Economies of Extremes: Lessons from Venture-Capital Decision Making

Journal of Operations Management, Forthcoming

37 Pages Posted: 1 Aug 2014

See all articles by Suzanne de Treville

Suzanne de Treville

University of Lausanne - Faculty of Business and Economics; Swiss Finance Institute

Jeffrey S Petty

University of Lausanne - Faculty of Business and Economics

Stefan Wager

Stanford University - Department of Statistics

Date Written: July 30, 2014

Abstract

An organization's ability to exploit extreme events - such as exceptional opportunities - depends on its capacity strategy. The venture capital industry illustrates the interplay of expensive capacity and negative externalities from high utilization. The cost of adding a venture capitalist provides a strong incentive to run lean, but such leanness may make it impossible to evaluate all interesting investment opportunities. Using concepts from extreme-value theory, we analyze the trade-off between the costs and benefits arising from an increase in the number of evaluated deals. We ground our analysis in 11 years of archival data from a venture capital firm, representing 3,631 deals, the decisions made, the reasons for those decisions, and the decision lead times. The firm identified 20% of arriving deals as worth evaluating during the screening process, but was not able to evaluate approximately 9% of those interesting deals due to a lack of capacity. We show that the value of increasing the number of deals evaluated increases with the tail weight of the distribution of deal values. When the right tail is light, increasing the number of deals evaluated may provide too modest a benefit to justify the cost. When, however, the right tail is heavy, the value of increasing the number of deals is likely to more than compensate for the cost of capacity. Our results provide new insight into the relative value of a chase capacity strategy that emphasizes responsiveness versus a high-utilization heuristic that emphasizes productivity. Our approach can be applied to other search operations such as personnel selection, quality circles seeking to identify root causes, and making employee capacity available for innovation.

Keywords: extreme-value theory, capacity strategy, venture capital, decision making

JEL Classification: D24, D81, M11

Suggested Citation

de Treville, Suzanne and Petty, Jeffrey S and Wager, Stefan, Economies of Extremes: Lessons from Venture-Capital Decision Making (July 30, 2014). Journal of Operations Management, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2458867

Suzanne De Treville (Contact Author)

University of Lausanne - Faculty of Business and Economics ( email )

Anthropôle 3073
Lausanne, 1015
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Jeffrey S Petty

University of Lausanne - Faculty of Business and Economics ( email )

Quartier Chambronne
Lausanne, Vaud CH-1015
Switzerland

HOME PAGE: http://www.hec.unil.ch/people/jpetty

Stefan Wager

Stanford University - Department of Statistics ( email )

Stanford, CA 94305
United States

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