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Lean Startups and Capital Ownership

April 23, 2014
6719452305_78383ce4e3_zIn the last few years, there has been a big emphasis in entrepreneurship on “lean” startups. Being lean basically means avoiding unnecessary costs early in the development of a new venture, thus minimizing waste and reducing the negative effects of uncertainty. For example, a common lean strategy involves using consumers to test a limited run of an unfinished product in order to furnish data before going to market. This allows the firm to gauge the likelihood of success before committing resources to full-scale production, which is expensive and uncertain. The conventional wisdom, which in some ways is just economic common sense, is that a new firm should stay lean for as long as possible. Yet one implication that is sometimes drawn from the lean approach is that capital ownership is a negative for early-stage entrepreneurs, because in some ways owning capital narrows a firm’s strategic options, both economically and geographically. Lean ideas are especially popular in high-tech industries (where they originated), which are more likely to be driven by ideas and lines of code than intensive investment in plant and equipment. The lean philosophy may then hint at some interesting questions for Austrian economists. For instance, if it is true, as many Austrians have emphasized, that entrepreneurship requires resources (and especially capital goods), how would economists respond to the claim that successful entrepreneurship doesn’t or shouldn’t require capital assets (at least in its early stages)? In fact, I think there may be some important common ground between the lean view and the Austrian one. First, even the leanest firm needs to start somewhere, with some kind of capital (even if it’s just a computer in the entrepreneur’s garage). The problem for lean firms isn’t whether to own all potentially useable capital goods or none of them, but which capital assets to own. In other words, running a lean startup involves careful thinking about the boundaries of the firm. Lean startups are not completely without capital, it’s just that their strategy is to avoid buying it until it makes the most sense; that is, not to expand the boundaries of the firm until absolutely necessary. Being lean is therefore an example of the kind of economic calculation and judgment that Austrians emphasize is at the core of entrepreneurial decision making (including decisions about firm size). Furthermore, the decision to be lean can work for or against entrepreneurs, depending on their ability to forecast the future. It makes sense to expand the boundaries of the firm at its inception if entrepreneurs are correct in anticipating that there are profits to be captured through quick, large-scale investment. If, on the other hand, an entrepreneur’s speculation is faulty, the initial investment goes to waste—exactly the problem the lean approach hopes to avoid. Caution is often entirely reasonable, with the caveat that too much of it might mean the loss of market share if the firm takes its time developing the product. If we look at things this way, I don’t believe there is any inherent tension between the lean view and an Austrian one. In fact, it seems to me that when understood in the context of economic calculation and judgment, the lean philosophy is actually a pretty good example of Austrian theory at work in practical entrepreneurship. Photo credit. 

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