While the major focus of Nassim Nicholas Taleb’s book, ‘Fooled By Randomness’ is on trading and stock markets, there are some important insights which businesses can draw from his arguments and apply more generally to business decisions and strategy. The following are a few choice observations that business decision makers should bear in mind:
Humans are hardwired to assume that the world is less random than it in fact is. Don’t mistake success (even repeated success) for wisdom.
When we see a business suddenly experience success with a product or service, it’s easy to assume this means that they’ve made smart decisions and benefited from good leadership and direction. This isn’t necessarily the case! Often a certain amount of fortunate timing and circumstances have contributed to the success they have experienced.
Executives who have presided over successful periods at large businesses are often hired by other companies to fill top rolls in the hope that they will be able to replicate their successes. Often this does not work out as expected.
An easy to understand example of this is sports team managers. Sometimes a sports team will significantly over-perform during the tenure of a particular manager leading to a larger more successful team hiring them. Often the result is that the new manager falls short of expectations because their previous success was caused more by luck and circumstances than their own ability.
Similarly, businesses that suddenly emerge as success stories can attract a lot of attention and other businesses may attempt to emulate them. In the long run though this may not be a sound strategy as the market conditions that made them successful could change just as suddenly, robbing them of their advantage and leaving them no longer able to compete.
Worse yet, occasionally a small business will make an insane gamble that pays off by pure luck. When this happens, people tend to label the decision maker as a genius and seek to learn from their “wisdom”. The problem is that we only tend to hear about the winners as they rise to prominence, while the many losers, who made similar gambles and lost, disappear from the market.
Just because something is unlikely or painful to think about doesn’t mean it won’t happen! Each day things that have never happened before are taking place around the world.
When faced with a business decision there will often be some potentially disastrous and unpalatable possible outcomes. People tend on the whole to underestimate how likely these sorts of outcome are and even to dismiss them as impossible, especially when the disastrous outcome is something that hasn’t happened before.
A business that wants to continue to prosper needs to avoid situations that expose them to potentially severe consequences or at the very least take steps to manage the risk through insurance and legal agreements limiting liability.
Consider the possible outcomes of every major business decision you make. Do you have a plan in place to protect your business if things don’t go well?
When making business decisions, the objective should be to maximise your mean expected outcome. Don’t be fooled by other more intuitive measures like the median or the mode.
Given the choice between a number of different actions, the temptation is to choose the one with the highest probability of success. It seems obvious, but this is often not the best choice!
Often it’s better to choose the less likely action if it offers larger gains in the case it succeeds or if not acting has a small chance of causing huge losses. Consider the following example:
If option A has a 70% chance of winning you £10,000 but option B has a 30% chance of winning you £100,000 then choosing A you would expect on average to gain £10,000×0.7=£7,000, while choosing option B would give £100,000×0.3=£30,000. In this case, although option A is more likely to result in a profit, choosing option B is better because if you keep making choices like this then on average you will be better off.
Insurance is a good example of the opposite situation. Most of the time paying for insurance has a very high chance of costing you money for no gain, but if you don’t pay for insurance there is a small chance that you will suffer a very large cost (possibly so large that you can’t recover), so when considering the average expected outcome it is better to pay for insurance.
What happens when you get all of this wrong?
Consider the case of Kodak and the digital camera. Kodak was the first business to develop digital camera technology, inventing the first working model in 1975 and creating the first marketable DSLR unit in 1989.
Senior leadership was not impressed though. By their own assessment, demand was not likely to be too large and any sales they did secure would only eat into their profits from the traditional film market. On top of that there would need to be a large initial capital investment to enable mass production of the product. From their perspective, the chances that digital cameras would come to dominate the market was slim and as such it was not worth making the investment.
What they failed to consider was the severity of the impact on the company if they were wrong. If digital cameras came to replace standard film cameras and they gave up first mover advantage then the potential damage to their business was huge! If they had properly considered what would happen if they had guessed wrong, they would have realised that the correct decision was to move ahead with digital cameras.
The failure to cover off this possibility (the likelihood of which they had grossly underestimated) was one of the major contributing factors to Kodak’s subsequent decline and eventual bankruptcy in 2012.
Modern Enterprises are generally far more aware of how to effectively balance risk and reward and as such are less prone to making these sorts of errors, but smaller businesses should bear in mind these traps of lazy or emotional thinking if they want to avoid a fatal misstep.
Of course, one way to ensure your business doesn’t go the way of Kodak, Compaq, Borders or any other failing company is by staying close to the market and understanding what future trends might impact on your future industry sector. Of course, market research can help to gather insight in terms of expectations and future needs but here at B2B International we can help you to predict the future with our Horizon Scanning services.