The Pestilence of US News

Every morning I get US News delivered to my door. It’s the only dead tree newspaper I’ve ever subscribed to in my life. Lest you begin to think this is some kind of endorsement, know that I never signed up for it, I don’t pay for it and I tried a couple of times to cancel the thing. It’s a pestilence.

When I say delivered to my door, I actually mean chucked out of a moving car onto the bottom of my driveway. This means that every day if I don’t pick the thing up and throw it out it will accumulate, rain or shine. When it snows we inevitably miss picking up a few and after the melt find a few soaked lumps of pulp we then  scrape into a garbage can.

But US News doesn’t care. They’re selling ads. It’s better thought of as an advertisement flier than a newspaper even though every day they publish news stories. And my routine has settled into a grim coexistence with this pest on my driveway. Each morning on my way to work I pick it up and at least get to muse at what headline they decided to put above the fold. It’s a kind of meta-curiosity for me: what is the world focused on today? Then, without even the courtesy of unfolding the thing, I casually toss it into the train station garbage as I jog to my 632am ride into town.

Today I opened it.

US News obviously noticed my haughty indifference and mutated to deliver its payload (advertisements) to its destination (my driveway) more efficiently. You know what doesn’t matter to US News, anymore? The news. Check out the front page:

US News Front Page Advertisement

I realize this kind of publicity is what they wanted but they can only abandon their journalistic integrity once (assuming this is the first time). Hope it paid well!

Disruption in Insurance: Harder than it Looks

I wrote the following long form essay for an industry publication. Enjoy!

Disruption in Insurance: Harder than it Looks

I think it was AirBnB that did it best. And I suppose Uber. These two companies introduced a new way of conducting very old businesses, transforming the experience where most would never think transformation was possible. Taxis in particular are horribly contaminated by regulation and special interest politicking. If they are vulnerable, isn’t insurance? Isn’t everyone?

I am a reinsurance broker and one of the things we do is link startup insurance businesses with the capital and partnerships they need to execute. After a while of doing this, you notice even dissimilar ideas fail for similar reasons, which I’ll get into below. As a salesman I am of course an optimist so think of this essay as a list of critiques you, as an entrepreneur, need to overcome to leave your dent in the insurance universe. I hope you do!

I used the word disruption up there and it (the word) is everywhere these days. However, if you were Clay Christensen, the Harvard Professor who coined the term “disruptive innovation” in a 1996 HBR article and subsequent book, you’d probably be frustrated. The term has become massively popular, of course, but widely misunderstood to mean something like ‘tech startups win!’, which isn’t what he was going for. For one, all businesses use technology and new entrants have always used it better than incumbents. Yet all new entrants aren’t ‘disruptive’. Uber has brought dramatic change but Christensen himself is on record saying he doesn’t think it’s disruptive, in the sense he meant for the word.

Real disruption, as defined by Christensen, is scary. For most companies, being relentlessly focused on the customer is a good thing: know what they want and deliver that with focus, discipline and low prices. Or maybe not! In Christensen’s telling, disruption reveals this strength to also be a deadly weakness.

He defines disruption as entering a market from an overlooked customer base, of which he says there are two kinds: low-end footholds and new-market footholds. Low-end footholds start with “less demanding customers” in that they consume much simpler, lower quality products than the mainstream market. The disruptor then progresses up to higher quality customers. In new-market footholds, the disruptor tackles non-consumption first by cultivating customers who had never used the product, then moves into an incumbent’s turf later. In both cases, the end game is offering the final group of customers an equivalent product to the incumbent’s but at a dramatically lower price.

Startups are trying to do this all the time and they are failing all the time. I picture an incumbent smugly chuckling to himself as a constant buzz of startups tap against the window over and again until they drop. What do they fail? Maybe the incumbent thinks discipline of execution and focus on the customer keep it from wasting time on these fancy pants tech ideas. The poison in that chalice is that a company can get in the habit of dismissing everything new and assuming an old ‘bad’ idea can’t ever become good. Venture capitalist Marc Andreessen likes to roll out the old dotcom bubble whipping post,, and note that, an almost identical business, was recently sold for 3.3bn. Timing is more important than creativity and timing cannot be planned.

In insurance, the best example of real disruption comes from developing countries in the form of microinsurance. Check this out from the Microinsur website:

We have introduced new forms of protection for emerging customers, including micro-health, political violence, crop and mobile insurance all over the world. In each case, we didn’t start by designing a product in a board room – we visited our customers in markets and villages to understand how they cope with the variety of risks in their lives. The result of this client-centric approach is a new suite of solutions, and the opening of a new market for insurance.

This hits both of Christensen’s entry points: new and low end! In listening to Microsinsur’s founder Richard Leftly’s interview, it’s clear he is aware of this, talking about the power of delivering insurance solutions at phenomenally low overhead costs. A good idea, then. How about timing?

Microinsurance only becomes disruptive if it moves upmarket and the challenge there is regulatory: most insurance buying is forced. Compulsory purchasing makes customers stupid, especially at the low end of the market where the smartest bargain hunters live. Regulators set the rules for what customers can buy and don’t want change. And they have good reason! New products make it hard to tell when someone is underpricing to win, later to collapse in a mess the regulator needs to clean up.

Are regulators ready to try something different? I don’t see it but it’s common for insiders to miss signals of coming revolution. That’s the problem with timing, you need to try (and probably fail!) in order to answer the question: why now?

Enter Disintermediation

I think that when people say disruption they really mean disintermediation. Disintermediation is probably the number one ‘swing for the fences’ strategy for any business. Everyone deals with intermediaries and endures their transaction costs for the benefit of accessing a market. Disintermediation removes the transaction costs but also removes the market! Let’s take three examples:

  1. Cutting out brokers (going direct to consumer or agents)
  2. Cutting out insurers (Automated underwriting)
  3. Cutting out everyone (peer to peer insurance)

Each has been around for decades but none has taken off, really. Here are some ideas for why.

*Cutting out Brokers*

Example: direct insurers and reinsurers

Your broker protects you from getting screwed. Screwed means buying something when an identical product could be had for less. Brokers protect by forcing insurers into the ring to fight for your business. Now, insurance is also complex, requiring some expertise to ensure coverages and terms really are identical before you compare prices. Such expertise means brokers cost good money! Is it worth it?

Let’s come at this a different way by asking “do brokers cause more competition or does more competition cause brokers to appear?” I say the latter: brokers are a symptom of competition, not a cause. And competition is not constant, which means the strength of the broker also rises and falls. That, in turn, means there are two ways to legitimately cut out a broker: 1) remove the need for competition; 2) get insurers to compete without a broker.

Removing competition is not as crazy as it sounds. Consider my business, reinsurance: over the last 30 years the market has had several big negative surprises, causing incumbents to question their understanding of certain businesses, opening up room for several waves of startup reinsurers with distinct appetites. No question those were competition-enhancing episodes.

In between those episodes we’ve witness the reverse: appetites converging as the claims environment settled down. This means carriers consolidate to save on costs since they find it harder to secure an underwriting advantage against others’ identical view of risk. We call this a soft market.

Fewer differentiated options in the market makes a direct relationship more appealing. That said, a complete unification of strategy among reinsurers in volatile business will probably never happen. And even then brokers will always have deeper relationships with the marketplace than a reinsurance buyer and that means better deals. A disempowered broker is still the best place to keep from getting screwed.

In direct insurance things are a bit different, particularly in non-catastrophe-exposed personal lines where products are homogenous and margins are thin. There, new entrants are unable to replicate the data of the incumbents and so bear enormous risk of unknowingly underpricing their business.

Critical mass of is not a new problem in insurance. A hundred years ago the market solved it by banding together to create rating bureaus, centralizing the analysis and often prescribing rates themselves. It was an era much more comfortable with collusion and monopoly than today. That solution is showing its age in many lines: the data needed to put together a state of the art personal lines rating plan has exploded and is growing still. ISO, the heir of the rating bureaus, isn’t keeping up. So market participants have two options: strengthen ISO or be huge. They chose the latter.

The real technological development is that direct carriers are passing on discarded customer leads to competitors, in effect creating bilateral marketplaces. GEICO pioneered a version of this by generating a customer, stripping out the auto and partnering with other carriers (mostly large) to sell the other products. The additional cost of passing a lead to another carrier’s system is zero so why not have a world where large direct carriers are all linked up and whichever portal you enter generates an extra fee for that carrier? That would be a market without a broker but can carriers really stop themselves from manipulating the prices somehow or denying access to the market until your reject a higher priced policy first?

As always, cutting out the broker begs the question: how do you know you’ve got the best deal?

*Cutting out Insurers*

Example: catastrophe hedge funds cutting out insurers and reinsurers and going direct.

Insurance deals in risk. Risk isn’t real, really, like buildings or dishwashers or iPhones are real. Risk is a bad outcome we can’t see coming. Since we can’t see it we can’t avoid it.

That’s nice, says the insurer’s accountant, but that doesn’t help me fill out this tax return. How much money are you making and if you tell me none of it is real again you’re going to jail? Well insurers start with revenue for taking the risk (premium) but no claims payments for a while. What should the accountants do with that? Well, before insurers there were two options, a legal one and an illegal one. The legal option is to declare all the policy limits as obligations and put them on your balance sheet. But we can’t just pay today for every bad outcome that might happen tomorrow, there are too many possibilities!  So enter the illegal one –  to just pretend our way to an answer.

Boy the second one sounds way better. But we still have risk! Now the risk is that the insurer really is insolvent and we don’t know it yet. Who takes this risk? Nobody wants it, least of all policyholders who need their claims paid. So the state takes the risk and puts it into a box called a guarantee fund. They charge for that little trick, of course, demanding money and regulation.

Insurer disintermediation is a really about cutting out the regulator but then someone else has to take the insolvency risk. A workaround exists: using a ‘front’, being a business that takes no risk and only supplies regulatory services. All the other functions: underwriting, finance, claims processing and claims risk are all administered by a variety of agencies, consultants and reinsurers.

Fronting companies are really small, financially speaking, because the premium all goes to pay the agents and consultants and reinsurers. There remains this tiny little probability of the reinsurers, agencies and consultants going out of business or not honoring their various promises. They call it tail risk. But the front is riskless, so who takes that?

Great question! In the (non-fronting) wild, the insurer takes it and keeps a few risk absorbers against bad outcomes: premium, capital and the guaranty fund. The thin front doesn’t keep the premium base, being the first and biggest of those absorbers. As a consequence, modern fronts tend to be incredibly selective of what they accept and/or push as much of this as possible onto the other counterparties.

But as soon as you need to quantify the insurance limits exposed you’re back to the pre-insurance era of accounting, declaring all the limits and capitalizing them on your balance sheet. It really doesn’t work:

There are something like 29 million small business in the US. Each has a GL policy for, say, $1m limit and pays probably something like $1,000 for it. In theory, then, there is 29 trillion in GL limit outstanding for 29 billion in premium. That’s a 1000x disparity.

That’s why insurers aren’t asked to hold collateral against all that limit exposed. But the scope for something going wrong is huge and finding a way to absorb tail risks is the challenge in disintermediating insurers. Policyholders with valid claims aren’t going to get a haircut. Shareholders are tiny compared to the limits exposed. To disintermediate the insurance company you need to answer: who gets the tail risk?

*Cutting out Everyone*

Example: reciprocals, pools, captives, lemonade.

Here’s a cartoon example of how insurance works: we pay premium to an insurer who pays it right back to us as claims. Well, they also sit on it for a few years and keep about a third of it to fund the system: brokers, underwriters, finance departments, taxes. A third?! For giving us back our own premium? Yes.

To an economist, literally everyone in the industry, not just brokers but insurers, reinsurers, adjusters, etc, are intermediaries: they aren’t ‘doing anything’, just shuffling money around, keeping some for their trouble.

Exciting opportunity alert! Let’s cut them all out, go peer to peer and pocket the savings. Not a new idea, I’m afraid. Legend has it that the first insurance companies had exactly such a structure: merchants pooling their losses from sunken ships. So literally every other feature we see of the insurance industry was deliberately invented: brokers, underwriters, finance departments, actuaries…

Let’s defend all our jobs by first stepping back a bit. Insurers protect us from random chance (God) and moral hazard (other customers!).

Protecting us from God is about getting enough volume. House fires are too volatile to pool among 10 or 15 friends. And bigger pools are hard to coordinate so you have to pay someone to help with that. Enter the insurance company processing department and perhaps reinsurance for extreme cases.

I’d argue every other feature of our business exists to protect our premium dollars from moral hazard (ie our fellow customers). Think of the merchant in our primordial insurance pool who lies about his ship sinking and pockets the cash. An insurer is really just a pool of money that each insured has a claim to. Is it so surprising some will greedily eye that cash when they think nobody is watching? Defending the pool against wrongful claimants is what the industry does.

But what about customer service! Lemonade in particular uses the idea of insurers’ poor service as its key promotional message. Even granting that customer service is poor, root problem isn’t that insurers are evil, it’s that customers lie! Even forgetting simple fraud, how about the insured that doesn’t repair his sprinkler system because he has an insurance policy? Moral hazard is incredibly tricky (expensive) to identify. Even then, the higher expense of oversight yields massively larger benefits in reducing the cost of invalid or avoidable claims. This makes insurance cheaper! The chance that you need the customer service is pretty low. The chance that you want those hundreds of dollars of premium back in your pocket is pretty high.

So you can think of the insurance market as having found a balance between low premiums, which customers like, and suspicious and skeptical customer service, which customers don’t like. Cut all that out and you have to answer: how do I protect customers from each other?

So It Can’t Happen?

Now, of course Uber and AirBnB, in particular, looked completely stupid at first. Lots of very serious people had lots of really good reasons for why they would fail. And look at them now! The problem is that those serious people, wrong on those two counts, are normally right. Startups capture the imagination exactly because they’re so outrageous and unlikely. In a mostly market economy like ours, the world is complicated and dramatic changes are very rare. Want to make the highest probability prediction for next year? Start with “more of the same ahead”.

The answers you need to the questions above need to be better than the answers the industry already has:

  • “How do you know you’ve got the best deal?” I test the market with a broker
  • “Who gets the tail risk?” Insurance shareholders and guarantee funds
  • “How do I protect customers from each other?” underwriting and claims management
  • “if disruption, why now?”

The answer to the last is to usually point out any number of the cutting edge technologies of the day and scoff at how slow incumbents are to adopt them. I agree there is opportunity there.

But even startups launched by insiders underestimate the reason insurance is different: you don’t know your costs up front. Without a track record of success regulators, rating agencies and reinsurers will slam the door shut. Building that track record takes time. And during that time incumbents catch up and startups often assimilate, are acquired or blow up.

What’s a startup to do? I say don’t fight against the basics of insurance, use them to your advantage instead. There are times new entrants are allowed in. We call them hard markets and they can work as laboratories of insurance innovation. Incumbents lose faith in their understanding of the risk and deliberately retreat. The system is begging for someone who can be more nimble and solve the market problem.

As I write this perhaps the Caribbean is a good choice, decimated by Irma and Maria? These are challenging situations because along with whatever technology a new entrant wants to bring to the market they need to solve a pricing problem for the risks. But the entrant has a pricing problem no matter when they enter. At least they’re on even ground with everyone else in a hard market!

”This article was first published in the Journal Of Reinsurance, a publication of the IRUA – – and is reproduced with permission.”

The Face of the Intangible Economy


In my industry, small firms are going extinct. It’s crystal clear in the reinsurance broker world but the same thing, I think, is happening to all links in the insurance risk chain from agents to reinsurers. Why?

I’m looking forward to an upcoming podcast conversation where I’ll try to make some progress on that question and in advance I’ve been brushing up on all kinds of literature. This year a key book came out, *Capitalism Without Capital* which has interesting things to say about the rise of the intangible economy.

What I love about this book is that it refers to data that is available to download, so I did! My question: how have firms actually been changing over the last 20 years?

The big three intangible categories were R&D, software and something called “organizational capital”. All are growing in the amount of ‘capital’ they represent in firms of all industries though R&D is growing more slowly than overall capital growth (so its share is declining) and software much more quickly.

No big surprises so far and much of the commentary I’ve read on this topic tends to focus the mind’s eye on R&D and software when drawing up interpretations of what is going on. But what on earth is organizational capital? It’s growing at about the same rate as the overall capital growth so its share is constant. Oh, and it’s the biggest (in the UK*)!


To find its definition you need to dig into the source material, specifically this paper by Carol Corrado, where she describes two components of “organizational capital” (I’ve transcribed the description below in a giant quote):

    1. an external component, being money paid to management consultants; and,
    2. an internal component, being the proportion of payroll paid to management.

I haven’t been able to find a breakdown of the internal vs external component. I used the UK data above because it was easier to get the nominal data as a check. This doesn’t include any judgmental adjustments for how much of the spending creates a persistent asset (obviously much time is wasted and some time from managers for example will be spent on things that aren’t necessarily related to intangible assets).

So, compared to fifteen years ago the average firm today spends a ton more money on software, a lot more money on consultants and management and somewhat more on R&D. 

That makes sense to me. More thoughts to come in the podcast.. stay tuned!


*The US data has much more R&D and much more mineral exploration than the UK, the latter of which I think distorts things a bit. Organizational capital is about 15% of the US figures and its share is rising quite fast.

the giant quote from Corrado:

Investments in organizational change and development have both own account and purchased components. The own-account component is represented
by the value of executive time spent on improving the effectiveness of business organizations—that is, the time spent on developing business models and corporate cultures. The purchased component is represented by management consultant fees. The purchased component is estimated using the SAS annual revenues from the management consulting services industry, which rose substantially in the 1990s, from $27 billion at the start of the decade to more than $80 billion during 1998–2000 (table 1.3, line 9a).

The own-account portion is estimated as a proportion of the cost and number of persons employed in executive occupations, which rose very rapidly in the 1990s. Given that executive median pay exceeds the median pay for other employees, the fraction of total private payroll spent on executives and managers is substantial, almost 22 percent in 2000 (Nakamura 2001). Applying the executive and manager payroll share to total private business-sector compensation yields an estimate for managerial and executive costs of nearly $900 billion per year in the 1998–2000 period.

If just one-fifth of management time is spent on organizational innovation, then businesses devoted more than $200 billion per year to improving the effectiveness of their organizations during 1998–2000 (table 1.3, line 9b). This figure is highly sensitive, of course, to the admittedly arbitrary choice of one-fifth as the fraction of time managers spend on investing in organizational development and change; as a result, our estimate for this component ranges from $105 billion (based on a one-tenth fraction) to nearly $350 billion (which assumes one-third). Adding in the $80 billion annual expense for management consulting (described above), our point estimate of total spending on organizational change and development is nearly $300 billion per year from 1998 to 2000.

Interview with Me

I did an hour-long interview with Nick Lamparelli for his Profiles in Risk podcast. Nick and I met when he commented on this very blog a few years ago, an experience that he says inspired him to engage with social media, blogging and podcasting himself. Needless to say, Nick’s rocketed past me in accomplishment there.

In the interview we cover:

    • That time I cried and other exam experiences
    • How my two main jobs now, sales and analytics, are both things I hated/feared before starting work
    • Honesty and being real
    • Reinsurance and the recent hurricane events

Link to the full interview here. I did enjoy it. Maybe there’s something to this podcasting thing. Stay tuned!


A couple of years ago I (once again) swore off exams and this past January I (once again) broke that promise. I started studying for CAS Exam 7.

There wasn’t a lot of room for this. I had a pretty demanding job and three kids at home under 5. I bathe them every night, read them books and tell a story before bed. Now I was to detonate this nice little balance with a first attempt at an upper level actuarial exam? No way.

But a colleague started studying for 7 and I felt a pang of.. jealousy? Brutal though the exam process is, that feeling of pushing yourself to your limit is addictive. Real life problems are hard, too, of course, but real life payoffs tend to take a long time. That buzz of a duel on exam day and the rush of the result with genuinely high stakes is hard to get anywhere else.

So this was an experiment. Can I start four solid months out and study only on my commute and in little chunks here and there and pass an exam? Well, the self-talk went, if I can cover the whole material twice by the signup deadline, I’ll go for it. But that was in March! To get there I needed to commit hard in January. If this was nuts at least I’d only lose two months of my life.

Turns out it wasn’t nuts! Or at least it was achievable. It was definitely nuts. I had my 500 cue cards done by mid Feb. I scheduled daily close reading sessions with my co-studying colleague (we actually got to about 2 a week). Every minute I was focused.

In the back of my mind I knew that the chances of my delicate little balance blowing up in my face was pretty high. That means I was scared. Constantly. For months.

It works, you know, fear. Learning is so painful your mind desperately looks for every little way to procrastinate or avoid the work. You convince yourself to focus on the things you’re good at. You self-deceive about the stuff you’re not good at, like, “oh, I get that” after one problem (Liar!).

The way to suppress the fear is to feel mastery over the material. But since exam outcomes are always a bit random true mastery is almost impossible. That’s why the fear comes back fast and drives you on.

I tasted the lash of fear for four months. I had good weeks and bad weeks but contained studying to my commute and the cue cards I literally carried everywhere. Still reading to my kids at night, I started cautiously feeling good.

Then the wheels came off. We had the floor replaced in our house and it went wrong. I had to take the week off work (no commute!) and we moved into a hotel for 5 days. With the kids of course. Two weeks before the exam. The very day we move back in I fly to Europe for a week-long business trip. And on the first night in Europe, I get the flu. Influenza B, from a Chuck E Cheese we visited trying to kill an afternoon while they demolished our living room. All three kids and my wife got it, too. And they were home sick while I was away. I had it bad. They had it worse.

I wasn’t able to crack a book until Saturday night having not studied for 13 days. The exam was the following Thursday morning. My family was exhausted. I was exhausted. But fear had been there all along, growing stronger. It was terror now. Did I have enough time?

I sat for the exam. Felt good about it. But I was burnt out. Normally after sitting I sheepishly look up the next exam’s syllabus: what’s next? Not this time. I couldn’t bear to look at it. Others download the exam when it’s released and replicate their answers to guess their grade. That thought made me nauseous. My colleague was all ready to dig into Exam 8. No way. I don’t want to do that again. I’m burnt out.

Where I come from a burnout is a kid that smoked too much weed and has that heavy lidded, slow talking disposition welded to their personality. This feeling is similar. It’s not laziness, really. Lazy people are lying to themselves about the consequences of them parking their ass for another week. Burnouts know what we’re missing. We’re making an informed decision to sit stuff out. It ain’t worth it!

So my result notice went to my junk mail and I got it late. I was in no rush. This exam didn’t mean much on its own if I was truly done. A pass, though! It still feels good, I have to say, but…

No more exams.

(again! I know..).


Hey, thanks for reading this. If you enjoyed it and think you’d want to get a short weekly email from me with some article and podcast links, consider signing up here!

Disruption In Insurance

My latest on Here is the intro:

For any company, it’s good to be relentlessly focused on the customer: success means knowing what they want and delivering that with discipline and low prices.

Or maybe not! The amazing thing about disruption theory, as defined by Clay Christensen, who coined the term in his 1996 HBR article and subsequent book, is that it reveals this strength to also be a deadly weakness.

Do click through and read!

Study Tips – How To Be Awesome in 10 Steps

My latest for insnerds. Here’s the intro:

I have a longstanding love/hate relationship with professional exams since starting my career. I’ve done CFA exams and actuarial exams (CFA are easier.. just). I’ve passed exams; I’ve failed exams. I’ve panicked in an exam and failed. I’ve cried after passing an exam. I was once so ashamed of myself after failing (fourth fail in 7 months) I couldn’t bear to talk to anyone and hid in a coffee shop for hours. And when I emerged I lied about the result!


And I persevered. Here’s what I’ve learned.

Please do click through and read!

I Blogged Elsewhere

I was asked by a reader to post for a neat insurance media startup, Somehow an organization with nerds in the name didn’t have any actuaries involved. Well, I’m happy to put an end to that! Here is my contribution. One excerpt:

In any negotiation, you are introducing a seriously high risk of human fallibility, and the shareholders of these organizations have very strong preferences for the kinds of errors they want their organizations to make. Risk taking organizations want fewer false positives (doing fewer bad deals), and sales organizations want fewer false negatives (ditching fewer good deals). They fight it out to correct for cognitive bias.

Please do read the whole thing.

Big Company, Small Company

Some time ago I was toying with the idea of opening a retail franchise. Now, I didn’t know a thing about retail, but I remembered one of my marketing professors was a retail specialist, so I emailed him. He suggested a textbook and I ordered it (older version because, come on, $120!?). Then, for the first time in my life, I read a textbook trying to learn rather than just get through a course.

Complete waste of time. No real advice on how to actually run a business. Instead, lots of features for memorizing a load of minimally useful jargon: summary bullets in the (large) margins, more bullet summaries at the end, narrative summaries, Q&A and very little actual advice.

I eventually passed on the franchise but was left with the impression that the academy has very little to offer business owners. So with that in mind, this article from the OECD has got me thinking of the big picture of my own business.

The core idea boils down to this graph, which charts the increasing gap between labor productivity of the top firms and the rest (note how much stronger this is in service firms):


They also note that the churn in firm rankings is dropping, too, so firms at the ‘global frontier’ are getting older and that

“..evidence from eight European economies suggests that MFP growth over the 2000s was weaker in sectors that recorded larger declines in the share of young firms (under 6 years), and in particular start-ups (under 3 years)”.

The authors like this explanation:

More importantly, the rising gap in productivity growth between firms at the GF and other firms since the beginning of the century suggests that the capacity of other firms in the economy to learn from frontier may have diminished [emphasis DW].

They go on quite a lot about how firms should learn from each other and that promoting this should be the key policy goal.

I don’t buy it.

Firms do learn (steal) from each other but I think the biggest difference in success is management’s desire and ability to take raw (stupid) ideas and turn them into great businesses. That is about high quality people, effective management, perseverance, passion. Those things aren’t any more scarce than they were 50 years ago.

Interestingly, there’s a hint of an explanation I much prefer in the paragraph following the quote above:

Firms at the global productivity frontier are typically larger, more profitable, and more likely to patent, than other firms. Moreover, they are on average younger, consistent with the idea that young firms possess a comparative advantage in commercialising radical innovations (Henderson, 1993; Baumol, 2002) and firms that drive one technological wave often tend to concentrate on incremental improvements in the subsequent one (Benner and Tushman, 2002). However, the average age of firms in the global frontier has been increasing since 2001 (Figure 12). To the extent that this reflects a slowdown in the entry of new firms at the global frontier, it could also foreshadow a slowdown in the arrival of radical innovations and productivity growth [emphasis DW].

The big point the authors miss here is that the large firms, which are themselves young, were once small firms that beat the frontier firms du jour. They did figure something out. Then they sat on that idea and mined it.

Here’s Peter Thiel:

Thiel flagged top entrepreneurs such as Bill Gates, Larry Page, and Mark Zuckerberg as people who had built their businesses on unique ideas, and advised future innovators that, “if you’re copying these people, you’re not learning from them“.

Now I summon Horace Dediu:

What really causes a company to fail is disruption. The business model around which all products, customers and priorities are built; the culture, the skills and “DNA” of the company; is vulnerable. This vulnerability is why companies have considerably shorter lifespans than the people who work there. They are one of the most fragile of organisms: high infant mortality, with short, unpredictable lives.

Microsoft ascended because it disrupted an incumbent (or two) and is descending because it’s being disrupted by an entrant (or two). The Innovator’s Dilemma is very clear on the causes of failure: To succeed with a new business model, Microsoft would have had to destroy (by competition) its core business. Doing that would, of course, have gotten Ballmer fired even faster.

The key thing that Disruption Theory taught me is that profitable firms can’t make big changes. Management snuffs out the raw (stupid) ideas instead of building businesses with them. Their first priority is to protect the existing business which real disruption necessarily destroys. Any other innovation is called sustaining innovation, in that it can be adopted by incumbents, making them stronger, not weaker. So if I observe older firms and stagnant rankings my question is: why aren’t the younger firms innovating? Peter Thiel again (video):

It’s not a fact of nature that the slowdown has happened. We’ve become risk averse, we’re regulated to death, we’ve become incrementalist and we’re not really willing to take bold steps. We’ve talked ourselves into thinking that throwing angry birds at pigs is the best we can do.

“We” don’t want innovation? I think that’s right, actually.

There happens to be an enormous amount of confusion over disruption in insurance circles because people think you’re talking about the periodic purge of the market cycle. The laggard firms do tend to take a lot more damage during cycle turns and cyclical startups do tend to use the newest tech so cyclicality acts as an accelerant for innovation. The fact remains, though, that the cycle of the insurance business is much more powerful in the short term (ie for your career) than innovation. The vast majority of startup firms in insurance businesses owe their scale to good cycle timing.

The average culture is thus highly aware of cyclical change but under-appreciates structural change. I work at a small company, dwarfed by our competitors by 10x, 100x, 500x and I see every day how the large organizations are slower to react to new ideas than we are. They can’t jeopardize that existing business! So though it makes me feel good to say that we are leaders in much of what we do, quicker to invent, quicker to adopt, we feel our lack of resources all the time and resources have been enough to keep the incumbents entrenched. They do a good enough job! No innovation we’ve led has been so novel that our competitors can’t either steal it or ignore it and cede to us the moderate growth that rewards moderate innovation.

But moderate innovation is still something and we’ve capitalized on maturing technologies in data capture, storage and analytics. These are sustaining innovations so everyone benefits but they’ve still been transformational on a longer time scale.

Back in the dark ages, decisions were made at the hyper-local level and only consolidated for financial reporting purposes. Large organizations could not be centrally controlled because it was too expensive to answer any question other than: are we making an accounting profit?

So they had a culture of delegated decision making: independent, proud, cunning and highly social. Deals were done on the proverbial napkin because a low oversight, high trust relationship meant mistakes could be corrected or swept under the rug with ‘special deals’ later on.

Then technology facilitated oversight and accountability from a distance. People who could manage systems and build models to oversee operations were suddenly empowered at the expense of grass roots freedom. This concentration of information (power) enabled a wave of consolidation, snuffing out the need for individuals to manage external relationships. Less freedom, more oversight, less (individual) trust, more transparency. We all became a bit more corporate and the culture changed.

My story is that this drove the consolidation of reinsruance brokers, too. Back in the old days, an individual broker would spend half his career working for someone else, building up a book and then selling that book to a bidding firm or starting his/her own shop. The individual relationship was what mattered. Today the value of those relationships is significantly eroded. Business is ‘corporatized’, more services are required and a whole hierarchy of relationships are needed to manage the hierarchy at client and counterparty organizations. The actual change has been long and painful, yet the firms that remain are mostly the same ones that we started with, excepting for a whole lot of M&A.

Now we can test the OECD observations and analysis against my experience.

  • Are the small firms lagging behind the large ones? Check.
  • Is the gap widening. Yep, probably.
  • Is it because they can’t learn from the large firms? No, I don’t think so.

I think small firms are disappearing because the industry wants scale to supply capital-intensive and relationship-intensive services. Small firms generally have the same ideas as the big firms but they just lack the resources to implement them. To win (survive), small firms need to have better ideas.

My company has been different from other small firms in that we’ve been able to implement new ideas that large firms haven’t. We have a superior process. But our ideas haven’t been powerful enough to unseat the megas in a meaningful way.
Scale rewards itself and it’s hard to break into that virtuous cycle. M&A works, but it is difficult not to revert to the cultural mean doing that.  And scale the ‘easy’ way yields the most stagnant of entities: constantly fighting over itself. Maybe most importantly of all, there are very few small firms still in existence in my business, so nobody to buy.

And that’s the key feature that the OECD report misses. Something is different out there that is killing startups before birth. I say increasing rewards to scale have kept smaller firms from getting a seat at the table.

The market prefers scale to the innovations it’s been presented.