7 Lessons Business Owners Can Learn from Austrian Economics
Apart from dealing with government intervention, understanding markets is probably the most challenging task of any business owner or entrepreneur. It was for good reason that Ludwig von Mises insisted that economists and institutions that teach economics go out of their way to share economics theory with business owners and the general public. Economics, as Mises wrote: "deals with society's fundamental problems; it concerns everyone and belongs to all." This applies, not least of all, to the daily problems of owning, starting, or running a business.
And Mises wasn't alone. The Austrian School has long concerned itself with being accessible, and not positioning itself as a school of esoteric knowledge for a few scholars. So what can business owners learn from the basic insights of the Austrian economists? There are at least seven lessons that can be quite helpful for those seeking to grow and sustain business ventures:
One: People Act: Let us get to the basics. Praxeology, as described by Ludwig von Mises, states that people act and they do it looking to increase their satisfaction. Business owners (businessmen, entrepreneurs, and managers — I am using all the terms interchangeably here, but in theory, they are not the same) have specific goals. Usually they are looking for profits, or what is sometimes called “better financial performance.” Meanwhile, their clients are usually looking to pay as little as possible for the best possible products they plan to consume. Every action can be considered self-interested and, in business relations, since actions are unconstrained (i.e. people act freely, without being forced to), business owners have to provide the best possible goods or services at reasonable prices. If they do not, someone else will. Moreover, people’s goals and wishes are subjective — so two different people can value the same product in very different ways. These intrinsic differences lead to differentiation in offered prices, in products and lead to the creation of different brands for similar.
Two: People and Things Are Different. Business men know that every client is unique and that their tastes and wants change on a daily basis. Austrian-school economics explains that every human action is based on the different kinds of knowledge under possession of the actor. Knowledge changes over time, those changes will lead to modifications in the characteristics of demand. Consumer demand dynamism will ask for constant adaptation from suppliers in the production process which will lead to constant innovation, entrepreneurs and business men will guide that change. On the one hand there is the diversity of desires and wills and the dynamism of demand, and on other hand there is the demand for intermediate goods derived from final product’s demand. Demand in every industry will always be heterogeneous and dynamic. Business owners cannot sit on their current advantages. The myth of the rich businessman that can afford to sit around and do nothing is exactly that: a myth.
Three: The Market Is Dynamic. When entrepreneurs act they are doing so to try to solve their own problems by solving their client’s problems. F.A. Hayek and Israel Kirzner saw the market process as tending towards equilibrium. Lachmann1, on the other hand, said that market actions could be coordinating, discoordinating, equilibrating, or disequilibrating, and that in the really important cases the disequilibrating tendencies prevail. Put more simply: the market is constantly changing, and entrepreneurs will need to constantly adapt. When a new and innovation product reaches the market — as frequently happens — it changes the whole competitive landscape.
Four: Nobody Has Full Knowledge Neither companies nor clients know everything and this limited access to knowledge directly influences business decisions. Mises stresses that it is impossible to possess all knowledge at the same time. Hayek says that knowledge is spread in society, knowledge acquisition is thus costly and imperfect, as any successful business man knows: “the more you know, the more you know that you don’t know much.”
Five: Resources Matter. Firms can be understood as groups of resources, including human resources and their knowledge. Resources are always heterogeneous and imperfectly mobile. For instance, it is impossible for a restaurant owner to use the resources that he has at hand to create a new business consulting company, a shoe factory, or a construction business at the same time or with the exact same materials. In economics we call this "capital heterogeneity." Resources (that economists usually call ‘capital’) cannot be immediately transferred between two different lines of production or even two different stages of the same production. You could try to do that, but the effectiveness of the resources will be diminished. Further: entrepreneurs, are responsible for combining and recombining resources continuously because of the new attributes, technologies and new consumer demands. Firms with a competitive advantage in one segment of the market could see this advantage disappear elsewhere. When combined: tangible and intangible, heterogeneous and immobile resources and heterogeneous demand, bring a number of different possibilities to firm organization. Those business owners who combine these resources in a way that most pleases consumers will be the most successful.
Six: Managers Analyze and Act. What about the role of managers? Manager are agents that have the company’s decisions in their hands. Managers act based on their knowledge and incentives, self-interestedly. Decisions will be implemented through actions and results will be observed after the passage of time. Managers need to act via recognizing, understanding, creating, selecting, implementing and modifying the various strategies that firms put in place. In short, managers or business owners need to constantly innovate. (See Peter G. Klein here and here, and Bylund here.) When analyzing market needs and acting upon them, these agents are acting to adjust to constantly-changing realities of the marketplace.
Seven: Competition Is About Generating Advantage. Competition is based on the ongoing search for resources capable of generating competitive advantage. Learning happens when people within firms gain a better understanding of market signals — especially financial signals — that convey information about the company’s competitive position. Bad results indicate competition in a segment in which the firm has no competitive advantage. Firms that hold competitive advantages will have to defend their position by innovating continuously because competitors will act to try to overcome other firm’s competitive advantage through the modification of their own set of resources. Changes won’t lead to an optimum stage, but to growing diversification.
At the core of all of this is the need to better serve customers. Since the preferences and desires of all consumers are constantly changing, business owners and managers who contantly strive to discover and understand both what consumers want, and how resources can be used to deliver the products people demand. This is not an easy task, and it's why a better understand of economics, as Mises knew, is something that can benefit everyone.
- 1. LACHMANN, L. M. Capital and its Structure. Institute for Human Studies. Original edition published by Bell & Sons, Ltd., on behalf of the London School of Economics and Political Science in 1956. 1978.