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Entries in gambling (2)

Monday
Feb182013

Gamblers

Kenny Rogers, 1978

Research on the neuroscience of gambling featured in The Economist and  marketing practices used within the casino industry itself as detailed in the "Blackjack" episode of This American Life suggest gamblers are not addicted to winning.

Gambling addicts are addicted to having nearly won. Their brains crave losing by the smallest of margins more than winning itself. A maladaptation of the amygdala seems critical.

"The researchers found that those who scored highest in gambling severity also showed the most activity in the midbrain area in response to near misses. (They did not differ in their response to real wins, however.)

"This area of the brain is of interest to researchers because it is where dopamine, a neurotransmitter, is produced. Dopamine has been implicated in other addiction studies. It could be the near misses that enhance dopamine transmission in gamblers who suffer the most severe problems, the study suggests."

Abstract: "Gambling Severity Predicts Midbrain Respons to Near-Miss Outcomes," Henry Chase and Luke Clark, Society for Neuroscience, 2010.

PDF: "Neurobehavioral Evidence for the 'Near-Miss' Effect in Pathological Gamblers," Reza Habib and Mark Dixon, Journal of the Experimental Analysis of Behavior, 2010.

Tuesday
Jan172012

Most Small Businesses Shouldn't Be

In “The Illusions of Entrepreneurship,” author and professor Scott A. Shane shows the reality of American entrepreneurship as being decidedly different from the myths that have come to surround it.

A Professor of Entrepreneurial Studies at Case Western Reserve University, Shane takes "entrepreneurship" to mean small business start-ups. He compared data from the past 30 years done by university researchers on business start-ups and found that the United States isn’t very entrepreneurial at all.

In 2002, the top 10 countries in percentage of population that owned new and young businesses were:

  1. Thailand (27.2%)
  2. China
  3. New Zealand
  4. Greece
  5. Brazil
  6. Switzerland
  7. Australia
  8. Jamaica
  9. Venezuela
  10. Finland

America was at 9.9% (p. 16). And America has not gotten more entrepreneurial over time. In fact, Shane cites that a higher proportion of people started businesses in 1910 than they do today in the U.S (p. 7).

Shane points out that more entrepreneurial countries are generally poorer than less entrepreneurial countries. One explanation: capitalism. As equipment increases productivity, more people quit working for themselves (traditionally, farming) and go work for the people who own the equipment.

Also, as countries get richer, “they change where economic value is created; first from agriculture to manufacturing, then then from manufacturing to services,” which also accounts for the shift from people working for themselves to people working for others (19).

Image from highwoodsbees.com

Farmers and Postmen

In the U.S. from 1983 to 2002, the career with the highest percentage of self-employed was horticulutral specialty farming; during those 20 years, all 100% were self-employed, and 98.59% of all farmers in general were self-employed. Health practitioners, podiatrists, dentists, auctioneers, fishers, and authors all measured over 70% self-employed, as well (49). 

The lowest percentage of self-employed workers during that same time period were Federal mail carriers (0.02% self-employed) and elementary school teachers (0.03%). Police, high school teachers, bank tellers, miners, technicians, administrative support and assemblers all scored less than 2% self-employed.

Other notable careers that were self-employed:

  • 7.2% of engineers were self-employed; 
  • 12% of car and boat salesmen;
  • 26% of actors and directors;
  • 29% of carpenters;
  • 39% of lawyers;
  • 45% of musicians and dressmakers;
  • 50% of hunters and trappers;
  • 54% of veterinarians;
  • 71% of writers.

Photo from eating colorful.blogspot.com

Wyoming and California

Bust the bubble: San Francisco isn't very entrepreneurial. The Bay has a far lower proportion of small businessmen and women than the #1 U.S. city in terms of percentage of small-business entrepreneurs: Laramie, Wyoming.

Per capita, there are two and a half "new-business entrepreneurs" in Laramie for every one entrepreneur in San Francisco, which ranks 121st, far behind self-employed meccas like Bozeman, MT; Farmington, NM; Rock Springs, WY; Rapid City, SD; Pikesville, KY; Laredo, TX; Brunswick, GA; Newark, NJ; Anchorage, AK; and Enid, OK (23).

Most Americans when they think "entreprenuers" immediately think of venture-capital backed, high-growth technology businesses, but those firms—the Microsofts, Apples, Googles, etc.—make up only a tiny fraction of new businesses. As businesses of opportunity (rather than raw necessity), venture-capital backed tech and medical companies generate virtually all value and jobs from start-up businesses.

“Since 1970, venture capitalists have funded an average of 820 new companies per year. These 820 start-ups—out of the more than 2 million efforts to start a business in this country every year—have enormous economic impact. In 2003, companies that were backed by venture capitalists employed 10 million people, or 9.4% of the private sector labor force in the United States, and generated ... 9.6% of business sales in this country” (162).

That means venture capitalists only fund 0.03% of all new businesses every year, making the odds (assuming a level playing field) of getting venture capital for a new business 1 in 4000. (The odds of fatally slipping in the bath or shower are 1 in 2232) (p. 91).

So what do most small businesses in the U.S. look like?

Shane says, “The typical entrepreneur [is] a married white man in his forties who started his business because he didn’t want to work for someone else and who is just trying to make a living, not build a high-growth company.

“The characteristics that make people more likely to start businesses aren’t all the desirable ones that our myths associate with entrepreneurship. The data show that the likelihood that a person starts a business increases if he:

  • is unemployed
  • works part-time
  • has changed jobs often
  • makes less money

“Finally ... the experiences often associated with being an entrepreneur—immigrating, dropping out of school, and networking—don’t actually increase the odds that people will start businesses. 

“Instead, going to college, getting a professional degree, and having some experience managing others in a business setting are the experiences that actually increase a person’s odds of starting a company” (63).

According to Shane's research, the typical start-up is home-based, employs one person, and has no intention or prospects of growing. It was started using $25,000 or less of the founder’s savings in a run-of-the-mill industry where there are many firms and profits are slim. The business's lifespan is five years or less, during which time the founder makes less money and has fewer job benefits—while working more hours—than if he worked for someone else (160 - 161).

Image from Flickr.com

Don't Forget the Death and Taxes

In his NOLO series book "Deduct It! Lower Your Small Business Taxes," accountant Steven Fishman reports that, not only are these kinds of sole proprietor start-ups less profitable, but they are also much more likely to get audited by the IRS than other business entities, especially for middle-income sole proprietors (462).

In 2010, the IRS audited:

  • 0.4% of partnerships
  • 0.4% of S corporations
  • 0.7% of regular C corporations with assets worth less than $250,000

However, in that same year, the IRS audited:

  • 2.5% of sole proprietors earning between $25,000 and $100,000
  • 4.7% of sole proprietors between $100,000 and $200,000, and
  • 3.3% of sole proprietors above $200,000

Fishman advises that incorporating or forming an LLC greatly reduces your audit risk, but comes with added complexity, fees, and, in some states, additional taxes (467).

Don't Believe the Job-Creation Hype

Contrary to popular political arguements, Shane says “start-ups don’t generate as many jobs as most people think, and the jobs they create aren’t as good as jobs in existing companies” (161).

“New companies—those that are one to two years old—employ only 1% of people in this country,” Shane says, “Newly formed firms account for only 6 to 7% of gross or net new jobs created every year. ... For ‘new’ firms to create 50% of net new jobs, we would have to expand the definition of ‘new’ to include all firms that are nine years old and younger” (158). Nine years old isn't a very new business.

Add to this, “most businesses are started by people who have a significant amount of experience working in the industry in which they are launching their new companies.” (69).

Photo from heirloom radio.com

Small Business Is Usually Necessity

So why do Americans start small businesses that overwhelmingly aren’t innovative, have no intentions to grow, lack a competitive advantage, and involve providing the same skill or service provided at the founder’s last place of full-time employment?

Because they have to.

America isn’t getting more entrepreneurial. More than anything, we are repackaging and redefining "entrepreneurship" from the ashes of unemployment and chronic under-employment.

Given this, should we create political policies that make it easier and more attractive for more people to start a small business? No, we should not.

Shane says we need to reduce the loans, subsidies, regulatory exemptions, and tax benefits for small businesses. “Because the average existing new firm is more productive than the average new firm, we would be better off economically if we eliminated policies that encourage people to start businesses instead of taking jobs working for others”—assuming that jobs working for others exist (163).

Shane dismisses the idea that we can't know which start-ups will become high-growth businesses. We absolutely can. It will be one of the few venture-capital backed firms.

“This view [that we don't know which businesses will succeed] may be politically appealing, but it is naive. It assumes that we can’t identify the things that make new businesses more likely to survive, generate profits, increase sales, and hire people. 

“Unless the beliefs of venture capitalists and sophisticated business angels are completely wrong, and the research discussed in this book is completely incorrect, we know what criteria to focus on” (63).

Image from Daily Mail UK

What If You Can't Resist the Myth?

For those who feel they must start a business, Shane’s advice is fairly straightforward: 

  • Recognize that 90% of the fastest growing private companies in this country sell to businesses (118)
  • Start marketing sooner, rather than not at all (119)
  • Don’t compete on price, but rather on quality or service (119)
  • And “improve your chances of success as an entrepreneur by starting a company in an industry that is better for start-ups” (116)

From 1982 to 2000, the best industry for start-ups was pulp milling (p. 115). If you started a paper pulp mill during the 1980s or 90s, you had an 18% chance of becoming a big, rich, job creating, Inc. 500 firm. Six mills made it in 18 years! 

  • Computer firms were second with 4.2% of 2,359 firms becoming Inc. 500 firms; 
  • Guided missiles and space vehicles were third with 3.3% of 60
  • Measuring and controlling devices, 2.0% of 2,482
  • Communications equipment, 1.9% of 1,543
  • Drugs, 1.8% of 1,092.

On the long end of the spectrum:

  • Legal services, 0.008% of 129,207 made it to Inc. 500 status;
  • Eating and drinking places, 0.007% of 494,731;
  • Used merchandise store, 0.004% of 24,442;
  • Automotive repair shops, 0.004% of 124,725;
  • Beauty shops, 0.004% of 79,081;
  • Residential care, 0.004% of 27,710;
  • Videotape rental, 0.004%, or 1 of 27,793. 

Even with those terrible odds, we cannot help but admire and respect the riverboat-gambler mentality of those who give small business a whirl. After all, somebody wins the lottery: an attitude of irrational optimism perfectly in line with America's Winner Take All economy.

What If It's About Happiness?

The only other explanation Shane sees for why people would start a small business involves the perception of satisfaction. “It makes people happier,” he says, as 62.5% of people who work for themselves reported being satisfied or very satisfied with their jobs, compared to only 45.9% of others. 

Women cite the flexibility to work while caring for small children. Men and women both cite the importance of working in a small organization where they can interact directly with everyone and have more autonomy, flexibility and control over their lives.

“Studies show that to be as satisfied when he is working for others as he is when he is working for himself, the average person needs to earn 2.5 times as much money” (109).

Image from fashionfame.com

Is "Satisfaction" Enough?

At the core, it depends on how much an individual truly enjoys working harder for less money while enjoying a perception of more freedom. For most people, those feelings of satisfaction are probably not worth the opportunity cost of more gainful employment at established businesses.

Perhaps this fatalism, mixed with a handful of strike-it-rich myths, is what we really mean by “the American entrepreneur." However, to feed the myth and artificially force rates of entrepreneurship up is terrible economic policy. 

As Shane concludes, “Increasing the number of people founding construction firms and hair salons and taxi services that don’t do anything innovative isn’t going to do us much good. In fact, it might hinder our economic growth because new businesses are, on average, less productive than existing ones” (162).

Image from mlive.com

Any political argument that exalts small business probably plays on voters' minds in the same way that Las Vegas casinos owners do: by turning losing odds into big gains for those outside the game who get everyone else to put skin in the game.

As Paul Krugman stated in an op-ed piece "America Isn't a Corporation," we should not mistake governing a macro-system as conceptually the same as doing what’s best for an individual firm.

Scott Shane’s book suggests that perhaps we should govern in a way that’s actually worse for the majority of individual small businesses and strive to create conditions that supplant their having to start in the first place.

Kill Mom-and-Pop businesses? Yes, if then created jobs that paid Mom and Pop better in the job market to account for the satisfaction they feel "working for themselves." But our myths about business and entreprenuership suggest we will not do that: myths about working hard, myths about creating jobs, myths about freedom—they are worth lots of money to the country's owners.

And the odds of a small business owner getting a 250% pay raise are worse than slipping in the shower, which is unfortunate, because 50% of small business owners and their employees don't have health insurance, either.

Source:
“The Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live By,” Scott A. Shane, Yale University Press, 2008.