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July 28, 2011

The Start-Up Law of Comparative Advantage

I can type faster than my assistant.  If she is reading this blog, she may dispute this (and we may have to have a show down with the help of an online typing test), but I'm a pretty darn fast typer.

But, if my assistant were to sit in on my board meetings for me while I stayed back in the office and typed, I'm not sure my entrepreneurs would be very happy (at least, I hope not!).

Thus, despite the fact that I may be a faster typer than she on an absolute basis, it's way more important for my job as a VC that I maximize my time working with entrepreneurs, something I am comparatively better at than she is.

This simple example is derived from an economic law discovered by David Ricardo that has always fascinated me, called the Law of Comparative Advantage.  This law says that it does not matter  whether a nation is better at producing a particular good on an absolute basis as compared to another nation.  What matters is whether a nation is comparatively better at producing a particular good as compared to other goods it can devote its resources to producing relative to another country.

Unfortunately, I see too many founders ignoring the entrepreneurial corollary to this law, the Start-Up Law of Comparative Advantage.  I'm no David Ricardo, but it seems to me that if entrepreneurs followed this "law", the gains to their start-ups would be akin to the gains attributed to free trade.  Here's why:  founders are typically gifted, multi-talented, versatile professionals.  As such, they get sucked into spending time doing things that they may be better at than the others in their organization on an absolute basis, but that, comparatively speaking, they are worse at in relation to the handful of things that they are uniquely suited for.

I work with one founder/CEO who is so talented, I think he literally could perform the job function of each of his direct reports better than they could.  But if he spent all his time doing operational project management or tactical sales activities, he wouldn't be able to spend time on the things that only he uniquely can do relative to his teammates.  

In a fast-growing start-up, a founder needs to be very protective and strategic with how they spend their time.  Founders are always complaining that they are spread too thin, are overwhelmed with the job at hand, and struggle to figure out how they should be prioritizing their efforts.

I would submit that, above else, there are two areas a founder should not delegate:  product and people.  Product-related activities include developing customer intimacy (studying the "voice of the customer"), designing features, thinking through product strategy and setting priorities.  People-related activities include hiring, setting the culture, coaching and mentoring.

If a founder finds themselves spending the bulk of their time on issues not related to product or people issues, they are violating the Law of Comparative Advantage.  They need to rethink whether they're delegating in the wrong areas, and not being (appropriately) obsessively hands-on in the right areas.

I remember reading once that in the early days at Microsoft, Bill Gates and Steve Ballmer would review each other's calendars on a monthly basis and give feedback to each other on where they should be spending their time.  That concept has always stuck with me, and my partners and I endeavor to do the same periodically. 

Try the following exercise:  at the end of the week, write down the top 6-8 categories of time spent on your start-up (e.g., product, people, project management, operations, marketing, sales, investor relations, miscellaneous).  Just as a lawyer would, track your hours at the end of the week by "billing" each of these buckets.  When you step back and analyze how much time you are actually spending (as opposed to how much time you think you are spending), you may find you can make appropriate adjustments to better deploy your time. 

Adhering to the Start-Up Law of Comparative Advantage may not earn you the Nobel Prize in Economics, but it will help you direct your time more productively when starting your company.

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Product and people are usually the two hardest jobs in a start-up, especially in the early stages. Luckily, they are also the most rewarding jobs when they are executed well.

And If you need to race your assistant, TypeRacer is probably the most fun way to do it - http://play.typeracer.com

Nice application of comparative advantage within a micro-economic environment. You could add to the argument by more explicitly using the concept of opportunity cost to further drive home the point.

Great article.. from someone who left studying finance to be an entrepreneur... although it might be part of product .. I would actually add in another P which shouldnt be delegated ... which is process.

I think that entrepreneurs need to build in operational efficiency into their business & the general ethos of their company so simply expecting other people to take the initiative and own the task of implementing systems to measure and being involved in ensuring the business runs smoothly is super risky. You shouldn't be implementing the system but you should be active in ensuring processes are in place.

poor operational efficiency constrains rate of growth, which is fundamental to the success of a startup for both the entrepreneur and investor

slight omission/typo - should have read 'and NOT being involved'

I agree, and it applies more to the CEO than to the company. Companies today are scalable (a concept alien to Ricardo) so if Google has an absolute advantage over you that's too bad. People aren't scalable. You can't do everything so comparative advantage is crucial.

Nice interpretation to law comparative advantage. Slective delegation is indeed a key to success of any start up.

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That's a great point about scalability, Pavlos. I'm not sure Ricardo could have imagined the behemoths like GE, JPMorgan Chase, Apple, Google, IBM and the organizational challenges they present. Many think modern-day multi-nationals are themselves evolving into nation-like entities and cultures, but that's a whole 'nother blog post...

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Interesting perspective, Vincent. I would have said hire someone else who is great at process. Most founders are best at product, creativity, vision and people - not process. I've seen too many investors force process too early on creative founders to be convinced of this one.

I could not agree more! I especially like the statement "I would submit that, above else, there are two areas a founder should not delegate: product and people." This is exactly what I have come to believe through the on-the-job learning as an entrepreneur. Thank you for the excellent post.

Process strategy: entrepreneur.
Process implementation: delegated.
Sometimes process represents a truly innovative competitive advantage over existing traditional systems, and is a part of the success.
But I fully agree on P & P.

While I agree with the article and enjoyed the application of competitive advantage, there are times when a founder/CEO must focus on fund raising which takes a considerable amount of time and energy. Investors invest in people and no one more so than the CEO. It is one task that can’t be delegated, notwithstanding a lot of the prep work can be. But the face in front of the investor has to be the CEO and I have seen too many think they can turn that over to the CFO or some outside consultant/banker. If the CEO can’t raise money, it really does not matter how well they or others do everything else!

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Very true, Scott.  Rule 1 of entrepreneurship is never run out of money and it is impossible to outsource this critical task.  

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