Complexity economics, dispelling venture capital conventions, and good bubbles
The future of innovation is global. We discuss it here. October 2021 Edition.
Topic of the week
Everything I’ve ever been taught in economics, both macro and micro, relied on the assumption of mass rationality across disparate actors. Of course this was a simplification, but we had no better way of understanding the world practically.
A new approach to economics is emerging: complexity economics, which I have found myself diving into deeply, and resonating with strongly, for the world of innovation. This Nature article is riveting, exploring the foundations of the approach. See the abstract below.
“Conventional, neoclassical economics assumes perfectly rational agents (firms, consumers, investors) who face well-defined problems and arrive at optimal behaviour consistent with — in equilibrium with — the overall outcome caused by this behaviour. This rational, equilibrium system produces an elegant economics, but is restrictive and often unrealistic. Complexity economics relaxes these assumptions. It assumes that agents differ, that they have imperfect information about other agents and must, therefore, try to make sense of the situation they face. Agents explore, react and constantly change their actions and strategies in response to the outcome they mutually create. The resulting outcome may not be in equilibrium and may display patterns and emergent phenomena not visible to equilibrium analysis. The economy becomes something not given and existing but constantly forming from a developing set of actions, strategies and beliefs — something not mechanistic, static, timeless and perfect but organic, always creating itself, alive and full of messy vitality.”
This approach is so much closer to how the world actually works - why certain entrepreneurs succeed, certain products or ideas become viral and certain startup ecosystems flourish.
What do you think?
We often think of consumers, angel investors, and customer preferences as individual items. Fascinating analysis on the importance of ‘squads’ - groups acting together, and in particular their impact to the innovation economy. “Squads have existed for thousands of years as vital forms of social and economic organization. Thanks to group chats and a wave of private online social platforms, squads are reemerging today as a potent cultural force that rejects a strictly individualist market philosophy. Squads play a key role not only in internet community dynamics but in emerging economic networks.” And tech is powering a reemergence of squads in new ways.
We may be in a bubble. But is that a bad thing? Perhaps not, because well-behaved bubbles often make history. “But even though the term “bubble” is usually pejorative, the right kind of bubble, at the right time, can exert a powerful positive effect on the world. A bubble is an objectively irrational shared belief in a better potential future … but that doesn’t just describe someone bidding up asset prices; it also describes anyone who chooses to build that kind of future. (And it’s not a coincidence that the other social sense of “bubble” is a filter bubble — a fact- and criticism-proof barrier that keeps a set of people convinced against all external evidence that they’re right.)”
One of the reasons I’ve advocated a camel strategy is optionality. Businesses built on a foundation of sustainable and replicable unit economics, with a manageable burn don’t depend on venture. Rather it is a tool that allows them to accelerate when, how and if they so desire.
I’m therefore often asked what I think about the current venture capital boom. Of course things are good on paper, but it is also more complicated. Great piece that talks about the other side of the table for Venture Capitalists. “It’s not just that it’s a lot harder to write checks at what feels like a reasonable clip at the moment, or that most VCs feel they can no longer afford to be price sensitive. Many of the founders with whom they work are being handed follow-on checks before figuring out how best to deploy their last round of funding.” More money is not necessarily good. [Too much money] “can also serve as a distraction, as well as hide fundamental issues with a business until it’s too late to address them…Taking on more money also oftentimes goes hand in hand with a bigger valuation, and lofty valuations comes with their own positives and negatives.”
What is venture capitalist best practice? As I’ve written about previously (and perhaps at nauseam), there are Silicon Valley conventional wisdoms. They are often not applicable for most of the world. I enjoyed this piece dispelling pre-seed conventional wisdoms. It explores whether you should take pro-rata, how concentrated your portfolio should be and how your fees should be structured.
With all the news on the chip tech shortage, I found myself trying to understand the complicated global and interdependent supply chain. Here is a short highly visual primer I enjoyed.
What is the future of work? Distributed teams do bring productivity increases. But more and more research also highlights its downsides. A new study of that “analyzed data on the communications of approximately 61,000 Microsoft employees in the U.S…revealed that while hours worked went up slightly when employees shifted to working from home, communication, particularly real-time conversations, fell significantly.” In summary, remote work helps in short term but has longer term downsides. That’s why I expect we’ll see more hybrid solutions including for instance a few days in the office (or weeks) and a few from remote. The answer will depend on the business, the product and the leadership philosophy as well.
The story is not new, but mainstream Silicon Valley interest is: the future of innovation is global. Thoughtful piece that highlights the opportunity and ten examples of innovators at the Frontier. At the same time, too much of a good thing can be bad. So much money is flowing into Frontier markets, and often by folks who have rarely done business there and many not understand the macro risks. In that vein I share this warning piece.
Last week I shared about the promise and challenges of embedded insurance. Video of the talk at Insuretech Connect below.
Book of the month
This month I’m still reading the phenomenal but also gigantic: The Wizard and the Prophet: Two Remarkable Scientists and Their Dueling Visions to Shape Tomorrow’s World by Charles Mann.
To continue on the parenthood theme I had earlier in the year, I’m also reading All Joy and No Fun: The Paradox of Modern Parenthood by Jennifer Senior. As the NYT Reviews it: “Parenthood as we know it — predicated on the unconditional exaltation of our children — is no more than 70 years old, and it has gone through radical readjustments over the past two generations. As children went from helping on the farm to being the focus of relentless cosseting, they shifted ‘from being our employees to our bosses.’”
The role of parents has completely shifted over the last 100 years. “Every debate we have had about the role of parents — whether they should be laissez-faire or interventionist ‘Tiger Moms,’ attachment-oriented or partial to the rigors of tough love — can be traced back to the paring down of mothers’ and fathers’ traditional roles.” As parents we only know what our role is not: “teaching kids mathematics and geography and literature (schools do that); providing them with medical treatment (pediatricians); sewing them dresses and trousers (factories abroad, whose wares are then distributed by Old Navy); growing them food (factory farms, whose goods are then distributed by supermarkets); giving them vocational training (two-year colleges, classes, videos). What parents can agree on, whatever their approach, is that it’s “for the child’s sake, and the child’s alone. Parents no longer raise children for the family’s sake or that of the broader world.”
Notes: Special thanks to Austin Arensberg for sharing the squad piece and Ross Buhrdorf to introducing me to the Santa Fe institute and complexity economics