The Austrian school of economics is an approach to the subject with some distinctive
characteristics that help business leaders find profit opportunities. Like much of economics, professors tend to be focused either on pure theory or else on public policy implications. Business applications are the red-headed stepchild of economics.
My series Business Planning With Austrian Economics has appeared on Forbes.com. This article provides a quick summary with links to the original articles.
Subjective value is one of the Austrian school’s first important contributions, emphasizing that the worth of a good or service is based on what people think of it, not some intrinsic characteristic of the item. I wrote, “Ask not how much it costs to make it; ask how much it is worth to the customer.”
Methodological individualism in business avoids pointing fingers at a group. I wrote about internal business service problems, “The problem—if there is one—is not with a department. It’s with particular people taking particular actions.”
Spontaneous order describes phenomena such as the economy and language as the product of humans, but not designed by any humans. I advised “Your employees do not need everything planned for them. They can figure a lot of stuff out for themselves, developing better methods and systems as they go.”
Marginal analysis is how Austrian economists (as well as some others) resolved the diamonds-water paradox. Water is necessary for life but valued lower than luxuries. The answer is that the price of water is based upon one additional unit of water. Unless we are dying of thirst in a desert, most of us are not willing to pay much for one additional glass of water. I describe my own experience: “As a young corporate economist, I was stunned to learn how many business decisions are based on average costs rather than marginal costs. I saw this in public utilities, mining and banking as well as the many businesses I later consulted for. Corporate leaders must continually reinforce the importance of marginal analysis, even when the actual numbers are educated guesses.”
Market processes are a major focus of Austrian school economists. Instead of assuming a given product with supply and demand curves, they ask how people discover the best products to offer. My advice: “Every company needs to routinely look for new opportunities, as well as opportunities that competitors may see to poach profits. It’s easy to get focused on optimizing the current marketing plan or improving the current supply chain. But big, disruptive changes cannot be ignored nor underestimated.”
Business cycle theory developed by the Austrian school economists has some truth to it, but too many adherents see the economy as perpetually on the verge of recession due to monetary policy errors. I disagree: “People following the Austrian theory of the business cycle have been far too pessimistic over the past decade, missing a long period of economic expansion. Some may argue that we are due for a major recession, but predicting a downturn years too early causes a business to miss the upside. Exploiting the boom is vital to protecting a business from a bust.”
What Business Are You In is a question that reflects market processes. Gas stations morph into convenience stores, then start upgrading food offerings and may look like delicatessens or cafes. I explained “the Austrian economics insight calls for humility. We all love a leader who knows where to go. In truth, anybody who believes to know exactly where a business should go is crazy. Instead, a great leader stimulates experiments, tests, and trials.”
Statistics in Business was prompted by the Austrian school’s disdain for efforts to find underlying truths through statistical analysis. My perspective: “The wholesale rejection of empirical work by some Austrian economists is unwarranted. I began my corporate career estimating the long-term growth rate of the economy. A billion dollars’ worth of capital spending would hang on my forecast. That sounds precarious, but there’s simply no denying that long-lived projects may be worthwhile if demand will grow, and not worthwhile if demand fails to grow. Statistical analysis of past relationships won’t give a perfect forecast of future demand, but it’s usually better than guessing.”