2 ways of learning to fail with comfort

Failing can’t be a comfortable event. Or so I believed for a long time. Until I came across a suggestion from Nassim Taleb thirteen years ago (December 2008) which said, “Learn to fail with pride, comfort and pleasure”. My initial reaction was disbelief. And yet I decided to take the suggestion very seriously and kept on testing it as a hypothesis. Over the past decade, I discovered that I don’t experience pride and pleasure when things don’t work out. However, I felt it is possible to be comfortable with failing. And the experimentation involved trying 2 broad approaches: (a) protecting against the downside, and (b) subtracting expectations both of which came from Taleb himself. So here is a short reflection on what these approaches meant for me. But let me begin with the context.

Nassim Taleb’s interview was published in December 2008 issue of McKinsey Quarterly. It was related to Taleb’s book “The black swan: The impact of the highly improbable” which got published in 2007 and became a big hit especially during the financial crisis of 2008. In this interview he was asked, “What would your ideas look like in practice for, say a manufacturer?” And Taleb said, “If risk doesn’t cost you a lot, take all the risk you can. Do more trial and error. Learn to fail with pride, comfort and pleasure.” And then he added, “But try to have less downside exposure by building more slack into your system through redundancy, more insurance, more cash, and less leverage. Imagine a shock. What will happen if there’s a shock? How many months could you keep operating?”  

When I read Taleb’s interview in December 2008, I was self-employed for a little over two years. My consulting pipeline was dry and with the impending downturn there was failure written all over. I was uncomfortable and anxious, far away from being proud and pleasurable. We had moved into a new apartment and there was a burden of housing loan. And hence, I was both sceptical and curious about “learning to fail with pride, comfort and pleasure”. It didn’t take me much time to drop the “pride and pleasure” part as unnecessary and stick to just “learn to fail with comfort”. Here is what it meant for me to experiment with the two approaches:

Protect against downside: Over the next few years, I did following:

• Paid off the housing loan and increased the cash position. I was lucky to have some stocks from my previous employer that helped in this process.

• Wore helmet while cycling and seat-belt while driving 😀

• Took data backups seriously and it became a ritual. Laptop crashed a few times but never became a big issue.

• Took protecting customer’s confidential information very seriously. Similarly, while building on others’ ideas, I made sure I attribute credit to the source of ideas. Learned to make modest claims about what management of innovation can achieve in an uncertain world.

• Took low-cost experimentation very seriously. This meant offering different open workshops in hotels and testing which ones are more attractive to customers. Many of them didn’t last and it didn’t hurt at all. Started presenting my ideas through blogs which was and is free and I find it to be a good platform for early testing of ideas.

Subtract expectations: No matter how much one tries to protect oneself, with helmet, cash, insurance or a vaccine, an accident or a virus can spring unexpected surprises. And the setback could feel like a failure. This is where we turn to the question: Why expect at all that life will be smooth? In fact, can one routinely anticipate disruptions?

Seneca, a first century Stoic, is one of Taleb’s heroes in the book “Antifragile: Things that gain from disorder”. Seneca used to mentally write-off all his possessions before going to bed as if he were to be in a shipwreck. If he still had them when he woke up, it was a bonus.  Seneca was a shipwreck survivor and perhaps he had experienced the fragility of life first-hand. Taleb quotes Seneca, “He is in debt, whether he borrowed from another person or from fortune.”

Thus expectations or desires are also a kind of debt which turns into obligations to be fulfilled. When not fulfilled it feels like a failure. “Oh, I couldn’t buy the car I wanted so badly.” But subtracting expectation debt is not as easy as paying off monetary debt. Expectations can be deep-rooted and subtle. We can’t just subtract the waves on the ocean, can we? So this is what I learned from spiritual teachers like Jiddu Krishnamurti, David Bohm and Eckhart Tolle that I could apply it my context.

An expectation gets subtracted when it is seen as meaningless. And to see expectations in action one needs to learn to watch the movement of thought while thinking. This movement is subtler than the movement of breath. Moreover, expectation per se is not bad. It is the force behind the expectation turning it into an absolute necessity that makes failing dreadful. Over the years, watching the movement of thought has become a second nature for me. However, thought is a sophisticated process and it is extremely good at creating self-deception. So watching the movement of thought is a lifelong learning process.

Does it mean I have no expectations? No. I do make plans – some short term (course teaching plan) and some long-term (consulting focus for the next few years). Earning a livelihood is still important. However, if things don’t go as per the plan, and they invariably do, it doesn’t surprise me. In fact, I anticipate and watch out for surprising signals, both positive and negative and course correct if necessary. And failing has felt normal and comfortable for the past several years.

To summarize, protecting against downside exposure and subtracting expectations are two ways of learning to fail with comfort. Subtracting expectations needs alertness to watch the movement of thought and recognize the meaninglessness of expectations when they don’t make sense anymore.

A peek into Bezos’ big bet review: Alexa example

Innovation review has been an important element in my consulting work for the past decade and a half. And I have seen that it becomes trickier when it comes to reviewing big bets. In “Amazon unbound: Jeff Bezos and the invention of a global empire”, Brad Stone gives us a peek into how Jeff Bezos reviews his big bets like Alexa, Go, Fire Phone, AWS, India, and more. I found it very interesting. Here is an example of how such a review went for Alexa.

On January 4, 2011, Bezos sent an email to a few select executives including his technical advisor or TA, Greg Hart, “We should build a $20 device with its brains in the cloud that’s completely controlled by your voice.” By then Hart and Bezos would have perhaps discussed the advent of speech recognition multiple times including once in late 2010 when Hart demonstrated Google’s voice search on Android to Bezos. Soon after the email, Hart was assigned the secret project to build such a device and he moved out from his TA role.

By early 2013 the product codenamed Doppler was in beta testing mostly from a few hundred Amazon employees. The data was noisy and it wasn’t enough. The device didn’t look promising yet. Bezos kept asking, “How will we even know when the product is good?” Rohit Prasad was leading the effort in building a far-field speech recognition engine, a core part of Doppler. Prasad and Hart prepared a graph showing how Alexa would improve as data collection progressed. For each successive 3 percent increase in accuracy, they needed to double the data.

In one of the reviews with Bezos, Hart, Prasad, and team proposed to double the speech science team and postpone the launch from summer to fall. Bezos commented, “You are going about this the wrong way. First, tell me what would be a magical product, then tell me how to get there.” Then the question came whether the team had enough data. Prasad answered that they need thousands of more hours of complex, far-field voice commands.

Bezos factored in the team’s request for additional speech scientists and calculated how long the revised team would need to get the requisite data. He asked, “Let me get this straight. You are telling me that for your big request to make this product successful, instead of it taking forty years, it will only take us twenty years?” His math was correct and the team didn’t have a plan. Bezos ended the meeting abruptly say, “You guys aren’t serious about making this product.”

This review resulted in a serious introspect in the team and they came up with a plan of outsourcing the data collection. The new program called AMPED ended up renting neighborhoods first in Boston and later expanding it to 10 cities and recruiting contract workers. The rented homes and apartments were sprinkled with Alexa devices disguised as pedestal microphones, Xbox gaming consoles, TVs, and tablets. The contract workers worked eight hours a day, six days a week, reading scripts from iPad with canned lines and open-ended requests.

By 2014, the Alexa team had increased its store of speech data by a factor of ten thousand. When all this was presented to Bezos in the review, he said, “Now I know you are serious about it! What are we going to do next?”

Bezos’ comment, “First tell me what would be a magical product, then tell me how to get there” would get repeated in different forms. For example, in the review of another of his big bet, India business, Bezos would ask Amit Agarwal, Head of Amazon India, “Tell me how to win. Then tell me how much it costs.” It reminded me of George Day’s innovation portfolio management framework, “Real-win-worth it” (HBR Dec 2007).

image source: amazon.in

My 3 takeaways from Scott Adams’ “How to fail at almost everything and still win big”

A few months back my friend RamP recommended Scott Adams’ “How to fail at almost everything and still win big”. At that time, I was struggling to convey the importance of “fail fast, fail often” principle to the students in my course on innovation at IIMB. The book helped me in showcasing to students how successful people like Scott Adams have a long list of failures and they are not shy of presenting it. But the book doesn’t stop at flaunting failures; it goes deeper than that. It presents some of the key challenges we face in our creative journey and suggests some practical approaches in tackling them. And it does so in a witty style. Here are my 3 takeaways from the book:

Fail often in order to succeed: “You want to be steeped to your eyebrow in failure,” Scott says, “It’s a good place to be because failure is where success likes to hide in plain sight. Everything you want out of life is in that huge, bubbling vat of failure. The trick is to get the good stuff out.” That’s quite an insight. In chapter 4 titled “Some of my many failures in summary form”, Scott presents 22 failures and the lessons he learned from them. Chapter 5 is dedicated to “My absolutely favorite spectacular failure”. I would buy this book just for these two chapters. When I present my failure resume in the class, students comment that my failures weren’t that bad. When I tell them the Nassim Taleb quote, “Learn to fail with comfort, pleasure, and pride,” they feel if you are failing comfortably that means you are not trying hard. Perhaps it is not easy to understand that for an idea with big upside, the cost and downside of experimentation doesn’t have to be high. In my failure to communicate this point lies an opportunity for me to improve my presentation in the future.

Goals are for losers, system for winners: “If your goal is to lose ten pounds, you will spend every moment until you reach the goal – if you reach it at all – feeling as if you were short of your goal,” Scott adds, “Goal-oriented people exist in a state of nearly continuous failure that they hope will be temporary.” He suggests that one should treat the system as primary rather than the goal. How is system different from goal? He says that running a marathon is a goal while exercising daily is a system. If you do something every day, Scott calls it a system and if you are waiting to achieve it someday in future, it is a goal. My take is that both have a place but the question is where do you place emphasis? Scott suggests that system should be primary and I feel the same.

Maximize personal energy: How does Scott approach the problem of multiple priorities? He says he focuses on only one metric – “my energy”. Scott says, “The main reason I blog is because it energizes me. I don’t need another reason.” In fact, Scott goes on step further. His Dilbert comic creating process is divided into two stages to maximize the energy-generating ideas and drawing the final art. He has observed that his creative energy is at its best during morning time. So he tries to get new Dilbert ideas at that time. And he draws the final art in the afternoon which is less creative. Shopping drains his energy, so he minimizes shopping. Everyone is different and hence one should pay attention to things that give and drain energy.

I enjoyed the book and strongly recommend it to anyone who wants to preserve or develop the creative part within oneself. I find all the three suggestions valuable, keeping a failure resume, focusing on the system rather than goals and paying attention to the sources of energy. Hope you get to experiment with them.

image source: amazon.in
Nassim Taleb quote is from his interview by Alleb Webb in McKinsey Quarterly, December 2008 issue.

Could “Create a margin of safety” be the toughest of the 8 steps to innovation to master?

Café Coffee Day founder V. G. Siddhartha’s unfortunate demise coincided with my class on “Margin of safety” in “Strategic Management of Technology and Innovation” course at IIM Bangalore. “Create a margin of safety” is the 8^th step of the "8-steps to innovation" book I co-authored. Siddhartha allegedly committed suicide by jumping into the Netravati river near Mangalore. We would never know the exact reasons why Siddhartha took such an extreme step. Given the debt situation of Café Coffee Day group, could it be possible that Siddhartha lost track of margin of safety? And, if a seasoned businessman like Siddhartha can overlook margin of safety, could it be the toughest step to master?

When I discussed this question with my friend and co-author of “8 steps to innovation”, Prof. Rishikesha Krishnan, he suggested I read the book “Failing to succeed: The story of India’s first e-commerce company” by K. Vaitheeswaran. It turned out to be a textbook case demonstrating how difficult it might be to internalize the principle of “margin of safety”. Let’s look at a few anecdotes from the book which illustrate this point. But before we look at it, let’s note that we are looking at a venture story when it hit a downward spiral. The Indiaplaza story contains several ups and many things that the founders should be proud of. Moreover, innovators and especially entrepreneurs should be indebted to K. Vaitheeswaran for the candid narration of his experience. It is so rare in the Indian context.

June 2009:  "A jewellery vendor from Delhi came to our office with a few thugs and abused me with choice expletives in front of all staff members and threatened to beat me up physically if I did not pay up the dues within two days."

"An apparel vendor from Surat came to the office accompanied by a local policeman. The policeman threatened to arrest me if we didn’t settle the dues in one week."

August 2012: "I had stopped drawing my salary from August 2012, and worse, I had made the mistake of using my personal credit cards to spend for the company. Every day private collectors visited our home on behalf of credit card companies and loudly demanded money to embarrass and shame me in front of my neighbours and family. Then I decided to withdraw my Provident Fund (PF) because we desperately needed money."

December 2012: "The last week of December was terrible. On 31 December 2012, New Year’s Eve, a group of drunk people banged on our apartment door loudly and in front of my neighbours, family and some friends abused me for non-payment of dues. I was falling into bouts of depression and my health was taking a severe beating."

April 2013:  "When this deal (a potential acquisition) fell through, the creditors became furious. In a few days, our office was swarming with creditors in person. An electronics merchant, during the conversation in our office, pulled out a dagger and placed it on the table. The managing director of a big publishing and distribution house from Delhi met me in Bengaluru and said that he would ‘throw babies in front my car’ when I was driving."

August 2013: "I was standing inside the Ulsoor police station on Cambridge Road in Bangalore. I waited to be interrogated by the inspector on a complaint filed personally against me by a merchant."

8 December 2013: "I had quit and I was not coming back. I had nothing to show for my efforts over fourteen years except for several court cases against me, social media abuse, being avoided like the plague by people I knew and being branded a failure."

At one point the author says, “Whenever I read about people taking their own lives due to financial troubles, I confess, I can understand and sympathize with a moment of madness.”

Building a “margin of safety” involves asking two questions: “What kind of catastrophic risk is there? And, can I live with it?” From the anecdotes above it looks as if the worst-case scenario was not difficult to imagine in 2009 itself. And yet no major action was taken to protect oneself against such a situation. Hence, I am beginning to wonder if creating a margin of safety could be the toughest of the 8 steps to innovation to master.

Managing the tricky transition from “idea?” to “idea!”

When Steve Jobs shortlisted the idea of portable music player during an offsite in 2001, the idea had many unknowns. These included questions such as, Who is the customer? Which technology do we use? What business model shall we adopt? Etc. Let’s denote such an idea with the notation “idea?” The question mark at the end indicates that the idea has uncertainty associated with it. Fast forward 3 years and Jobs was in Madison, New York City and he saw people wearing white headphones on every block. That is when he realized that the idea has taken off – it has become “idea!” – an idea without much uncertainty. Every successful innovation goes through this transition from “idea?” to “idea!”. However, many fumble during the transition. Let’s see how in this article.

Tata Nano stands out for the unusual pre-launch publicity it got as an innovation. As it was being launched several success stories were being written. However, the car has done far below expectations so far. In FY 2012-13, 23K Nanos were sold, in the first half of FY 2013-14 10K Nanos were sold as against the nominal factory output of 250K cars per anum (source: Wikipedia). As Nano was being designed and developed, I am sure it was being treated as an “idea?”. However, as it was being launched, was Team Nano  already treating the idea as “Nano!” – sort of “done deal!”. This part is not very clear. At this stage, the business model (Who, What, How) was still untested and hence it should have been treated as “Nano?” and subjected to rigorous testing. Based on the publicly available information, it looks as if that didn’t happen (I could be wrong here).

No matter how successful an idea is, it doesn’t last forever. Hugely successful iPod is no exception. Around a year ago  (Jan 2014), Tim Cook CEO of Apple announced, “All of us have known for some time that iPod is a declining business.” In fact, in 2009, Peter Oppenheimer, then CFO of Apple, mentioned, “We expect our traditional MP3 players to decline over time as we cannibalize ourselves with iPod Touch and the iPhone” So when did the iPod go back from “idea!” (success guaranteed) to “idea?” (future uncertain) state again? Well, it was in the same year in which Steve Jobs had seen iPod on every block in Madison, New York City – 2004. It was in this year that Jobs expressed his concern in an Apple Board meeting, “The device that can eat our lunch is cell phone.” The project that got started eventually led to the creation of iPhone.

That brings us back to the question – Is there anything like “idea!”? Can there ever be a state in the journey of a product where success is guaranteed? I don’t think so. In fact, the euphoria around the market success can be a sure shot sign of some untested assumption being overlooked. The only time an idea enters “idea!” state is while it enters the sunset zone – and the certainty is that of death! Of course, in the case of iPod, even that is uncertain in the near future.

In short, no matter how fantastic your idea is, don't be in a hurry to treat it as an "idea!". Treat it as an "idea?"  and be clear about the key untested assumptions at every stage of its evolution.

source: Steve Jobs comment on the future of iPod that he presented to the board is mentioned in his biography "Steve Jobs" by Walter Isaacson, page 465.

1996 Everest disaster and a lesson in “design as if implementation matters”

When I finished reading “Into thin air: A personal account of the Mt. Everest disaster” by Jon Krakauer a couple of weeks ago, it was still considered the worst Everest tragedy. It is a story of a disaster that happened on May 10 and 11, 1996 on Mt. Everest in which eight people died in a single storm including two expedition leaders: Rob Hall and Scott Fischer. However, as I am writing this blog, it is no longer the worst tragedy. Friday before last, on April 18, sixteen Sherpas got killed in an avalanche. Climbing Mount Everest continues to be a risky affair and no amount of learning is likely to completely eliminate the risk. In the words of Krakauer - On Everest, it is a nature of systems to break down with a vengeance. That doesn’t prevent people like me in deriving learnings from the 1996 disaster story. Here is my key take-away from “Into thin air”.

Rob Hall was world’s leading Everest guide running a company “Adventure Consultants”. By 1995 Rob had assisted thirty nine clients reach the top of the mountain and return back safely. In 1996 May expedition his team had clients some of whom had paid as much as sixty five thousand dollars in order to get to the world’s tallest peak.

Rob was disciplined and meticulous. He had fine-tuned an effective acclimatization plan that would enable the team to adapt to the paucity of oxygen as you go up. Rob knew that timing is crucial in Everest expeditions. He lectured the team repeatedly about the importance of having a pre-determined turnaround time on the summit day. It would be 1pm or worst case 2pm. Everybody was to abide by it no matter how close one was to the peak. “With enough determination, any bloody idiot can get up the hill,” Rob would say, “The trick is to get back down alive.”

On the summit day, Rob reached the summit after 2pm and waited for his team member Doug Hansen to reach the summit till 4pm before they began their descent. Doug was so tired by the time he reached the top, he didn’t have much energy left to come down. As luck would have it, he ran out of his oxygen too. Both Rob and Doug got caught in the storm that followed and didn’t make it down. How could a disciplined expedition leader like Rob Hall make such a mistake of not adhering to a predetermined turnaround time?

As Krakauer writes in the book: Lucid thought is all but impossible at 29,000 ft. In addition, the intensity of the desire of achieving the goal – for you and for your clients - is much higher than the cold-blooded process adherence and turning back at 2pm. In short, your thinking is heavily biased. But equally importantly, it is known apriori that your thinking is going to be crooked as you climb up. Then why not plan taking into account such a possibility? Is it possible to create a plan that accounts for the distorted thinking during its implementation? This is the central question when you want to “design as if implementation matters”. To use the Elephant-Rider metaphor of the mind, it is like the Rider planning for a situation when the Elephant has taken over. How do we do it?

Here are a few options none of which is fool-proof: One, responsibility of the turnaround decision can be delegated to a place where the mind is less emotionally charged and has more oxygen e.g. the base-camp or camp-one. Two, after the predetermined turnaround time, everybody coming back takes the responsibility of requesting the up-going climber to turn around, despite your position in the pecking order.

Three, each expedition team performs pre-mortem before the expedition begins.  In this exercise everybody in the team imagines a situation in the future when the project has been a massive disaster. In Everest expedition, it means imagining your own body lying around 28,000 ft and several other casualties. And then listing down what all went wrong. That leads to various precautionary measures and a common understanding of the importance of a protocol such as turnaround time.

“Design as if implementation matters” has significant implications for the design of business strategy.  A strategy which gets finalized in an offsite in cosy settings may fail to take into account the emotional biases of the team during its execution – just like Hall’s Everest team.

No amount of planning can eliminate the risk in Everest expeditions or in business. However, techniques such as pre-mortem may help increase the “Margin of safety”.

A related video: 
Mt. Everest - The storm (1996) - A PBS  documentary on the 1996 disaster directed by David Breashears, one of the members of the IMAX team who climbed Everest during the same season and also helped the teams caught in the storm. 

Joseph Schumpeter and the principle of indeterminateness

For most of his life, Joseph Schumpeter, the prophet of innovation, was seeking an exact science. It would be a science that would precisely predict the economic developments including innovations. However, Schumpeter’s quest for exact economics ended quietly in the penultimate year of his life in 1948. How did this transformation happen? Let’s look in this article.

“Despite all his pioneering work of integrating other disciplines into economics, Schumpeter in the mid-1940s was still looking for a key to ‘exact economics’ in the sense of a determinate and predictive science”. Thus begins the penultimate chapter (Chapter 27) of Schumpeter’s biography “Prophet of Innovation” written by Thomas McCraw. What, according to Schumpeter, was the key hurdle in creating such an exact science?

One hurdle Schumpeter felt was mathematics. He performed daily exercises in calculus and tried to master advanced techniques such as matrix algebra. In fact, he thought that a new type of mathematics may be needed for the exact science. However, as Schumpeter delved more into the business history, he started discovering a completely different barrier in creating a predictive science.

As Schumpeter studied business history he asked the question – “Who was it that acted, how and why and what may be the effects that may be traced to such actions?” As he analysed various innovations he realized that a creative response which is “outside the range of existing practice” can never be predicted and is therefore indeterminate. He called this insight – Principle of Indeterminateness. He announced the verdict of his quest in his presidential address at the annual meeting of the American Economic Association on December 30, 1948 (see the picture above).

Schumpeter had realized that social location of individuals plays a significant role in shaping their intuition which in turn determines their creative response. In fact, he felt that psychology is at the heart of all social sciences. And he noted with regret that economists did not consult or work with professional psychologists. Instead they preferred to invent their own assumptions about the mental processes of producers, consumers and people in general.

It would take another half a century before a psychologist (Daniel Kahneman) would get a Nobel Prize in Economics. Incidentally, the first cognitive illusion Kahneman would discover – the illusion of validity – would be closely linked to the principle of indeterminateness. Kahneman writes in the chapter titled “The illusion of validity” in his book “Thinking, fast and slow” – The main point is not that people who attempt to predict the future make many errors… it is that the errors of prediction are inevitable because the world is unpredictable.

My 3 take-aways from Nassim Taleb’s Antifragile

“What do you do if you cannot predict?” is the title of chapter 13 in Nassim Taleb’s bestseller The Black Swan (TBS). Antifragile expands the 10 page chapter into a 500 page book. I find the question important and its exploration useful in my work on improving innovation effectiveness. And hence I turned to Antifragile.  But I am allergic to fat books, notwithstanding the kindle versions. Fortunately, the essence of the approach to the “What do you do?” question is presented in four of the twenty five chapters (chapter 9 to 12). Rest of the book is about the definition and the importance of antifragile and equally about ranting against Harvard Profs, bankers with black tie, Alan Greenspan and loads of philosophy. It wasn’t difficult to skim and skip through most of it. In this article we look at my 3 take-aways from Antifragile on the “What do you do?” question. But before that let’s look at the definition of antifragile.

What is Antifragile? Wind extinguishes candle and energises fire. Thus fire is benefited from the wind and candle is harmed by the wind.  Anything that has more upside than downside from random events (or certain shocks) is antifragilie. The reverse is fragile. In economic systems, fiscal deficit is a source of fragility and innovation is the source of antifragility. In personal life, corporate employment is fragile (to downturn) while tenured-prof-cum-fiction-writing is antifragile. A bestseller and your life may change.

1. Fragility is measurable, risk is not: Can you predict the chance of you getting fired from your job? No. But can you imagine the consequences of you getting fired? Yes, you can. Fragility is about the potential impact of rare events and not about predicting the occurrence of the events. As we saw in an earlier article, Ken Cox, Technical Manager of the control systems program of Apollo 13, didn’t have the foggiest idea of the probability of command module failure. However, it wasn’t difficult to imagine the consequences of such a failure.

One way to measure fragility is to calculate acceleration of harm due to unit change in something. For example, you may check additional harm from Fukushima reactor when tsunami goes beyond certain level. Similarly, you can check the additional delay in traffic when the number of cars on the road increases by certain percentage. If we detect acceleration of harm, it means the system is fragile.

2. First step is to reduce fragility: Taleb says – the first step towards antifragility consists in decreasing downside rather than increasing upside. To make profits and buy a BMW, it would be a good idea to, first survive. In the movie, Million dollar baby, the boxing coach Frankie (Clint Eastwood) tells Maggie (Hilary Swank) following during a coaching session:

Frankie: You forgot the rule. Now, what is the rule?
Maggie: Keep my left up?
Frankie: Is to protect yourself at all times. Now, what is the rule?
Maggie: Protect myself at all times.
Frankie: Good. Good.

Unfortunately, one can never know all such harmful events or create a full-proof protection. However, one can reduce one’s exposure. For example, adding redundancy helps. Commercial aircrafts have redundancy built into almost all aspects of their design – engines, autopilots, instruments, pumps, generators, air and hydraulic systems, controls etc. Another way to reduce fragility is to keep a system as simple and small as possible.

3. Optionality is the key lever to antifragility: Thales, a Greek philosopher from Miletus in pre-Socratic era (perhaps a contemporary of Buddha), is one of the heroes of Antifragile. According to a story, Thales reserved olive presses ahead of time at a discount. The harvest turned out to be good and Thales rented the presses out at a high price when the demand peaked. What Thales bought was an option – right but not an obligation to use the olive presses. Options which allow you more upside than downside are vectors of antifragility.

In an earlier article we saw how Paul Buchheit spent 6-7 hours building a Gmail prototype involving content-targeted ads. In fact, he himself didn’t believe that the experiment would work. But he didn’t lose much in doing the activity and it led to the most successful business model for his employer – Google. Taleb says that low-cost trial-and-error activity like that of Paul can be seen as the expression of an option. The tricky part is to recognize the favourable outcome.

It was a pleasant surprise to meet Seneca, a Roman philosopher, in Antifragile. Seneca’s method to counter fragility was to go through mental exercises to write-off possessions. So when losses occurred you don’t feel anything. Anything you gain is a bonus! For example, Seneca started his journeys with almost the same belongings he would have if he were shipwrecked – a blanket plus a few things. Taleb calls this antifragility in its purest form. Isn’t that similar to Krishna’s advice of non-attachment to Arjuna?

Image sources: Wikipedia.org and movies.tvguide.com

Warren Buffett’s biggest mistake and the psychology of decision making

When Warren Buffett speaks it appears as though an old sage is speaking. And yet he is so fond of talking about his fallibility. During his first India visit this week, he said in an interview with ET, “I have made plenty of mistakes. Over the last 60 years, sometimes I have misread the future. [And] that’s gonna happen to me again in the future”. Interestingly his biggest mistake didn’t happen because he misread the future. It happened because he got mad at the person on the other side and ended up buying instead of selling. How did that happen? And what were its implications for Buffett? Let's see in brief below.

Berkshire Hathaway (BH) was formed in 1954 in New Bedford, New England from the merger of two textile mills each of which traces its origin to 19^th century. By the time Buffett’s buddy Dan Cowin from Graham-circle suggested him the idea of buying BH, it was making losses for over a decade. However, BH was interesting to Buffett because it was selling cheap. According to its accountants it was worth $22 million as a business or $19.46 per share. And yet, you could buy a share for just $7.50. BH’s President Seabury Stanton knew this as well and whenever he would close a mill and sell its assets, he would issue a tender to buy-back shares. So Buffett devised a strategy to buy BH on a low tide and sell whenever Stanton issues a tender for stock purchase at some profit. The point is Buffett started buying BH not for keeping it forever but for selling it.

In his usual style, Buffett drove up to New Bedford one day to see the place for himself. When Buffett was reluctantly ushered into Stanton’s palatially furnished, ballroom-size office, he saw that there was no place anywhere near Stanton’s desk to sit. The seventy one year old six-feet two niches Stanton was used to summoning people to stand before him while he sat behind his desk. The two men seated themselves at the uncomfortable rectangular glass conference table in a corner and Stanton asked Buffett at which price would he sell when the next tender comes up. Buffett said, “I‘d sell at $11.50 a share if it’s in the reasonably near future”. However, when Buffett actually received the tender letter back in Omaha a few weeks later, Stanton had quoted $11 3/8. Buffett felt Stanton cheated him for 12.5 cents less per share. He got furious and decided he would buy a controlling stake of BH and fire Stanton. And that’s what he ended up doing.

Unfortunately, what Buffett got at the end of the heroic act was a lousy business. This is how Buffett remembers what happened next in his 2010 letter to shareholders, “The dumbest thing I could have done was to pursue “opportunities” to improve and expand the existing textile operation – so for years that’s exactly what I did. And then, in a final burst of brilliance, I went out and bought another textile company. Aaaaaaargh! Eventually I came to my senses, heading first into insurance and then into other industries.” No wonder when MBA students at University of Georgia asked him about his mistakes, he said, “Number one is Berkshire Hathaway”

Elephant-Rider model we looked at earlier tells us that our decisions are mostly governed by the Elephant side of our thinking. And the Elephant is emotional. And when emotion takes over, the tiny Rider which is the rational side of our thinking has no chance of influencing the decision. This Warren Buffett story illustrates how weak the Rider is even if you have the best Rider in the world.

Source: The Snowball, by Alice Shroeder (Chapter 27, Folly).

Image source: www.rationalwalk.com/?p=5052

What legends learn from gambling: Warren Buffett & the Rules of the Racetrack

I don’t gamble. At least that is what I would have liked to believe. “Nice people don’t gamble” is what I was told in school and at home. But when I look back on various decisions I took – like my investment in Satyam stock or leaving the job to become self-employed – each looked no different from a gamble. What differed were the odds and the stakes. Now I no longer look at gambling as – stuff that only other people do. It is something we do all the time whether we know it or not. What do people learn from real gambling? Here is an interesting tale from the chapter titled “The rules of the racetrack” in Warren Buffett’s biography “Snowball” written by Alice Shroeder.

“Pop, there is just one thing I want. I want you to ask the Library of Congress for every book they have on horse handicapping.” This is what Warren told his dad Howard who was at that time a Congressman living in Washington D. C. Howard cribbed, “Well, don’t you think they’re going to think it’s a little strange if the first thing a new Congressman asks for is all the books on horse handicapping?” Sixteen year old Warren persisted (1946) and got several books from the library. He studied them all and created his models. Tested them on old data he found in old racing forms in North Clark Street in Chicago. Through this process Warren discovered The Rules of the Racetrack:

1. Nobody ever goes home after the first race.
2. You don’t have to make it back the way you lost it.

The racetrack counts on people to keep betting until they lose. Couldn’t a good handicapper turn these rules around and win? Warren was to discover the answer first hand soon.

Warren found a new friend to go to racetrack with, Bob Dwyer, his high school golf coach. Together they started going to the racetrack in Charleston, West Virginia. Dwyer taught Warren advanced skills in reading the most important tip sheet, the Daily Racing Form. Warren recalls, “Sometimes you would find a horse where the odds were way, way off from the actual probability. You figure the horse has a ten percent chance of winning but it’s going off at fifteen to one.”

Then one time, Warren went to Charleston by himself. And he lost in the first race. But he didn’t go home. He kept on betting and he kept on losing, until he had lost more than $175 and his pockets were stripped nearly bare. This is what Warren recalls:

“I came back. I went to the Hot Shoppe, and I treated myself to the biggest thing they offered – a giant fudge sundae or something – and there went all the rest of my money. While I ate, I figured out how many newspapers I had to deliver to make up what I had lost (Note: Warren used to deliver Washington Post in the morning). I was going to have to work more than a week to make back the money. And I’d done it for dumb reasons.

You are not supposed to bet every race. I’d committed the worst sin, which is that you get behind and you think you’ve got to break even that day. [That is when I really learned] The first rule is that nobody goes home after the first race, and the second rule is that you don’t have to make it back the same way you lost it. That is so fundamental, you know. It was the last time I ever did anything like that.”

It is time we give some respect to bookies. By the way, which school do they go to?

1930: The year when Benjamin Graham re-discovered “Margin of safety”

1930 was the year when the Great Depression was in its infancy and Warren Buffett was born. It was also the year when Warren’s guru Benjamin Graham was at his career’s mid-point and he would re-discover the principle of “Margin of safety (MoS)”. MoS would become one of the core principles of Graham’s investment style known as value-investing. It would be published in the book Security Analysis in 1934. MoS, I believe, is also one of the core principles of systematic innovation. Question is – How did Graham forget the principle in the first place? And how did he re-discover it? Let’s see it in brief in this article.

By 1930 Graham was 36 years old and had been in Wall Street for 16 years. He had experienced what it means to lose big-time twice. The first loss was in 1903 when Graham lost his father. Graham was 8 years old and his father 35. For the next several years Graham saw practically all the assets including furniture and jewelry disappearing from home, some of it to the pawn shops. The second loss was during the market panic of 1907 when his mother’s margin account was wiped out and her bank closed down. Things began to change slowly for Graham when he entered Columbia on an Alumni scholarship.

During the great bull market of 1920s Graham saw considerable reversal of fortunes. In the middle of 1929, Graham’s fund was sitting on a two and a half million dollars capital – put in long terms investments and short term hedging & arbitrage operations. By the end of 1929, in spite of the September crash of Dow Jones, Graham’s fund had lost only 20 percent compared to a much larger loss of Dow Jones. In a few circles, Graham was being referred to as “financial genius”.

In January of 1930 Graham visited Sr. Petersburg, Florida for holidays along with his family. He met a man named Mr. John Dix who was ninety three years old. Mr. Dix’s father had founded the John Dix Uniform Company of Long Branch, New Jersey. Dix asked Graham all about his business, how many clients he had, how much money I owed to banks and brokers and innumerable other questions. Graham answered them politely but with smug self-confidence. Suddenly Dix said with greatest earnestness, “Mr. Graham, I want you to do something of the greatest importance to yourself. Get on the train to New York tomorrow; go to your office, sell out your securities; pay off your debts, and return their capital to your partners. I wouldn’t be able to sleep one moment at night if I were in your position in these times, and you shouldn’t be able to sleep either. I am much older than you, with lots of more experience, you’d better take my advice”. Graham felt the old man couldn’t possibly understand his business and thought Dix’s ideas were preposterous. Of course, Dix was 100 percent right, Graham 100 percent wrong.

Graham would remember Dix in June when the Dow Jones would reach the abysmally low level of 42 from the April level of 279. Graham’s loss in 1930 was 50 percent, in 1931 it was 16 percent and in 1932 only 3 percent. Graham suffered but perhaps far lesser than others. Surprising part is - Graham doesn’t blame himself for the failure to protect himself against the disaster. What is it that Graham regrets?

In 1928 Grahams had moved into a duplex apartment with terrace on the 18^th and 19^th floor of a thirty storied building at the heart of New York City. It had ten rooms and a rent of $11,000 per year and the lease was to run ten years. Considering Graham’s gains of $600,000 before taxes for the closing year, the expenditure appeared modest even by highly conservative methods. He was proved wrong and pretty soon Grahams moved out of the apartment. What was Graham’s learning?

The true key to material happiness lay in a modest standard of living which could be achieved with little difficulty under almost all economic conditions. Graham would remember Mr. Dix and the New York apartment experience for the rest of his life.

Source: Benjamin Graham: The memoirs of the Dean of Wall Street, McGraw-Hill, 1996

Related articles:

Margin of safety: My most favorite insight of 2009

Edison’s folly and understanding the exposure to negative Black Swan

Story of the “Real Rancho” – Ranchhodlal Chhotalal (1823-1898) – Babu ban gaya Businessman

We looked at the innovations from Rancho (Amir Khan) in “3 idiots”. Well, there was also a “Real Rancho” a Babu turned dashing entrepreneur who put the city of Ahmedabad prominently on the map of industrial India. Let’s look at how Ranchhodlal Chhotalal (1823-1898) went about setting his cotton mill.

1. A project was promoted by a group of merchants in Surat in 1847. Their idea was to use modern technology to product cotton goods. Some Englishmen working or living in Gujarat acted as their technical consultants. The project, however, did not go beyond the conception stage as the promoters developed cold feet even before the first concrete steps were taken.

2. Ranchhodlal Chhotalal was a highly educated man well versed in Persian, English, Sanskrit and Gurajarati. He had risen to the highest position in government service to which an Indian could at the time aspire. Ranchhodlal came to know of the aborted Surat project from one of the British officers Captain Goerge Fulljames.

3. In 1850 Rachhodlal obtained technical details of the Surat project from Fulljames and proposed to set up an industrial dream for producing cotton goods. He joined hands with an English cotton planter, James Landon, who offered to contribute half the capital required provided Ranchhodlal arranged for the other half. A couple of Baroda bankers agreed to invest but eventually backed-off due to their mistrust in Landon. Landon withdrew and project didn’t take off.

4. In July 1854 Cowasji Davar from Bombay floated the first cotton mill, the Bombay Spinning and Weaving Company with a share capital of Rs. 5 Lakh.

5. In the meantime, Ranchhodlal restarted his effort of starting a cotton-mill in Ahmedabad. This time he succeeded in convincing investors and registered the Ahmedabad Spinning and Weaving Company in 1859 – close to a decade after he conjured up his dream. The capital involved amounted in the first instance to one lakh of rupees and the mill contained at first 2,500 spindles only and no looms.

6. A number of factors contributed to the delay between the foundation of the mill in 1859 and its actual opening in 1861. One, Suez canal had not opened and all vessels from England had to sail via the Cape. Second, the ship carrying the machinery for the new mill caught fire and was lost at sea. It was insured and fresh machinery was ordered. The English engineer who came for building the mill, C. Dall, died before the machinery arrived. The machinery had to be transported from Bombay to Ahmedabad on bullock carts.

7. After unsuccessful engagements with four European engineers, one Edington completed the work and served for two years from 1861 to 1863 and put the whole mill into good working condition.

8. Initially the mill barely paid a dividend of six percent. Hence, additional capital was raised to increase the number of spindles from 2,500 to 10,000 and to establish weaving department with 100 looms. This increased the dividend to nine percent and substantial fund was carried over to reserve fund.

9. Subsequently, Ranchhodlal built second mill in 1872 containing 14,500 spindles. The mill prospered until 1875 when a disastrous fire destroyed practically the entire building which was uninsured. Ranchhodlal rebuilt it with his own expenses within a short time of a year.

There are four things that I find interesting in this story:

1. Collaboration with British: Unlike his peers Ranchhodlal built successful partnerships with Britishers in raising money as well as gaining technical know-how. His government service helped.

2. Successful demo: Let’s define success demo is that milestone when the investors actually put money. This happened for Ranchhodlal in 1858-59. And it did not happen because Ranchhodlal showed any prototype or demo. It happened because Davar showed that the model works in Bombay and that boosted the confidence of the investors. It’s like saying, “Look, I can do it here because, he has done it there”. And the same logic didn’t work when “here” meant Ahmedabad and “there” meant Manchester.

3. Role of insurance: There were two Black Swan events each could have potentially crippled the whole business depending upon circumstances. First one when the ship carrying machinery caught fire and the second one when the second mill was burnt. Insurance helped in the first one and Ranchhodlal was rich enough by the time second event happened.

4. Finding optimal scale: As the first mill started operations Ranchhodlal figured out that 2,500 spindles are not enough and the mill needs looms too. When the spindle count was increased to 10,000 and 100 looms were added, the divided reached a respectable nine percent.

Ranchhodlal also did significant contribution to building infrastructure in city when he was the President of Adhmedabad municipality. This is how Florence Nightingale praised him, “Ahmedabad is working splendidly at water supply and sewerage under its native president Mr Ranchhodlal Chhotalal... we hope the good example will be followed by other cities.”

Source: Memoirs of Rao Bahadur Ranchhodlal Chhotalal by S. M. Edwardes and Concise Oxford history of Indian business by Dwijendra Tripathi and Jyoti Jumani