Vernon (and Fred) Smith

by Russ Roberts on May 21, 2007

in Podcast

This week’s EconTalk is with my Nobel-prize winning colleague, Vernon Smith. We talk about whether supply and demand works, the purpose of experimental economics, the insights of Hayek and lots of other stuff. He tells an amazing story of how his first paper in experimental economics got accepted at the Journal of Political Economy. He also talks about the work of Roy Radner showing how a firm may deviate from standard models of profit maximization and risk-taking because of the risk of bankruptcy in ending the life of the company. It reminded me of this story about Fred Smith and the early days of Fedex.

When Fred Smith first started FedEx, he struggled desperately to make payroll. At one point he raided the family trust fund without his sisters’ permission (they later sued him) and was forced to keep borrowing money to cover his costs. Finally, the bank in Chicago that had been lending him money said enough—we’re done, No more loans. Smith found himself at O’Hare airport facing the trip back to Memphis knowing he would have to tell his employees that it was over. He simply didn’t have the money to pay them. As he looked up at the departure board for the status of his flight home, he noticed that a flight was leaving soon for Reno. Instead of going to Memphis, he went to Reno and took all the remaining money he had (insufficient to cover the next month’s salaries but still something) and began gambling. (It may have been roulette, but I don’t remember.)

Fortunately, for those of us who often want to get a package somewhere overnight, he had a run of good fortune at the gaming tables, enough to cover the next month’s salaries. During that time, revenue picked up and FedEx survived and ultimately thrived.

I suspect Fred Smith doesn’t spend a lot of time gambling (at casino odds, anyway) with the revenue of FedEx. But facing extinction, he became quite a risk-taker.

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eddie May 21, 2007 at 1:32 pm

Wikipedia's entry on FedEx says the following:

"There is a popular story that the company almost went bankrupt in its first year, but to make it through the Christmas season, Fred Smith convinced his employees to work at 70% of their wage. He then took all of his money to Las Vegas and made enough at the tables to weather a few more months until business picked up. In fact, while financial distress was extreme and expense account payments were deferred, the reported voluntary pay cut was never requested or given. The trip to Las Vegas was real, but the company's future was neither wagered nor won that day."

No source is given in the Wikipedia article, so I can't verify the claim. However, a modest Googling suggests the apocryphal amount won was a mere $27,000. That seems like an insignificant sum compared to the $95,000,000 initially invested in the company. I can't imagine that twenty-seven grand would mean the difference between continuing operations and closing up shop for a company that had already burned through a hundred million.

It makes a good story. But the stories that make good stories are the ones most likely to be just stories.

JohnRDewey May 22, 2007 at 4:44 am

Eddie, you are correct that the $27,000 Fred won didn't by itself save FedEx. But it did save Fred Smith's morale at a very critical time. Here's how Fred Smith told the story to Jessica Savitch of NBC News:

"I was in Chicago when I was turned down for the umpteenth time from a source I was sure would come through. I went to the airport to go back to Memphis, and saw on the TWA schedule a flight to Las Vegas. I won $27,000 starting with just a couple of hundred and sent it back to Memphis. The $27,000 wasn't decisive, but it was an omen that things would get better."

According to Robert Sigafoos in "Absolutely, Positively Overnight";

"In those days even Fred Smith, the former financial golden boy, needed an omen in the face of what must have seemed to him to be an irrational universe."

I worked on important projects for Fred Smith for 13 years. Anyone who worked with the man knows the story is a true one. They also know that Fred probably embellished it over the past 30 years in building the legend that is so important to the FedEx culture. To FedEx employees, it doesn't matter if the facts don't totally support the legend.

eddie May 22, 2007 at 10:15 am

John, thanks for your clarification and insight.

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