all), it is very unlikely that I will use his services again. And I will certainly not recommend his business. In other words, he has destroyed the value of a potential repeat customer and a “free” inflow of customers (which could have been the result of keeping my, his customer, satisfied).
This is different in an existing, already established business, which — if properly managed — offers standardized goods or services in a standard way. No employee has the right (or is trusted) to change the business model.
But entrepreneurs do — and should. Starting your own business to do things exactly like everybody else is asking for trouble (unless, as with plumbers, licensing effectively thwarts competition). Nobody will recommend that you start a business to compete in a commodities market — unless you have an innovative approach (which, by definition, means you’re not actually competing in a commodities market). Incumbents have already tweaked and improved their production processes to keep their costs per unit of output below what you can accomplish as a startup doing the same thing.
Entrepreneurs doing Entrepreneurship
Entrepreneurs must create value. Note that some of the value creation can be as simple as using proper communication. Had this plumber instead of charging per hour (and, as this one did, stating that it took him two hours to drive home to get the forgotten tools!) charged a fixed rate or even stated that he took some off the total since it was only driving time, I would have been more satisfied with the service.
Even better, had this plumber stated up front that he’d charge a certain price for this kind of job, I would have already committed to paying it. Instead, he — and, presumably, most other plumbers — treat their business as a job: they do nothing different, they charge the same, and they focus on charging the customer for their cost (and not the value provided).
In hopelessly regulated and non-innovative industries like plumbing, non-entrepreneurial entrepreneurs can make a lot of money off of customers whether or not customers value their services. And since basically none of them think as entrepreneurs, consumers suffer comparatively outrageous bills for low-value services. But all it takes to disrupt this market is one innovative plumber to implement a different business model than everybody else is using.
To do this, the innovative plumber must think differently. He or she must place the customer and their satisfaction first — and adjust costs to the value provided. Not the other way around. Focusing on costs, and then “charging” customers based on those costs incurred, means leaving loads of money on the table. This is money that would benefit both plumbers thinking as entrepreneurs and their customers. That is what entrepreneurs do: they create value.
Managers, in contrast, keep costs down in producing the already given value. Both are needed in a well-functioning economy, and to contribute to a higher standard of living. We cannot take a shortcut directly to management and expect miracles, because we’ll only get more of the same. That applies both to the individual business owner, who will at best earn normal profits, and society at large, which will at best experience marginal economic growth.
