Entrepreneurs Who Create Value vs. Entrepreneurs Who Lock Up Value

from the cornelius-vanderbilt-was-the-skype-of-his-day dept

Andy Kessler is coming out with a new book today, called Eat People: And Other Unapologetic Rules for Game-Changing Entrepreneurs, which I wholeheartedly recommend. It's billed as "rules for entrepreneurs," but it's more than your typical "rules" book, in that it really discusses many of the key underlying themes we talk about here on Techdirt all the time: things about abundance and scarcity, value vs. price, why zero marginal cost matters, the importance of "free," the nature of disruptive innovation and how value is often created in the tearing down of old monopolistic business models.

If you haven't read Andy's previous books, well, you should. But, this latest is typical Andy: packed full of thought-provoking insights, but done in a nice, easy (and quick) to read conversational manner. Like all of his books, this one made me stop and say "huh, I never quite thought of it that way... but that's exactly right" many times.

After reading the book, I asked Andy if he'd do a guest post, diving into one point he made about the difference between "political entrepreneurs" and "market entrepreneurs," and he came back with the following wonderful historical example (also discussed in the book) about Cornelius Vanderbilt, who was the Skype or Napster of his day -- figuring out ways to get around the "political entrepreneurs" who offered high prices due to their ability to gain monopolies. It's a great read, enjoy:


While entrepreneurs are out there busting their humps, making something cheaper, expanding its usage, increasing productivity, fending off fierce competition, and hoping to turn a profit along the way, there are those who, through the stroke of a pen, make a killing doing absolutely nothing of value. These "political entrepreneurs" leverage their political power to own something and then overcharge or tax the crap out of the rest of us to use it. Political power instead of competition.

Carlos Slim Helu comes to mind who briefly passed Bill Gates in 2007 and 2010 to become the richest man in the word. He controls 90% of the phone lines in Mexico and 80% of cellular customers. He didn't invent anything. He doesn't drive down prices. There is little innovation. And why should there be? He is milking this franchise for all it's worth.

Easy money forever. But then again, maybe not. Because for every stroke of the pen, for every piece of legislation, for every paid-off congressman, there now exists a price umbrella that overvalues what he or any political entrepreneur is doing. Real entrepreneurs, "market entrepreneurs," recognize the price-to-value gap and jump in. Ignoring legislation, they innovate, disintermediate, compete, stay up all night coding, and offer something better and cheaper until the market starts to shift. I call home from Mexico using Skype. Eat that Slim!

There's one guy who figured this out before being a market entrepreneur became fashionable.

Cornelius Vanderbilt was born in 1794 on Staten Island, New York. As they say about Dominicans in Major League Baseball: you don't walk off the island, you gotta hit your way off. When he was sixteen, Vanderbilt's mom gave him $100 to clear and plant an eight-acre field. Instead, Vanderbilt bought a two-mast sailboat and started charging for ferrying passengers and goods around New York. It didn't take him long to save enough to get into where the real money was: steamships. The powers that be in the New York legislature had granted a thirty-year monopoly for steamship traffic to Robert Fulton and Robert Livingston, a classic move by political entrepreneurs. Fulton was even able to convince the politicians that he couldn't make money unless he doubled his prices. He set up a fat umbrella for Vanderbilt to shred.

In 1817, hired by a local businessman, Vanderbilt started running, quite illegally mind you, freight and passengers from Elizabeth, New Jersey, to Manhattan. He charged $1 per passenger, well under the $4 monopoly price, until he took most of the business. One dollar was probably below cost, but he also ran the ship's bar, a much higher-margin business! Vanderbilt was threatened with arrest and impounding of his ships so often that Vanderbilt started flying flags from his ship that said "New Jersey Must Be Free." Makes an old Jersey boy like me smile.

At one point, and how's this for twenty-first-century thinking, Vanderbilt lowered the price to zero, nothing, nada. He gave away the trip for free. He not only made money at the bar on the ship, but his wife ran a saloon at the Elizabeth port, right where the passengers conveniently spilled out of Vanderbilt's ship.

Notice, Vanderbilt didn't ask permission, he just did it. There was a $4 price umbrella and he shredded it down to $1. Fulton and Livingston eventually sued and, in 1824, the U.S. Supreme Court decided in Gibbons v. Ogden that interstate commerce was federal jurisdiction. So, wink, wink, only Washington could decide who could be political entrepreneurs, not states.

Vanderbilt never slowed down, charging $7 for the trip up the Hudson River to Albany, or $1 for each twenty miles for intermediate stops, well under the monopoly rate charged by the Hudson River Steamboat Association. He employed tubular boilers and coal instead of burning wood, cost-lowering innovations not previously tried by others milking the route. The competition quickly followed. Vanderbilt was eventually bought out by the Association so they could get their high fees. Over time, Vanderbilt ran one hundred ships around Long Island and up and down the coast, making a fortune.

Then he yanked the price down on the New York to San Francisco trip during the California Gold Rush. By going through Nicaragua instead of Panama, he shaved two days off the thirty-five-day trip. He cut prices from $600 to $400. His competitors were paid $500,000 by the Post Office to deliver the mail to California, so Vanderbilt offered to do it for free, and then he cut his passenger price for the trip to $150. Volume surged as every would-be gold miner had only to find $150 worth of gold to make the trip worthwhile.

It didn't take long for Vanderbilt to set his eyes on the lucrative transatlantic route. A political entrepreneur named Edward K. Collins got Congress to subsidize his business to the tune of $3 million and $1,000 a day so he could profitably run the route. Vanderbilt ran more efficient ships and undercut Collins, who was saddled with all sorts of rules and regulations that went along with his subsidy. By 1858, Collins went belly up from losing so much business to Vanderbilt. The only competitor left was Cunard, the subsidized British steamboat company. Vanderbilt cut rates, especially for second- and third-class passengers, and used iron-hulled ships with screw propellers, cutting the trip to nine days, much less than the wooden paddle-wheel boats. Again, lower prices and scale led to innovation, even though common wisdom says the opposite, that is, we need to subsidize unprofitable business (hear that rural broadband?) so they can afford to innovate. Yeah, right.

Again, Vanderbilt didn't ask, he just did it, lowering prices and gaining share, leaving subsidized and monopoly players in his wake.

During the Civil War, Vanderbilt sold most of his vessels to the Union and more or less moved on. Vanderbilt soon started playing with railroads, except this time he was able to buy stock, in the Harlem line that crossed the Harlem River into Manhattan as well as the Hudson line that ran up the east bank of the river all the way up to Albany. This meant he was competing against the old Steamboat Association again, and that he could lower prices on the trip even more!

Lots of stock manipulation charges followed Vanderbilt around, and he almost lost his fortune to a competitor named Daniel Drew, in a fight over the Erie Railroad. The New York Times likened Vanderbilt to medieval robber barons, who as gatekeepers, or actually more of a protection racket, would charge merchants for being allowed to operate on their land without getting robbed and beaten. Robber barons didn't do anything but charge for something they could do. Historian John Steele Gordon did some work trying to find references to medieval robber barons anytime before the 1850 reference to Vanderbilt, and came up empty. It fit a narrative, though, so the Times went with it, but there may never have been such a creature as a robber baron. With that reference, an expression was born that is still being used today.

Vanderbilt and Rockefeller and Carnegie built giant empires by lowering costs, again and again and again, creating economic growth and increasing living standards by constantly lowering the cost for steel or oil or transportation for passengers and freight, by boat or by rail. They had scale on their side, yet they were labeled "robber barons" for amassing huge fortunes. Go figure. Find something that scales and you'll be so lucky as to be vilified in the press and in high school history textbooks.

The real lesson? Those political entrepreneurs who thought they had it made, with a Hudson ferry, a subsidy to carry the mail, the transatlantic franchise and subsidy--they got fat, dumb, and lazy and set themselves up for a market entrepreneur to come in and take them out at the knees. Real market entrepreneurs should never rest on their laurels. Progress is a continuum. What seems like it is risk-free today carries the greatest risk tomorrow.


Reader Comments (rss)

(Flattened / Threaded)

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    weneedhelp (profile), Feb 3rd, 2011 @ 1:46pm

    Real market entrepreneurs should never rest on their laurels. Progress is a continuum. What seems like it is risk-free today carries the greatest risk tomorrow.

    Well damn, that seem like a whole lotta work. Ill just go to the Gov and get a monopoly. Much easier.

     

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      DJ (profile), Feb 3rd, 2011 @ 2:59pm

      Re: Real market entrepreneurs should never rest on their laurels. Progress is a continuum. What seems like it is risk-free today carries the greatest risk tomorrow.

      Sadly, there are too many people who read that comment and didn't recognize the sarcasm.

       

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    Anonymous Coward, Feb 3rd, 2011 @ 2:15pm

    Quick, jump in front of the parade and claim to be the band leader. Andy, did you learn that from Chris Anderson?

     

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    Dark Helmet (profile), Feb 3rd, 2011 @ 2:17pm

    Great article, except one thing:

    "Vanderbilt and Rockefeller and Carnegie built giant empires by lowering costs, again and again and again, creating economic growth and increasing living standards by constantly lowering the cost for steel or oil or transportation for passengers and freight, by boat or by rail."

    Rockefeller, for one, also made a great deal of his fortune coupling strong-arm tactics with competitors (not the economic kind) while going out of his way to do the same poltical entrepreneurship this article is lambasting. A brief review of what happened to Standard Oil and its many, many subsidiaries after they were investigated and ordered to break apart provides insight into this.

    Hint: they didn't break up the way they were supposed to, and Rockefeller then ended up owning a majority of stock in all of them anyway (or the banks that sat on their boards)....

     

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      DJ (profile), Feb 3rd, 2011 @ 3:04pm

      Re: Great article, except one thing:

      Yes indeed, and although his early days mark him as a brilliant entrepreneur, the latter days mark him as a monopolistic tyrant. It's interesting to note, too, that the artwork displayed throughout 30 Rock is blatantly Socialistic in nature. Makes you think....

       

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        Mike Masnick (profile), Feb 3rd, 2011 @ 3:14pm

        Re: Re: Great article, except one thing:

        Yes indeed, and although his early days mark him as a brilliant entrepreneur, the latter days mark him as a monopolistic tyrant.

        The switch from market entrepreneur to political entrepreneur happens to many successful companies... It's when they go from innovating to relying on the gov't to protect what they've built.

         

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          Dark Helmet (profile), Feb 4th, 2011 @ 6:08am

          Re: Re: Re: Great article, except one thing:

          "It's when they go from innovating to relying on the gov't to protect what they've built."

          Er, making the case for that with Rockefeller as an example is kind of silly, Mike....

           

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            Willton, Feb 4th, 2011 @ 7:58am

            Re: Re: Re: Re: Great article, except one thing:

            "It's when they go from innovating to relying on the gov't to protect what they've built."

            Er, making the case for that with Rockefeller as an example is kind of silly, Mike....


            Indeed. See the Sherman Act and the reasons for its enactment.

             

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    Rekrul, Feb 3rd, 2011 @ 5:00pm

    Unfortunately, ignoring the law when starting a business doesn't work in today's world. If you don't grease the right palms, you either get sued into poverty, or end up in jail.

     

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      LiamO, Feb 3rd, 2011 @ 5:56pm

      Response to: Rekrul on Feb 3rd, 2011 @ 5:00pm

      Google buying YouTube for $1.6 billion while it was still full of infringing content would argue otherwise

       

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    Steve R. (profile), Feb 3rd, 2011 @ 6:32pm

    Effective Deployment of Capital

    Nothing wrong with becoming rich, but there is an economic issue that has been ignored concerning those with extreme wealth. Can they effectively re-invest it?

    People can only juggle so many things. At a certain point you exceed your "span of control" and things "fall apart". For that reason the mega rich may have difficulty allocating investment money towards valid entrepreneurial ventures. Furthermore, since the mega rich have more money than they can reasonably use, they may have little incentive to truly seek our entrepreneurial opportunities. The money then languishes and so does innovation.

     

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      Jay (profile), Feb 5th, 2011 @ 6:12am

      Re: Effective Deployment of Capital

      That effectively says why those with true entrepreneurial spirit tend to be the ones with less money but want to achieve some type of financial success by any means necessary.

      Just think... Have you heard a lot from the DeBeers in regards to syndicated chips? Or is it someone else outside of that field innovating? Should DeBeers not innovate, someone will do it regardless. I think that's the main point here.

       

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      Julien Couvreur, Mar 15th, 2011 @ 6:12am

      Re: Effective Deployment of Capital

      Do you have evidence to support this concern? If anything, the successful entrepreneur seems to have a demonstrated track record of good investment choices.

      Also, don't forget that value is subjective, which makes it tricky to substitute your judgement to that of the entrepreneur.

      Also, assuming your concern is valid, the owner of the capital still seems the best candidate, as opposed to, say, government which would suffer from the same problem on an even greater scale.

       

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    Alex Tolley, Mar 14th, 2011 @ 7:27am

    Re: Vanderbilt

    "Conquering Gotham", by historian Jill Jonnes, paints a rather different picture of Vanderbilt while he owned the New York Central Railroad. His market entrepreneurial days were gone by then. He maneuvered to try to prevent the Pennsylvania RR from building their tunnel from Jersey to Manhattan which would have undercut the profitability of his own line.

     

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    Joe McCarthy, Mar 14th, 2011 @ 12:29pm

    Reminded of "The Theory and Practice of Oligarchical Collectivism" by Emanuel Goldstein

    The discussion contrasting the different phases of Vanderbilt's (and others') entrepreneurship, with the early phase marked by "market entrepreneurship" and the latter phase marked by "political entrepreneurship" reminds me of some insights from that jumped out at me in my most recent re-reading (and review) of 1984: Big Brotherhood, Hierarchies, Power and The American Way, especially those contained in "the book" by the allegedly traitorous archenemy of Big Brother:

    Throughout recorded time, and probably since the end of the Neolithic Age, there have been three kinds of people in the world, the High, the Middle and the Low. ... The aim of the High is to remain where they are. The aim of the Middle is to change places with the High. The aim of the Low, when they have an aim -- for it is an abiding characteristic of the Low that they are too much crushed by drudgery to be more than intermittently conscious of anything outside their daily lives -- is to abolish all distinctions in which all men shall be equal.

    Over time, the High become inefficient, insecure, or otherwise ineffective (e.g., being too "liberal or cowardly" or unwilling to use adequate force) at governing, the Middle seize the opportunity and enlist the aid of the Low to rise up against the High, on the premise of liberty and justice for all, after which elements from the Middle become the new High, and the Low are relegated to their former status, and the cycle starts up again. Or at least, it had been a cycle before the rise of The Party (and its contemporaries in Eurasia and Eastasia):

    The new movements ... had the conscious aim of perpetuating unfreedom and inequality ... the purpose of all of them was to arrest development and freeze history at a chosen moment. The familiar pendulum swing was to happen once more, and then stop ... the High would be able to maintain their position permanently.

     

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      Joe McCarthy, Mar 14th, 2011 @ 5:09pm

      Re: Reminded of "The Theory and Practice of Oligarchical Collectivism" by Emanuel Goldstein

      Oops, that quote above should read "to abolish all distinctions and create a society in which all men shall be equal".

       

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    Julien Couvreur, Mar 15th, 2011 @ 5:44am

    Rent seeking

    There are two important sets of concepts which help understand the rent-seeking behavior of political entrepreneurs:
    -voluntary vs. coercive action
    -legitimate laws/norms vs. legislation

    A lot of the ills people often attribute to capitalism (the social system of ownership and voluntary exchange) can actually be traced back to illegitimate coercion and legislation.
    The only conclusion I can reach is that constitutional boundaries and social constraints on the power of government (the monopoly on coercion and legislation) are crucial to keep entrepreneurs productive, as opposed to getting corrupted by temptation of easy power offered by an boundless government.

    I recommend two Austrian economists, Mises and Hayek, for further reading on this.

     

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    Anonymous Coward, Mar 15th, 2011 @ 5:57am

    The truth about robber barons

    Another take on political vs market entrepreneurs: http://mises.org/daily/2317

     

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