Survival Bias: why you should not be an entrepreneur!

Do you want to be an entrepreneur simply because your distant cousin created and sold a technology business to the Googles of the word for hundreds of millions of dollars? Wait! May be you are falling into what this curiosity.com blog highlights as a typical perception trap – the survival bias. 

Wikipedia describes ‘Survivorship bias’, or ‘survival bias’ as the logical error of concentrating on the people or things that “survived” some process and inadvertently overlooking those that did not because of their lack of visibility. 

The oft-quoted instance of survival bias is the one highlighted by a Hungarian-born mathematician Abraham Wald. He pointed out that one should not strengthen the body of warplanes based on the bullet-holes on a survived plane given the fact that it survived despite the bullets hitting the spots of those bullet-holes. Clearly, the planes that perished in the enemy attack may have been hit at different spots and the parts of plane’s body that may require strengthening, is the one without bullet wounds! 

So, why do we tend to focus on the survival stories instead of the failed endeavors? 

One of the reasons is that those who perish generally do so quietly and away from the gaze of the public. Failure is naturally painful and humans prefer to either erase it totally from their mind or endure it in isolation, away from the public gaze. When I searched books amazon with search term “success books”, I got 346,270 results whereas search term “failure books” yielded only 38,433 results!  

Not only is success boastful and bold, but it is also blinding! A full moon appears smooth and spotless. It is not easy to decipher imperfections on the surface of a shining body. It attracts attention and yet, distracts mind away from observing the details! No wonder, we so often walk into the survival bias trap. This bias can makes people emulate questionable ‘industry’ practices getting them in compliance troubles or lure them into burning our hard-earned cash on a wrong business idea. 

How do we avoid the survival bias trap? In my opinion, it needs a two-pronged approach. First and foremost, we need to train our minds to look at our own or others’ failures as a learning experience. We can learn from failures much more than what we can ever learn from the boastful success stories that are at best half-truthful. Secondly, when we hear a success or a survival story, let us ask for more details. Let us subject such survival cases to a much more robust analysis. It might reveal to us that such a survival came with some cost that we cannnot afford or it was an outright lie!

Next time when you see full moon, remember that it’s surface is full of craters! 

Can an Idea come from a vacuum? 

Great mathematician of all times, Srinivasa Ramanujam has been quoted to have attributed his genius intellectual spark to the super-human power, the God. I wonder what do the successful entrepreneurs like Steve Jobs, Mark Zuckerberg, and Bill Gates attribute their genius sparks to. How did they get to their game-changing mouse-traps? Did these ideas just appear from a vacuum?

I think not. I have not had a chance to work with any of these celebrities, but I certainly have had good fortune to work with and to learn from some very talented entrepreneurs. And one thing I have learned for sure … 

… Though great ideas outwardly appear to arise from a vacuum, they are, in fact, always born from an alchemy between fundamental elements. Ideas, much like the life itself, originate from a mysterious transformation caused by combination of five elements. These five elements are – Passion, Focus, Observation, Belief, and Association!

The First Element – The procreation journey of every game changing idea begins with PASSION. I have never met an entrepreneur who has built a successful business and who was not passionate about what he or she was doing! No one yet, at least in my knowledge, has been blessed with a winning idea in a domain about which he or she was not passionate.

The Second Element – having passion is great but one may feel passionate about great many things. The winning idea is born only when the person decides to FOCUS his or her attention to one of these interests. Scattered passion do not produce eureka moments. This focus may appear to the world as insanity or paranoia and could be overwhelming to the people around the entrepreneur. But that concentrated attention does generate disruptive mousetraps that conquer the word!

The Third Element – once one has a focused passion for a subject, OBSERVATION provides the “seed” of an idea. Every successful entrepreneur I have met has had keen eye for the opportunity – an opportunity create value by improving the ecosystem around him or her. Without an entrepreneur’s ability to scan the surroundings quickly to identify a chance to innovate, no idea can be born. An entrepreneur’s brain should be in a state of constant alertness to locate gaps that can be plugged through a new perspective … to come up with a new equation to prove some age-old unsolved theorem!

The Fourth Element – one of the biggest factors behind keeping an idea alive beyond its nascent stage is an undying BELIEF in it by its proponent. A number of times this belief arises out of the confidence generated by confirmation and re-confirmation of the seed concept during the exploration and the testing by the entrepreneur. Belief should not be blind. But it should also not get shattered simply because some industry veterans or pundits reject the idea as absurd. Many a times, the so-called industry experts tend have tunnel vision and their rejections could point to an opportunity!

Fifth Element – Another nutrient that is required to nurture the seed concept into a robust idea is the ASSOCIATION.   Successful entrepreneurs seek to prop up their nascent ideas with the assistance of a strong support group in form of co-founders, partners, early investors, and/ or anchor customers. Many a times, people emphasize the need for a team. But it is not just the C-suite team that converts a nascent thought into a blockbuster entrepreneurial idea. It is the association with a multi-faceted support system that matters. You, of course, need early investors who share your belief in the seed concept but you also need partners who would help  validate the concept. These associations would help you give a healthy body to the newborn idea that will help it survive the rigors of the real world.

How to deal with irrationality? A lesson from the Poker game (or the Presidential election)!

Humans are rational beings … or, are we? All our economic theories are based on an assumption of rationality of participating humans. Yet, all of us have, some time or other  have experienced irrationality while dealing with our family members, friends, colleagues, partners, and strangers! We saw irrationality at its peak in the recent Presidential Elections in US. And, believe me or not, I have been challenged by my own irrationality at times!

When we encounter an irrational behavior, it baffles us  … especially when we are faced with it unexpectedly. I always wondered, more often than not as an afterthought, how I could have handled a situation better when faced such a behavior. 

Seeming randomness is an inherent quality of the Irrational behavior. That is what throws you off your feet the most. It seems humanly impossible to think of a counter-measure to a random offensive position that an irrational person might take.

Haseeb Qureshi in his book “The Philosophy of Poker” talks about the randomness, albeit from a perspective of using it as a tool to win in Poker. He observes that humans are pretty bad at randomness. For example, if asked to imagin random outcomes of 20 coinflips without having an actual coin in hand,  we will usually end up very close to 10 heads and 10 tails. So it is important to keep in mind that a person behaving irrationally might be actually faking this randomness – just like a good poker player -and if we are careful enough, we can quickly unearth a ‘method behind madness’ and counter it effectively. It is possibly our own failure to detect and address the irrationality early on in the relationship that could be a problem. 

Haseeb also talks of some very interesting concepts such as gameflow: the “momentum” of the match, a pattern of decisions made over time, each decision influencing subsequent decisions. The two main elements of gameflow are simulated (faked) randomness and emotional dynamics. It is the emotional dynamics – emotions and the perception of emotions – that makes us weak when we deal with irrationality and gives the person acting irrationally an upper hand. I know an old saying: “I am not worried that old woman died, I am worried that now the death has become emboldened”. Our every emotional response to the irrationality, that can be and often is perceived as weak, emboldens it. 

Thus, I see two takeaways for myself: (a) be vigilant and recognize the pattern behind irrationality early on in the relationship – don’t let the faked randomness throw you off, and (b) design an emotional response such that it is not perceived by the irrational counterpart in the transaction as weak (that might involve bluffing as if you have stronger cards in hand)! This can help us snatch the momentum and turn the gameflow in our favor. 

A lesson that might be well worth putting in practice! 

Defeating Procrastination …

World Economic Forum published an interesting article on procrastination, just a day after I published my last blog “Analysis or Procrastination?”. The article places blame for procrastination on “misregulation of emotion”!

Overcoming the urge to procrastinate has to start with seeing it for what it is: a failure not in time-management, but in dealing with emotions.

The article also gives a tip to work one’s way out of procrastination. It suggests that even when there isn’t an appetite to consume an entire apple, one should begin by taking a small bite of the fruit. That would help the procrastinator to break the spell of indecisiveness. It advises to slowly build the momentum … by taking one bite at a time.

Sometimes back, I read a book (actually, heard an audio-book) named The Compound Effect. Darren Hardy, its author, also advises reaping huge rewards from a series of small, smart choices. The logic behind the compound effect is the same – take one step at a time and then build momentum!  Small beginnings do reduce immediate risks as compared to making a bigger decision yet let us have an option to make the bigger leap at a later date. Financial experts call them “real options” – options created by investing a small amount that gives an investor a right to invest more money at a later date in pursuit of a bigger return.

Learning how to create these real options in entrepreneurial life can truly unlock a lot of opportunities.

Analysis Or Procrastination?

procrastination.jpg

During many encounters with successful and not-so-successful business leaders, I have always been intrigued by their diverse, and sometimes, contradicting styles of  decision-making.  Some analyze, some rush, some procrastinate, and some just decide! In this world of BIG & IMPERFECT DATA, one of the most crucial prerequisites to achieve business success is an entrepreneur’s ability to engage in a, what I would call, pragmatic analysis – an ability to analyze an opportunity or a problem without getting trapped in procrastination!

What is a pragmatic analysis? The dictionary definition of pragmatic suggests that any decision and the underlying analysis to qualify being pragmatic should meet 3 basis tenets :

  1. It should be logical (sensible) – being sensible requires a decision to be aligned with a sound business logic that is vetted by the wisdom in the subject matter.
  2. It should be realistic – It should be within the realm of possibility and not be based on fantasies or lies. e.g. Splitting hairs by the leadership on an issue that has little chance of occurrence can cost an organization millions of dollars. It also means that while analyzing the issue, one should avoid being fervently optimistic or depressingly pessimistic!
  3. It should be practical and not theoretical – theories follow the GIGO ( Garbage In, Garbage Out) rule as they are only as good as the assumptions they are based on. One should question these assumptions before spending time and efforts to accept the theoretical conclusions. Successful business managers ask themselves if the assumptions and the conclusions are too far-fetched, based on multiple unresolved dependencies (“if-then scenarios).  And if the answer is yes, they reject these ‘theories’.

Easy said than done?

Top-line vs Bottom-line: Uber’s Historic Losses

Uber’s frantic chase for a market grab and top line growth has meant a negative bottom line of a whopping $1.2 billion in the first half of 2016. This, indeed, is an extreme case of the bottom line sacrifice for an impressive top-line growth of 18% in a quarter.  And all this seems like a great strategy as its valuation reaches $69 billion.

But this strategy has its critics, too. Some experts feel that Uber’s indirect subsidizing its users (drivers and riders) can create a temporary shift in its favor but may not guarantee a long-term customer loyalty. When subsidies are withdrawn, the value Uber offers can easily be replicated by others (including traditional taxi services) and Uber may quickly loose its charm!

This is a conundrum that almost all businesses go through to some degree or the other. It can present not just a choice between top-line growth and bottom-line but also a choice between long term investment in soft assets such as people/ systems and chasing an attractive short-term EBITDA. Current market valuation techniques do not take non-GAAP assets not captured by accounting books into account. Valuation models taught in business schools assume long-term cost of capital as well as long term growth. Many a times, positive cash flow and growth shown in distant future year on and around the plan horizon can translate in to a very high valuation at present value terms based on a “terminal value”.

Given these market realities, corporate decisions would always be guided by the desire to achieve a high valuation by “projecting” a bright future – be it by projecting high growth at the expense of present profitability or by projecting healthy short-term EBITDA at the expense of building a sustainable infrastructure. It is up to the investors to kick the tires and make sure that the company has a sustainable business model and has built a good infrastructure in terms of its people and systems, for it to travel the distance to reach that projected bright future!

Theoretical Valuation – A Postmortem? 

In my long finance career, I was involved in numerous ‘transactions’ that involved valuation – not just valuing companies and businesses but also valuing intangibles like Intellectual Property or Wireless Spectrum. The value of assets that I valued varied from single-digit millions to a few billion dollars. And one striking conclusion that I have reached after multitudes of transaction is this – today’s valuation theories are meant to explain valuation after the deal is done or at best to define the value boundaries for the deal participants but not to actually arrive at the valuation number at which the deal will be done.

Most of the valuation modern theories such as DCF look at the future earning potential of the business or the asset and arrive at what is called a “present value” using the valuer’s cost of capital or expected returns as the discounting rate.  What these valuation models try to do is to mirror the deal-makers’ mind-set in financial terms.

But these theoretical methods have two inherent shortfalls.

  1. They require some big assumptions – regarding long term cost of capital or the hurdle rate at which to discount future earnings to the present value and the long term growth rates … to name a few.
  2. More importantly, these methods present purely one-sided perspective and completely ignore the deal dynamics between the dealing parties, i.e. The seller and the buyer.

These shortcomings have plagued the valuation industry for decades and have pushed the deal makers/ arrangers to depend on generic data-driven dubious market multiples to strike deals! These dubious market multiples, which become circular self-fulfilling prophecies have, in fact, unwittingly led to many market hysteria & crashes fed by unreal frenzies & fears. 

Perhaps, emerging game theory could help us come to a better valuation theory that can actually be used to arrive at the valuation by using the dynamics between the “players”. Till such time, the theorist will be religated to the role of being the coroners of the deal industry conducting the value postmortems!

Westworld of the Entrepreneurship – Mistake & Evolution 

“Evolution forged the entirety of sentient life on this planet using only one tool, the mistake.” – from Westworld, an HBO Series

It is, indeed, a beautiful quote from Westworld, an American science fiction western thriller television series created by Jonathan Nolan and Lisa Joy for HBO.  Human-like androids with erasable memory & fixable bodies in a Western themed amused park in the show are tasked to entertain “real” humans. However, these androids start developing long-term memory and deeper philosophical nature – conceivably because of a  mistake!

Evolution, be it of sentinel life or that of various creative ventures set up the humans – the pinnacle of all sentinel life, will not be possible without that one essential element – mistake. But, is it true that mistake is the only tool on which entire evolution hinges? Perhaps not. If mistake is not followed by learning, evolution won’t happen.If you want to evolve, feel lucky that you have made some mistakes in the past. But, at the same instance, ask yourself what you ended up learning from those mistakes?

I have observed a strange fact of life. Humans generally learn only during their failures. 

Mistakes do not necessarily result in failures. And, if they don’t, more often than not, we may refuse to learn from those mistakes – in fact, our minds may not even register them as our mistakes.

I have seen many successful entrepreneurs locked into this “success-induced blindness”. What they fail to appreciate is that if they could succeed in spite of their mistakes, they could have perhaps conquered the world, if they had learnt from them and not repeated them all the time!

This is why one needs to have good advisors around oneself, seek their advise, trust them, and respect their opinions. That behavior distinguishes a star and a superstar!

Four Lessons for Silicon Valley from Its First Startup

“Thanks to the so-called “HP Way”—a philosophy based on the belief that people want to do a good job, and will do so if upper management trusts them and gives them the tools they need to do theirhqdefault1 best—HP routinely dominated markets with innovative, reliable, fairly priced products.” says Peter Burrows while reviewing a new book on Hewlett-Packard’s management history in his MIT Technology Review article dated November 28.

Peter enumerates the following 4 lessons for any start-up to live a long, happy, and healthy life:

  1. Know when to shrink – Organize your venture to give your business enough oxygen such that good ideas/models don’t get killed – even if it means contracting and not expanding!
  2. Don’t let the board of directors get stale – Be open to new and fresh perspectives. It also means not to let a “group think” to set in as a result of long association.
  3. Make sure “culture” is about values, not practices – Not to let the core corporate values turn into worthless rituals. Rituals that perhaps originate to re-enforce values, quickly lose their ability to guide the behavior in a positive way in a way values do.
  4. Groom successors—then groom more – Next generation is your guaranty against mortality. 

 

Corporate Venture Capitalism!

BMW recently increased the size of its venture capital fund, BMW i Ventures, to 500 million euros ($530 million) from 100 million and also decided to move its location to Silicon Valley from New York. Given that the car industry, which was technologically more or less stagnant for several decades, is now buzzing with innovation with AI  integration, It is not surprising to see BMW put additional emphasis on exploration.

Large corporations often struggle to keep up with their constantly innovating and evolving Eco-system. That is a result of an inadvertent flaw that creeps in as building regorous internal checks & controls slows down their response time and kills the enthusiasm for innovation. 

A few years back, I supported a program in a large cap US-based defense contractor to encourage  innovation. I got an opportunity to work with a few of their brightest engineering brains. These engineers were encouraged to leverage some of the company’s cutting edge defense-oriented technology to create innovative “civilian” business models. It was my client’s hope that such an innovation-driven approach can build a hedge against its revenue dependence of Government’s defense budget. Indeed, most of the large corporations sit on idle Intellectual Property assets worth billions of dollars. Encouraging innovation around these IP assets through an internal venture capital program was almost a no-brainer.

There is another reason for large corporations to piggyback on “portfolio” businesses funded through a venture capital fund to explore innovative business ideas. Game theory teaches us that a resourceful leader (like a winner of a 10,000 meters race) does not have to lead from the gate go. Ideally, a market leader can closely follow the “interim leaders” and sprint to catch up and win at an opportune time. Following a venture capital route can help leaders to closely follow the innovative ideas without creating an undue dent to their profitability or reputation in case these innovations fail.

The key question relating to success or failure of any of these program revolves around the culture of the corporate venture capital leaders and their ability to recognize that their risk-averse bureaucracy-driven board room strategies do not work well in innovative ventures’ war rooms!