Wednesday, February 1, 2023

Grocery Shopping and Other Business Traps

 When you go to the grocery store, or your partner does, how often are you purchasing a different brand or style of food? If you’re like most of us, you thoughtlessly wander down the aisles pulling off those same, familiar packages or produce. In the “name of efficiency” we don’t often stop to reevaluate our previous decisions unless there’s a hiccup in our system, like a stock shortage or dramatic price increase. Once we’ve made the decision about the most economical, most trusted, most nutritious, most flavorful, most delightful food stuffs, we make our shopping trip as short and painless as possible by getting the same old, same old. 

Likewise, in business, we have the same habits. Once we decide on certain service providers and suppliers, we thoughtlessly just “reorder.” Once we decide on our strategy, we rinse and repeat. Same with marketing channels and job advertising. If we make any adjustments, we increase the intensity: more, faster, harder… If one person is making the grade, hire another high-powered, more experienced person. If the sales leads aren’t happening, up the advertising budget, put it in more places, make it more frequent.

Rarely do we stop and question whether we’re heading in the right direction, targeting the right audience, seeing the gaps in competitive offerings. If there’s a problem, we want a magic pill to solve it. It’s true in our health—90% of heart disease patients don’t change their detrimental lifestyle—and it’s true in our decision-making habits. We rarely change how we do strategic planning, how we explore the unknown unknowns, etc. Even a crisis doesn’t make long-lasting changes. With a stock shortage, we go back to the comfortable, purchasing once again what we used to buy when it’s newly replenished. With strategies, we see glimmers of success and so we continue on blissfully unaware that this may lead to a dead-end, a trap.

You can reinforce habits, even business habits, with good feedback mechanisms. You can also create new habits by “burning the ships” so you can’t go back to the old way of doing things, the old standby “recipes” of strategies and decisions. Beware: even change programs don’t create lasting change.

When was the last time you made a long-lasting behavior change? When was the last time you made a significantly different, countercultural, revolutionary, industry disruption? Please don’t just thoughtlessly go down your business “aisles” plucking the same old, same old decisions and strategies off the shelves.

Friday, December 9, 2022

Profound Investment and Decision-Making Insight

I'm previewing a book, soon to be published, What I Learned About Investing from Darwin by Pulak Prasad. In the first chapter, he reviews Warren Buffet's strategy: don't lose money. He relates this to prey and predators not risking an error in judgment that a situation is good when it's bad. For example, don't risk thinking the watering hole is safe when you know a lion is nearby. Or don't risk chasing a heavyweight prey like a wildebeest if you're just a lightweight cheetah. In statistics, this is a type I error. The counterpart to this is passing on good opportunities; this is a type II error. According to the author, almost all, if not all, investment literature teaches you how to reduce the error of missing out on good opportunities.

The author's, mimicking Buffet, key insight so far in my reading is improving your systems to reduce taking risks on investments that appear good but aren't. You're overall performance in decision-making results, investments, etc. will improve dramatically.

The author uses this example: Suppose there are 4000 investment opportunities. Since most early businesses fail, the likelihood of good opportunities in that pool could be 25%. Suppose you have an 80% track record of being right--far above most sports statistics success rates, by the way. 

A lot of advice goes along the path of "you can't win if you don't play." "Need to buy a lottery ticket if you want to win." "Better to shoot a thousand times and hit 300 then shoot 10 times and only hit 3." As Taleb points out in Black Swan, it's impossible to precisely pick the winners so it's better to spread the bets knowing a few are going to win while most won't.

Prasad counters this by saying, "It's better to miss out on some good opportunities rather than waste time not improving the ability to avoid bad investments."

Take the 4000 opportunities. A thousand are good. You'll pick 800 of them with an 80% success rate; you'll miss out on 20% of the good opportunities. But you'll also pick 600 of the 3000 bad options (20%). Your overall success rate is 57%, slightly better than 50/50 or throwing darts at the list and picking that way (800/1400).

If you could reduce your risk in one of the areas, which risk would you select? Missing out on good opportunities or investing in bad companies?

Starting position: 20% type I, 20% type II = 57% success rate

Not missing good opportunities: 20% type I, 10% type II = 60% success rate [whoops, not much improvement since we'll get 900/1500 success ratio]

Not investing in bad opportunities: 10% type 1, 20% type II = 73% success rate [wow, a big jump since we'll get 800/1100 success ratio]

Also, if the ROI on the good opportunities equals the loss of the bad investments than, with a 73% success rate, your overall profits will soar compared to the other strategy of not missing out on some good opportunities.

Doesn't this just make sense? How come so many of us don't do this? Probably because we think if we spiral this logic to a reduced conclusion, we'll only be investing in savings accounts earning tenths of one percent on our assets. But I'm looking forward to Prasad teaching us how to spot those money-losing opportunities.

From the "Charge of the Light Brigade"