What Does Harvard Do Right?

Is Harvard the top rated college because it is the most clever in deciding who to admit? Not obviously. Instead, in the short run Harvard can gain plenty from a positive feedback loop: the best people apply and prefer to go there, which adds a glow to those who graduate from there, which makes the best want to apply, and so on.

While this seems an obvious and simple story, I must admit I haven’t been thinking enough in such terms, probably in part because I haven’t seen formal economic models that capture this story well. I thank venture capital (VC) titan Marc Andreessen for clarifying. Here is part of a 14 May twitter chat between him (MA) and myself (RH):

RH: VC is dominated by a few firms. What is the scale economy? Few geniuses? Info of seeing most pitches? Ability to create new fashions? Other?

MA: Core dynamic: A few firms have positive selection on their side; the other firms have adverse selection working against them.

The battle among VC firms is less “who is smarter?” than “who do the best founders approach first?”.

RH: OK, but why approach the top few first? What is more attractive about being funded by them vs others?

MA: Founders care about the VC brand halo because potential employees, potential customers, and other potential investors care.

RH: Is it just that top VC get first pick, so they are better picks, so their picks get halo by being in that pool, rinse & repeat?

MA: Yes, that’s the core positive feedback loop. How it starts is less meaningful than how it perpetuates.

Core dynamic: A few firms have positive selection on their side; the other firms have adverse selection working against them.

The battle among VC firms is less “who is smarter?” than “who do the best founders approach first?”.

The main historical driver of positive selection is prior success: a halo branding effect that new startups seek.

In essence, a new startup uses its VC’s brand as a credibility bridge until the startup establishes its own brand.

RH: Sure, but the question is why some VC brands shine brighter. Their money isn’t any more green.

MA: They have an aura of success as a consequence of having previously funded successful startups.

Arguably these dynamics are changing in real time in some interesting ways:

RH: Is there a prediction on if VC industry will become more or less concentrated as result of these changes?

MA: My belief is that VC is restructuring the same way retail stores, law firms, accounting firms, and investment banking did:

This seems to be the hallmark of a professionalizing industry being run properly. You either go big or you go specialist.

RH: I guess the key idea is that there are big scale economies with doing standard tasks, but big diseconomies for specialized tasks.

MA: Yes, but with the subtlety that the well-run scale players are also excellent at many of the specialized tasks.

RH: Many, but not most, or the specialized shops couldn’t exist long.

MA: This is exactly what happened in the talent agency business in the 1980s and 1990s. The big agencies got great at many things.

The specialized shops have to stay small and stay laser-focused on particular areas of specialized advanced competency.

But of course similarly, a scaled franchise firm that gets sloppy runs the same risk, can degrade itself into the middle tier.

RH: Summary: long trend is to scale given tasks, but also task specialization. Overall scale rises, but falls locally when specialize.

MA: Right, exactly. And this explains the size distribution — the scaled players have to be big; the boutiques have to stay small.

You see this in investment banking. You either work with Goldman Sachs or you work with a small boutique specialist bank.

RH: This makes sense, but I’m not sure we have any formal models that predict this correlation nicely.

This same sort of story also seems to work in the short run to explain why some journals have higher prestige. It is not so much that top journal editors are more clever, or use a smarter system to review submissions. It is just that the best papers are submitted there first, which makes the average quality of their publications higher, and so on.

In the long run, we see changes in the prestige rankings of these colleges, journals, investment banks, and venture capital funds. The key question is: what determines those long run changes? Do competitors with slightly better ways to evaluate or help submissions slowly win out over others? Or do other factors dominate?

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  • Robert Koslover

    If I may pose a related question: Why is Harvard *failing* to grow in accordance with its success? Allow me to explain: When a free-market/commercial business operating in one location becomes extremely successful, and the demand (and willingness/ability of customers to pay) for its products/services is both clearly and consistently greater than the company’s production, its management or stockholders will normally choose to expand, either by growing the company at its current location or by establishing new locations or both. Consider Walmart, McDonalds, Home Depot, etc. Customer demand for Harvard and similar top-level university educations is currently out-stripping demand, and has done so very consistently, year after year after year. I.e., there is no shortage of willing, paying customers, flocking from all over the world. Why hasn’t Harvard (or Stanford, or Yale, etc.) established new branches, in other locations, simply by copying its current formula? If Harvard established, say, just one new branch “Harvard” university in each of the time-zones in the USA, is there really any doubt that these new enterprises could become profitable? Note: let’s not quibble about calling Harvard “non-profit”! Money pours like Niagara into Harvard U’s coffers daily, and its high-ranking administrators make impressively big bucks… They are hardly disinterested in making all the money they can. Now let’s see, where was I? Oh, yes…. So, considering also Harvard’s currently *gigantic* endowment (over $32B, with a “B”, as reported in 2013), as well as the possibility of securing lucrative new arrangements with various state governments, wealthy donors, huge corporate sponsors (to put their names on the many new buildings!), etc, surely there both exists now, and can be found new, capital for such projects! So what, really, if these branch schools were (but only initially!) a bit less prestigious? Diplomas (and transcripts) issued would still say “Harvard University” across the top — people coming from all over the world would *want* that! And if the same standards were applied in both hiring faculty and accepting students at these new branches, wouldn’t these places ultimately become just as prestigious? So again I ask, why so *little* growth, Harvard, hmm?

    • http://entitledtoanopinion.wordpress.com TGGP

      Harvard makes its money from its endowment.

    • Matthew Graves

      Harvard looks like a Czechoslovakian firm to me. (I thought that was a standard term in economics, but I’m not finding it quickly on the internet, so maybe I’ve misremembered it. Anyway, it’s a worker-owned firm where workers are paid the average product of labor, rather than the marginal product of labor–this means that less workers are hired than normal, in order to keep the wages high, rather than continuing to hire so long as marginal production is higher than the wage.)

      I think this is because they’re more motivated by prestige than money, and prestige is more closely tied to average quality.

    • IMASBA

      “Why is Harvard *failing* to grow in accordance with its success?”

      Because much of its success comes from it being perceived as exclusive. Ferrari doesn’t crank out sports cars by the hundred thousands for the same reason. In the case of Harvard it would also be difficult to find enough world famous professors to stuff multiple locations with and we have to remember Harvard gets a lot of its budget from sources other than tuition (they might attract more students with lower tuition and multiple locations but not necessarily more “donations” from rich parents and alumni).

  • John_Maxwell_IV

    One straightforward strategy that a VC could employ to accumulate status quicker might be to invest smaller amounts of money in a broader variety of startups. Prestige from being involved in a home run might not scale linearly with investment amount… most don’t check to see how much equity you bought; the important thing is that you were “an investor”. That might explain the success of players like Ron Conway that invest small amounts in many firms. By investing a little in a lot of firms, they get to namedrop more home runs on their investment resume.

    Prestigious venture capital firms are engaging in a fairly complicated status transaction with the startups they invest in. VCs give startups *money* and *status* in the short term. In the long term, if the startups are home runs, they return even more *money* and *status* to the VC that invested. But there are lots of simpler status transactions that you see in the economy:

    If an *individual* gives *money* to an *organization* for *status*, we might say that they are “buying a luxury item”.

    If an *individual* gives *status* to an *organization* for *money*, we might say that the individual is “endorsing” the products that the organization sells.

    If an *individual* gives *status* to an *organization* for *money and status*, we might say that the organization is “awarding a prize” to the individual.

    If an *organization* gives *money* to an *organization* in exchange for *status*, we might say that the first organization is “advertising” with the second.

    (Note that status is not conserved. Working with Nike didn’t hurt Michael Jordan’s status perceptibly. But if Jordan started endorsing an appreciable fraction of the products sold in the economy, his brand would suffer. So status isn’t unlimited either; brands can be cheapened.)

    Universities are another complicated status transaction: In the short term, students give the universities money and the universities give the students status. As the student’s career progresses, they frequently give status and occasionally money to their alma mater.

    I think it’d be interesting to come up with a general theory of statusful organizations. Here are some highly statusful entities to provide some raw material for your brainstorming:

    * The New York Times

    * John Brockman/Edge.org

    * Research labs like Bell Labs and Xerox PARC

    * The Olympics

    * The Nobel prize

    * Venues like Radio City Music Hall

    * Apple and other companies on the Forbes list of most valuable brands: http://www.forbes.com/powerful-brands/list/

    * TED

    * The World Economic Forum

    * Top government think tanks like Brookings and the RAND Corporation

    * The Big Five book publishers

    * Top management consulting forums like McKinsey and Bain

    It probably makes sense to think of things like scientific and artistic accomplishments, good-looking people, clever writing, and high-quality products as exogenous factors that act as inputs to the status economy. The interesting thing is to understand the status & money transactions that take place depending on those inputs and the incentive structures that get built up.

  • CommentsCommunicationMajor

    It’s a pretty serious weakness of Twitter that I follow you both, yet it allowed me to completely miss this conversation.

  • IMASBA

    I’m not sure what the confusion is here, Robin. The big players balloon because of some positive viral effects and over time they decline because of some negative viral effects, in between you have the selection positive feedback loop and other self-fulfilling prophecies (the feeback loop is really just the the baby brother of the viral effect). It doesn’t have to be any more complicated than that. I am amazed someone like Marc Andreessen would admit such things, perhaps he suspects (potential) VC clients don’t read your blog?

    Also, the metrics of “quality” are usually very much suited to selection positive feedback loops. Although since big players do have a hand in establishing said metrics you can choose to see the metrics themselves as part of a positive feedback loop.

    • http://juridicalcoherence.blogspot.com/ Stephen Diamond

      Is Andreesen supposed to be some kind of great mind in economics? (Is account taken of the dependence of his own success on the magnification of small differences by feedback loops inherent in capitalism – this being much of the burden of the first volume of Karl Marx’s Capital?)

      • IMASBA

        I’m not sure. I suspect he’s genuinely interested in the dynamics of it all and enjoys discussing that subject with someone like Robin Hanson. At the same time he’s both admitting he’s just lifting on a viral effect (though I’m sure that for his own sanity he considers himself having been essential to establishing the right initial state for the viral effect to work with), this hurts the standing of the VC industry (and many others), and he’s boasting that this provides evidence that his VC firm is objectively among the most profitable. The latter could be seen as a commercial for his firm specifically, but the former is a rare form of honesty that hurts the economic elites in a very broad manner; he’s giving leftist activists a weapon to use against him. If I were Robin I’d say Andreessen signals that he’s feeling so untouchable that he can air his class’ dirty laundry on Twitter and get away with it.

  • efalken

    Harvard works really well because they keep admission constant as the world grows and more applicants arise, and Goldman can avoid getting too big. But if they just wanted to increase cashflow over the next several years, they would take in a lot more employees/customers, cash out, and watch as those newer low-quality products matriculate.

    Perhaps that suggests that if we think brand-values add value to the systems they operate in, you want them to have incentives like Goldman and Harvard, not McDonalds and GM. The key is that insiders retain a good deal (eg, Goldman bonus pool is about the same size as corporate profits) of the rents from the brand. There’s no getting around the inegalitarian attributes of such a mechanism, which most utilitarian models might find ‘non-optimal’.

    • stevesailer

      How much is gaining tenure at a university like making partner at a professional partnership?

      • efalken

        Recently I have seen one consultant pulled in whose signature credential is merely being an instructor at Harvard–the brand clearly is his main asset and he’s not even a tenured Prof. Elizabeth Warren doubled her salary (at least) via consulting for large corporations and government panels (crony capitalists love lefty profs), clearly using her Harvard professorship as her main asset, and was had $3MM in liquid assets as of 2010. Not quite Goldmanesque, but not bad, especially considering they probably get a lot more status rents being Harvard profs than Goldman partners that are good for things like getting their kids good internships and flattering press profiles.

    • David Wihl

      John Stuart Mill would find this highly utilitarian.

      “It is better to be a human being dissatisfied than a pig satisfied; better to be Socrates dissatisfied than a fool satisfied. And if the fool, or the pig, is of a different opinion, it is only because they only know their own side of the question.”

      The utiles of the few dramatically outweigh the rest, still leading to the greatest good for all.

  • stevesailer

    Andreessen learned a lot from Hollywood agent Mike Ovitz.

  • stevesailer

    Harvard’s dominant position today is a legacy of the University taking the lead in scientifically studying admissions in the mid-20th Century. Over the generations, Harvard invested heavily in researching admissions, for example Harvard President James Conant had Henry Chauncey research the SAT in the 1930s and then Harvard took the lead in pushing the SAT. Similarly, you can see how much intensive social science research Harvard did on its own admission processes in the 1970s from Robert Klittgaard’s 1985 book “Choosing Elites.”

  • http://www.referralcandy.com/ Visakan @ ReferralCandy

    IMHO– Harvard has this positive loop in their favor even more so than the top VCs, I think particularly because of brand loyalty from wealthy families.

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  • http://juridicalcoherence.blogspot.com/ Stephen Diamond

    I must admit I haven’t been thinking enough in such terms, probably in part because I haven’t seen formal economic models that capture this story well.

    Given your views on the superfluousness of many formal models (and this one in particular), that isn’t a very convincing explanation (unless insight into status doesn’t mitigate status strivings, which I suspect).

    What about the more important reasons: like your naive a priori faith in the market.

  • Silent Cal

    While trying to forumlate an alternative model for “Elite Evaluator Rents”, I hit a question that really belongs here: What would happen if a newcomer with the capital to absorb some early losses exercised elite selectivity at relatively discounted prices? Surely the quality of their graduates would be noticed eventually?

    I think the answer is that this would work eventually, but it might take a generation of losses, which would be hard to get the capital for.
    It might work faster and be viable if it were opened under a prestigious name. Has Google Ventures been more successful more quickly than an equally wise and wealthy VC without the name could have been?

    • http://juridicalcoherence.blogspot.com/ Stephen Diamond

      What would happen if a newcomer with the capital to absorb some early losses exercised elite selectivity at relatively discounted prices? Surely the quality of their graduates would be noticed eventually?

      Isn’t this subsumable under entry costs? Where monopoly results from prestige, the same analysis should apply. [One way of putting the conclusion is that prestige differentials can generate formidable entry costs.]

      • Silent Cal

        Yes, that makes sense.

    • stevesailer

      Wealthy Washington U. of St. Louis was following that strategy when I was applying to college in the 1970s. It seems to have helped its reputation over the last generation. Of course, it’s not a newcomer: it was founded by T.S. Eliot’s grandfather.

  • anonyxmousse

    Barring a strategic misstep by the top player, the order of a hierarchy of this type seems very hard to change. This is because the organization’s primary asset is reputation, held in the collective minds of all potential customers. How long have Harvard, Yale, and Princeton held their positions at the top of the university hierarchy? Decades at least. The same dynamic is observed in elite law firms., investment banks, elite advertising firms, elite preperatory schools, etc. Any brand whose primary value is in its reputation is incredibly hard to unseat, again barring a strategic misstep (damaging the brand and creating space for a competitor) or a change in the underlying situation. If the overall market grows, there is room for more players near the top, see Stanford for example as rising to near Harvard levels of reputation yet without diminishing Harvard’s rep. If the the overall market shrinks, as it did for banks and elite law firms in the recent financial recession, players may exit / get acquired (see Lehman, Merril Lynch), or downsize out of elite status (several law firms).
    There has always been an element of the “the best wants to associate with the best”, “A”-level players don’t work for “C” level players” (Jack Welch). However for large organizations, reputation is how most people keep mental track of the rankings, which is all that matters.

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