The Black Swan and You

Posted by Pelle July 9th, 2008 5 comments edit

By now many people have heard of Nassim Taleb’s amazing book Black Swan. This book has completely changed the way I think about the world as a whole and startups in particular.

I really recommend you read the book as I can’t possibly do it justice myself. However I will give a brief overview here. Hopefully in later posts I will go on about how this all applies to startups and technology.

The Black Swan itself signifies the highly improbable. Until one was discovered in Australia, Europe thought the idea of a black swan as being impossible. See Nassim’s own video explanation here. Anyway Nassim uses the term Black Swan as meaning a highly improbable event.

The importance of these highly improbable events are that it is very hard to properly analyze and plan anything as just about any major change (both good and bad) come through Black Swans.

Analysis or just telling stories?

No one in 1999 would have thought Google would rule the world. The tech world is filled with examples. But we are also very good at following what Nassim calls the narrative fallacy. It is very easy when we look back at previous Black Swan’s and over analyze them, building up stories on why this company succeeded or this company failed.

The tech startup blogosphere is particularly guilty of this. So many bits have been filled by bloggers (including me) writing “how to guides” filled with expert hindsight advice.

We never have enough data so we make up what’s missing

The whole key to this is understanding that there is really very little you can do to analyze your way to the truth. All important events a pretty much improbable and so unlikely that the only way you could use traditional forecasting models would be if you had all the data about everything at a pretty much infinite level of precision. This is because even small errors in data cause huge swings in the outcome of results.

He believes that intuition and blind belief can sometimes lead to less risky results than putting all your faith in scientific analysis and modelling. A great example he gives is that even a few hundred years ago, you would probably have a higher survival rate going to church to pray than going to one of the doctors at the time. The doctor’s while highly intelligent people just plainly didn’t know enough yet to safely perform their operations.

You living in Extremistan or Mediocristan?

There are areas where there is enough data to analyze things and succeed. The only problem is that it’s not normally possible to succeed in the world changing way this way. Nassim calls this kind of world Mediocristan.

Mediocristan is the world that most of us have been brought up to live in. It’s the safe place without much risk. Get good grades, go to a good university and work your way up through a series of permanent jobs. This way you can theoretically be pretty sure that you will end up comfortably well off.

Most of us entrepreneurs are bored of that world and aim for bigger things in life. So do actors, writers, ball players and many other types of careers. This is where you really work your ass of with very little chance of winning. All of us entrepreneurs are pretty much here in Extremistan.

Now it is cool that there is a Mediocristan and all and it can provide us with a pretty good living and not too much stress. The only thing about it is that Mediocristan while not really exposed to too much in the way of Positive Black Swans, it is still pretty highly exposed to a boat load of Negative Black Swans.

Most people living in Mediocristan don’t like thinking about the bad things that could happen, but really if there is something history (including very recent history) has shown us that the safe cushy jobs are unfortunately not safe. The whole cushy world built up in the industrialized west in the post world war 2 world is really extremely fragile and cracking big time.

Surviving in Extremistan

At first reading of Nassim, it’s very easy to think shit, is there nothing we can do to intelligently attack the world of Extremistan?

There are various things you can do. The first is to realize that if you succeed, it’s probably not exclusively due to your brilliant mind. More than anything else it is luck. You still need a brilliant mind of course to help guide you at every step, just don’t pretend that it alone will get you where you want to be.

Managing your risk is vital. This means exposing your self to as many possible good black swan’s as possible while protecting yourself against bad swans. That may seem like simple advice and it is, but the reality is probably harder than you think.

Extremistan Valley

VC’s expose themselves to many risky investments, where each of them have a defined cost to them if they fail. On the other side there is a pretty much limitless upside if one of these investments take off.

Paul Graham is a master of this from the investment side with his YCombinator. He is making a large amount of very small investments each with an extremely risky yet potentially huge return. YCombinator as an organization is spent trying to push the success of the group as a whole. Genius.

Yahoo followed the late 90s common sense approach of wanting to be the portal for everyone. This means there was a definite potential of success, however as all aspects of their business were/are so tightly knit together that every aspect of their business was really tied to every other aspect being successful. When Google hit them in the head as a Black Swan, they really have been stumbling due probably to this. Their properties that stray most from the mold (as they were created outside) such as Flickr are probably some of the ones that are most likely to succeed in the Google era.

What about Google? Google was itself a huge Black Swan. They were extremely successful and managed to use their smarts (See it is still useful) to monetize it. What about the rest of their businesses. I’m not really sure which other parts are successful and which ones aren’t. They could probably continue as a successful business just doing search and advertising until a new Black Swan hits them. However their strategy of 20% time is probably a way more important way of exposing them selves to near unlimited upside while only risking the 20% of their employees salary in this.

Extremistan and You

What about small startups, independent coders etc. The same raw advice about creating lots of positive exposure while limiting negative risk holds true. It is however very different if you aren’t already independently wealthy.

Swan eggs

One way you could do it is to focus on building a portfolio of small apps, essentially creating a sweat venture portfolio yourself. (Thats also why I my personal holding company is called Stake Ventures).

Rails and similar frameworks have lowered the downside risk (or upfront costs) while new platforms such as FaceBook is improving the upside risk for small micro applications. The combination of this doesn’t necessarily mean you’re going to win, but at least you are hatching more than one egg at a time.

Bootstrapping is definitely a bonus as it gives you flexibility. The minute you bring investors into it you may be forced to keep going down one track. Founder vesting is there to lower the downside risk of investors but heightens your own downside risk.

That said, the money that venture or angel capital can give you may be what you need to keep experimenting. Remember there isn’t a magic formula. Just always keep thinking about maximizing positive risk and lowering negative risk.

Getting your app out there exposes it to upside risk. Spending way too much time on features etc means you are increasing downside risk while not adding much in the way of upside risk. I’ve have been guilty of this myself on many occasions.

Once you see that one of your apps is starting to take off, you could start going down the path of finding funding to build on that momentum.

Conclusion

The Black Swan has forced me to rethink lots of things I have helt sacred for years. There is honestly a bit of a dilema in Nassim’s premise, which I’m sure he already knows about. If we aren’t to listen to experts, why should we listen to him. But I guess it comes down to faith in the end.

I know Nassim has been pretty good at answering critiques and highlighting misunderstandings around the web, so I’d love for him to comment himself if I’ve misunderstood things.

Posted July 9th, 2008 under:
Comments
typo July 9th, 2008 destroy

There are areas were there is enough data to analyze things and succeed.

There are areas where there is enough data to analyze things and succeed.

pelleb@gmail.com
Pelle July 9th, 2008 destroy

Thanks. Fixed it.

paras1987@gmail.com
Paras Chopra July 10th, 2008 destroy

If you remember, Nasim recommends living in mediocristan, not extrimistan. From what I deduce, he would seldom encourage someone to startup his company. :)

pelle@stakeventures.com
Pelle July 10th, 2008 destroy

While he says Mediocristan is the preferred if possible, he also says that it is generally an illusion.

He keeps talking about all the failed entrepreneurs as well as actors and writers working in coffee shops. Then its filled with tips on how to accept and manage the risk.

He himself as an options trader and author is not exactly living in mediocristan.

stake@will-k.com
Will Kamishlian July 18th, 2008 destroy

Good write up, Pelle. The options background and possibly some Hegel are apparent in Nassim’s work. Perhaps to oversimplify, it seems to me that a net effect of Nassim’s strategy is to look forward while seeding yourself to take advantage of what comes. If I’ve got this a bit right, I know some people who can look forward and some who can seed themselves but few who can do both.

I’ve always said that I’d rather be lucky than good; however, I’m also fond of saying luck favors the good. In some strange way, I think both are true.