Category: Decision Making

Luck Meets Perseverance: The Creation of IBM’s Competitive Advantage

Reading Time: 8 minutes

On Monday October 28, 1929, the stock market took one of the worst single-day tumbles anyone alive might have seen, with the Dow Jones averages falling about 13%. The next day, October 29th, the market dropped yet again, a decline of 12%. By the end of the year, the Dow Jones average was down more than 45% from its high of 381. Market historians are familiar with the rest of the story: The sickening slide would not stop at 45%, but continue until 1932 to reach a low of 41 on the Dow, a decline of about 90% from peak to trough.

American business was in a major Depression. But at least one businessman would decide that, like General Erwin Rommel would say years later, the path was not out, but through.

***

International Business Machines, better known as IBM, was created from the ashes of the Computing-Tabulating-Recording Company (C-T-R) in 1917 by Thomas J. Watson, who’d learned his business skills at the National Cash Register Company (NCR). Before Watson’s reorganization of C-T-R, the company was basically in three businesses: computing scales (to weigh and compute the cost of a product being weighed), time clocks (to calculate and record wages), and tabulating machines (which used punch cards to add up figures and sort them). Watson’s first act of genius was to recognize that the future of IBM was not going to be time cards or scales, but in helping businesses do their work more effectively and with a lot less labor. He set out to do just that with his tabulating machines.

The problem was, IBM’s products weren’t yet all that different from its competitors’, and the company was small. IBM’s main tabulating product was the Hollerith machine, created by Herman Hollerith in Washington D.C. in 1890 to improve the Census tabulating process, of all things. (It sounds mundane, but he saved the government $5 million and did the work in about 1/8th of the time.) By the late 1910s, the Hollerith machine had a major competitor in the Powers Accounting Company, which had a similar product that was easier to use and more advanced than the Hollerith.

Hollerith_Punched_Card
Hollerith Punch Card

 

HollerithMachine.CHM
Hollerith Machine

 

Watson knew he had to push the research and development of his best product, and he did, hiring bright engineers like Fred Carroll from NCR, who would go on to be known for his Carroll Press, which allowed IBM to mass-produce the punch cards which did the “tabulating” in the pre-electronic days. By the mid-1920s, IBM had the lead. The plan was set in late 1927.

Watson then pointed to where he wanted IBM to go. ”There isn’t any limit for the tabulating business for many years to come,” he said. “We have just scratched the surface in this division. I expect the bulk of increased business to come from the tabulating end, because the potentialities are greater, and we have done so little in the way of developing our machines in this field.”

Underneath that statement lay a number of reasons—other than the thrill of new technology—why Watson zeroed in on the punch card business. When seen together, the reasons clicked like a formula for total domination. IBM would never be able to make sure it was the world leader in scales or time clocks, but it could be certain that it was the absolute lord of data processing.

[…]

Watson had no epiphanies. No voice spoke to him about the future of data processing. He didn’t have a grand vision for turning IBM into a punch card company. He got there little by little, one observation after another, over a period of 10 to 12 years.

(Source: The Maverick and his Machine)

Watson’s logical, one-foot-at-a-time approach was reminiscent of Sir William Osler’s dictum: Our main business is not to see what lies dimly at a distance, but to do what lies clearly at hand. And with a strategy of patenting its proprietary punch-cards, making them exclusively usable with IBM tabulators and sorters, IBM was one of the market darlings in the lead-up to 1929. Between 1927 and 1929 alone, IBM rose about four-fold on the back of 20-30% annual growth in its profits.

But it was still a small company with a lot of competition, and the punch card system was notoriously unreliable at times. He had a great system to hook in his customers, but the data processing market was still young — many businesses wouldn’t adopt it. And then came the fall.

***

As the stock market dropped by the day and the Depression got on, the economy itself began to shrink in 1930. GDP went down 8% that year, and then another 7% the following year. Thousands of banks failed and unemployment would eventually test 30%, a figure that itself was misleading; the modern concept of “underemployment” hadn’t been codified, but if it had, it probably would have dwarfed 30%. An architect working as a lowly draftsman had a job, but he’d still fallen on hard times. Everyone had.

Tom Watson’s people wondered what was to become of IBM. If businesses didn’t have money, how could they purchase tabulators and punch cards? Even if it would save them money in the long run, too many businesses had cut their capital spending to the bone. The market for office spending was down 50% in 1930.

Watson’s response was to push. Hard. So hard that he’d take IBM right up to the brink.

IBM could beat the Depression, Watson believed. He reasoned that only 5 percent of business accounting functions were mechanized, leaving a huge market untapped. Surely there was room to keep selling machines, even in difficult times. Watson also reasoned that the need for IBM machines was so great, if businesses put off buying them now, certainly they’d buy them later, when the economy picked up. His logic told him that the pent-up demand would explode when companies decided to buy again. He wanted IBM to be ready to take advantage of that demand.

He’d keep the factories building machines and parts, stockpiling the products in warehouses. In fact, between 1929 and 1932, he increased IBM’s production capacity by one-third.

Watson’s greatest risk was running out of time. If IBM’s revenue dropped off or flattened because of the Depression, the company would still have enough money to keep operating for two years, maybe three. If IBM’s revenue continued to falter past 1933, the burden of running the factories and inventory would threaten IBM’s financial stability.

[…]

Watson’s logic led him to make what looked to outsiders like another insane wager. On January 12, 1932, Watson announced that IBM would spend $1 million—nearly 6 percent of its total annual revenue— to build one of the first corporate research labs. The colonial-style brick structure in Endicott would house all of IBM’s inventors and engineers. Watson played up the symbolism for all it was worth. He would create instead of destroy, despite the economic plague.

(Source: The Maverick and his Machine)

Most companies pulled back, and for good reason. Demand was rapidly shrinking, and IBM’s decision to spend money expanding productive capacity, research, and employment would be suicide if demand didn’t return soon. All of that unused capacity was costly and would go to waste. Watson took an enormous risk, but he also had faith that the American economy would recover its dynamism. If it did, IBM would come out on the other side untouchable.

Somehow, Watson had to stimulate demand. He had to come up with products that companies couldn’t resist, whatever the economic conditions. Again, thanks to Charles Kettering’s influence, Watson believed that R&D would drive sales. (ed: Kettering was chief engineer at General Motors.) So Watson decided to build a lab, pull engineers together, and get them charged up to push the technology forward.

Throughout the 1930s, IBM cranked out new products and innovation, finally getting its technology ahead of Remington Rand or any other potential competitors.

[…]

Within a few years, Watson’s gamble of manufacturing looked disastrous. As IBM pumped increasing amounts of money into operations and growth, revenue from 1929 to 1934 stalled, wavering between $17 million and $19 million a year. IBM edged toward insolvency. In 1932, IBM’s stock price fell to 1921 levels and stayed there—11 years of gains wiped out.

(Source: The Maverick and his Machine)

By 1935, IBM was still stagnating. Watson made the smart move to get out of the money-losing scale business and use the money to keep the remaining businesses afloat, but he was drowning in excess capacity, inventions be damned.

Then IBM got a stroke of luck that it would ride for almost 50 years.

After all of his pushing and all of his investment, after the impossible decision to push IBM to the brink, Tom Watson was rewarded with The Social Security Act of 1935, part of FDR’s New Deal. It was perfect.

No single flourish of a pen had ever created such a gigantic information processing problem. The act established Social Security in America—a national insurance system that required workers to pay into a fund while employed so they could draw payments out of it once they retired, or if a wage-earning spouse died. To make the system work, every business had to track every employee’s hours, wages, and the amount that must be paid to Social Security. The business then had to put those figures in a form that could be reported to the federal government. Then the government had to process all those millions of reports, track the money, and send checks to those who should get them.

Overnight, demand for accounting machines soared. Every business that had them needed them more. An officer for the store chain Woolworth told IBM that keeping records for Social Security was going to cost the company $250,000 a year. Businesses that didn’t have the machines wanted them. The government needed them by the boatload.

Only one company could meet the demand: IBM. It had warehouses full of machines and parts and accessories, and it could immediately make more because its factories were running, finely tuned, and fully staffed. Moreover, IBM had been funding research and introducing new products, so it had better, faster, more reliable machines than Remington Rand or any other company. IBM won the contract to do all of the New Deal’s accounting—the biggest project to date to automate the government…

This period of time became IBM’s slingshot. Revenue jumped from $19 million in 1934 to $21 million in 1935. From there it kept going up: $25 million in 1936, $31 million in 1937. It would climb unabated for the next 45 years. From that moment until the 1980s, IBM would utterly dominate the data processing industry—a record of leadership that was unmatched by any industrial company in history.

(Source: The Maverick and his Machine)

By combining aggressive opportunism and a great deal of luck, IBM was forged in the depths of the Great Depression. Like John D. Rockefeller before him, who bought up refineries during periods of depression in the oil industry, and Warren Buffett after him, who scooped up loads of cheap stocks when the stock market was crumbling in the 1970s, Watson decided that pushing ahead was the only way out.

History certainly didn’t have to go his way — FDR might not have been elected or might not have been able to enact Social Security. Even if he’d done it two years later, IBM still might never have made it.

But Watson’s courage and leadership did open the possibility of serendipitous fortune for IBM if the world didn’t end. Like oxygen combining with fuel to create internal combustion, those elements forged a monstrous competitive advantage when the match was finally lit.

Still Interested? Check out the excellent The Maverick and his Machine by Kevin Maney, where the excerpts above come from.

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Roger Fisher on a Better Way to Negotiate, Part 2

Reading Time: 8 minutes

In Part 1 of our series on the best-selling negotiation book Getting to Yes, we covered Roger Fisher’s four-part framework on Principled Negotiation — his “way out” of highly contentious negotiation. To review, the four parts were as follows:

  1. Separate the People from the Problem
  2. Focus on Interests, Not Positions
  3. Invent Options for Mutual Gain
  4. Insist on Objective Criteria

Habitual use of these four criteria is a way to build, or at least not destroy, win-win relationships in the process of negotiation. The truth is we all must negotiate from time to time. Refusing to negotiate is a strategy in and of itself — and usually a pretty bad one relative to the alternatives.

Fisher’s framework brings up some obvious follow-on questions: What if the other side is more powerful? What if they refuse to play by your rules? What if they play dirty?

Let’s check out a few.

(Don’t want to read online? Purchase a sexy PDF of the two-part series for only $3.99.)

Negotiate Fairly

What if they are more Powerful?

We’re all afraid of being taken advantage of in a negotiation. Our tendency to demand fairness is a big part of it, as is our tendency to try to minimize future regret. In a negotiation with a more “powerful” part, it would seem at times like our only play is to make a stand — demand that they meet us or we will not negotiate. That turns out to be a bad play sometimes, and completely unnecessary at other times.

To combat this, Roger Fisher introduced a concept that a lot of people know the name of but not how to use: the Best Alternative to a Negotiated Agreement. He addresses the basic problem of powerlessness first:

In response to power, the most any method of negotiation can do is to meet two objectives: first, to protect you against making an agreement you should reject and second, to help you make the most of the assets you do have so that any agreement you reach will satisfy your interest as well as possible.

The common tactics are to either cave very easily, thus ending the negotiation and any possible bitterness, or to set a “bottom line” and walk away if it’s not met. They’re both weak responses: The “softie” tactic almost assures you’ll take a deal that’s not in your best interest, while the “bottom line” mentality makes you rigid, unable to learn and adapt during the negotiation process and probably too focused on one single variable at the expense of other ones. (Lack of creativity.)

The better approach to understand your BATNA – Best Alternative to a Negotiated Agreement. It’s simple to understand in the context of a job offer negotiation: If you lose this negotiation, what alternatives do you have? If you set your “bottom line” too high and you lose, are you on the street? Or, do you have a great second or third option to go to?

While the BATNA acronym is useful and explanatory, it’s really just a dressed-up version of the elementary concept we call opportunity cost, which is constantly at play in life. Realizing that opportunity cost is a “superpower” in negotiation, we can derive the following:

  1. He with the best opportunity cost holds the power. Let’s say you’re negotiating with a large car dealership over the price of a new sedan. Who holds the power? On the surface it might look like the dealer does, given their stature in power. But if you have three dealerships in a 30-mile radius which can sell you the same car, the power is yours, not the dealer’s. When you enter into negotiation, you can almost always afford to lose and go down the street to another dealership, find a different type of car to buy, change your mind and go used, or even keep your current car longer. (That’s one reason why the car business is such a tough one.) Point being, size does not = power. Opportunity cost = power.
  2. Developing alternative opportunities is the way to gain power. If you’re afraid you’re entering into a job negotiation with no power, your best bet probably isn’t to play hardball, it’s to develop other job offers, or even figure out if you can afford to start your own business. Once you can afford to walk away, the power shifts at least slightly. Raise your opportunity cost bar to shift the odds and make the negotiation a little more fair.
  3. Think about their opportunity cost as much as your own. Can they afford to lose? If not, you probably have more power than you think.
  4. If they win the opportunity cost battle, argue on merit. Roger Fisher makes this final point well: To the extent that they have muscle and you have principle, the larger a role you can establish for principle, the better off you are. If your opportunity costs are weak, you must resort to making it clear that the house is objectively worth X, that you deserve to be paid Y, or that a drawn-out fight will only ruin your relationship. This goes back to insisting on objective criteria.

What if they Won’t Play?

A problem arises if you aren’t successful in shifting the negotiation to objective criteria or creating win-wins. Sometimes the other side simply takes a position and stubbornly (often irrationally) holds their ground. What then? There are two approaches.

The first tactic Fisher argues for is Negotiation Jujitsu. In other words, using their own forcefulness against them. Not playing their game. It’s nuanced and we won’t try to cover it all here — the book does it well. But the salient point is that you can’t react emotionally to forceful negotiation. Let them criticize, let them attack if they must. But your job is to keep asking objective questions. “You say you won’t accept less than $2,000 — where do you get that figure from? What makes you say that this is a fair number?” Keep things in the realm of objectivity and don’t get them further entrenched by “attacking back.”

Another part of the jujitsu is to explain to them the consequences of adopting an extreme position. Ask them, hypothetically, what would happen if things went the way they preferred. Fisher gives the example of an Arab-Israeli negotiation where an American was able to get the Arab contingent to understand that if the Israelis gave in entirely, their people would castigate them back home. It was enough to end that line of negotiation.

The last jujitsu tactic is to take criticism unusually well — not allowing the discussion to get personal, even if the other side wants to make it so. I understand you don’t want to be taken advantage of, neither do I — can you explain how your proposal is fair to me as well as you? Can you explain how my position could be altered to be more fair? What would you do if you were in my position? Soliciting an adversary for advice can be disarming if used wisely. All it takes is tamping down your ego. Good lines of inquiry don’t criticize, they probe and try to be helpful. And when you do so, simply pausing and letting the other side talk themselves into or out of a corner can work as well. Use silence to your advantage if you’re making sense and they’re reacting emotionally.

***

The second approach is to use a third-party to mediate. Have them draft up a solution as impartially as possible, with both parties giving input, and the final decision being a mere “yes” or “no” by each party. This can simplify and de-personalize the process.

If you cannot change the process to one of seeking a solution on its merits, perhaps a third party can. More easily than one of those directly involved, a mediator can separate the people from the problem and direct the discussion to interests and options. Further, he or she can often suggest some impartial basis for resolving differences. A third party can also separate inventing from decision-making, reduce the number of decisions required to reach agreement, and help the sprites know what they will get when they do decide. One process designed to enable a third party to do all this is known as the one-text procedure.

The essence of that procedure is to have a draft drawn up that best satisfies both sides impartially and without pre-commitment. The final decision for each party is a simple “yes” or “no” to the draft solution. You can do it yourself, asking for opinions and revisions as you go along, or have a third party take it on. In either case, you’re trying to change the game rather than fight a losing battle.

What if they Play Dirty?

A tricky tactic is defined as one that fails the test of reciprocity — they are designed to benefit one side only, and most often, the other side is not supposed to know they’re being used . Some of the most common dirty tactics include: Using phony facts, introducing phony authority, hiding dubious intentions, psychological manipulation, refusal to negotiate, and good-cop, bad-cop type routines. There are too many to enumerate, but the basic answer to all of them will be to refer back to the four central ideas of principle negotiation. You need to point out and negotiate the rules of the game itself when you suspect you’re becoming a victim of “tricky tactics” which you’re not supposed to know about.

There are three steps in negotiating the rules of the negotiating game where the other side seems to be using a tricky tactic: recognize the tactic, raise the issue explicitly, and question the tactics’s legitimacy and desirability — negotiate over it.

You have to know what is going on to be able to do something about it. Learn to spot particular ploys that indicate deception, those designed to make you uncomfortable, and those which lock the other side into their position. Often just recognizing a tactic will neutralize it. Realizing, for example, that the other side is attacking you personally in order to impair your judgment may well frustrate the effort.

The book has some great examples of dirty tactics in play, which are good to refer to. Another book to pick up some of these ploys is Cialdini’s Influence, one of the great books written to protect people against manipulation. However you learn them, it’s good to learn them well. Once you can see that it’s happening, you need to gently, non-threateningly, point out what’s going on and ask to return to principles, or to excuse yourself momentarily. These things serve to defuse an embarrassing situation. And never forget that the best defense in most cases is a worthy set of alternative opportunities, what Fisher calls the BATNA. These give you the ability to walk away if you feel yourself being manipulated with no recourse.

***

Negotiating is difficult. It’s a part of life that some people enjoy and some do not, leading to outcomes in the vein of the old saying Don’t ever wrestle with a pig — you’ll both get dirty but the pig will like it. Strong-willed negotiators have a natural advantage over those of us more averse to confrontation, and yet if we push back, stalemate is a usual result. Adopting the Principled Negotiation approach, rooted deeply in human nature, seems to give us the best chance of getting fair results for all involved.

Still Interested? Check out Fisher’s bestselling book, read Part 1 of our two-part series, or check out our post on Fisher’s approach to giving better feedback in the workplace.

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Elon Musk on Regulators

Reading Time: 1 minute

The Federal Aviation Administration had a meeting with Elon Musk they won’t forget. Musk met with them to discuss some approvals for the work one of his companies, SpaceX, was doing. The meeting reads like an episode of Dilbert. The FAA responded in the type of double-speak that only governments seem to master. So what did he do? He told one of the experts they were wrong.

“His manager sent me this long email about how he had been in the shuttle program and in charge of 20 launches or something like that and how dare I say that the other guy was wrong,” Musk says in Ashlee Vance’s book Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic Future.

“Not only is he wrong,” Musk says, “let me rearticulate the reasons. We’re trying to have a really big impact in the space industry. If the rules are such that you can’t make progress, then you have to fight the rules.”

And then he nails the fundamental problem with regulators.

There is a fundamental problem with regulators. If a regulator agrees to change a rule and something bad happens, they can easily lose their career. Whereas if they change a rule and something good happens, they don’t even get a reward. So, it’s very asymmetric. It’s then very easy to understand why regulators resist changing the rules. It’s because there’s a big punishment on one side and no reward on the other. How would any rational person behave in such a scenario?

The asymmetry he’s talking about is loss aversion. And it doesn’t stop at regulators, it extends into other areas as well. The same principle applies to most CEOs, managers and leaders. If you want to predict behavior, take a close look at the incentives.

As Keynes said: “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

 

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Three Filters Needed to Think Through Problems

Reading Time: 7 minutes

One of the best parts of Garrett Hardin‘s wonderful Filters Against Folly is when he explores the three filters that help us interpret reality. No matter how much we’d like it to, the world does not only operate in our circle of competence. Thus we must learn ways to distinguish reality in areas where we lack even so much as a map.

“Most geniuses—especially those who lead others—prosper not by deconstructing intricate complexities but by exploiting unrecognized simplicities.”

— Andy Benoit

Mental Tools

We need not be a genius in every area but we should understand the big ideas of most disciplines and try to avoid fooling ourselves. That’s the core to the mental models approach. When you’re not an expert in a field, often the best approach is one that avoids stupidity. There are few better ways of avoiding stupidity than understanding how the world works.

Hardin begins by outlining his goal: to understand reality and understand human nature as it really is, removing premature judgment from the analysis.

He appropriately quotes Spinoza, who laid out his principles for political science thusly:

That I might investigate the subject matter of this science with the same freedom of spirit we generally use in mathematics, I have labored carefully not to mock, lament, or execrate human actions, but to understand them; and to this end I have looked upon passions such as love, hatred, anger, envy, ambition, pity, and other perturbations of the mind, not in the light of vices of human nature, but as properties just as pertinent to it as are heat, cold, storm, thunder, and the like to the nature of the atmosphere.

The goal of these mental filters, then, is to understand reality by improving our ability to judge the statements of experts, promoters, and persuaders of all kinds. As the saying goes, we are all laymen in some field.

Hardin writes:

What follows is one man’s attempt to show that there is more wisdom among the laity than is generally concluded, and that there are some rather simple methods of checking on the validity of the statements of experts.

1. The Literate Filter

The first filter through which we must interpret reality, says Hardin, is the literate filter: What do the words really mean? The key to remember is that Language is action. Language is not just a way to communicate or interpret; language acts as a call to, or just as importantly, an inhibitor to action.

The first step is to try to understand what is really being said. What do the words and the labels actually mean? If a politician proposes a “Poverty Assistance Plan,” that sounds almost inarguably good, no? Many a pork-barrel program has passed based on such labels alone.

But when you examine the rhetoric, you must ask what those words are trying to do: Promote understanding, or inhibit it? If the program had a rational method of assistance to the deserving poor, the label might be appropriate. If it was simply a way to reward undeserving people in his or her district for their vote, the label might be simply a way to fool. The literate filter asks if we understand the true intent behind the words.

In a chapter called “The Sins of the Literate,” Hardin discusses the misuse of language by examining literate, but innumerate, concepts like “indefinite” or “infinite”:

He who introduces the words “infinity” or any of its derivatives (“forever” or “never” for instance) is also trying to escape discussion. Unfortunately he does not honestly admit the operational meaning of the high-flown language used to close off discussion. “Non-negotiable” is a dated term, no longer in common use, but “infinity” endures forever.

Like old man Proteus of Greek mythology, the wish to escape debate disguises itself under a multitude of verbal forms: infinity, non-negotiable, never, forever, irresistible, immovable, indubitable, and the recent variant “not meaningfully finite.” All these words have the effect of moving discussion out of the numerate realm, where it belongs, and into a wasteland of pure literacy, where counting and measuring are repudiated.

Later, in the final chapter, Hardin repeats:

The talent for handling words is called “eloquence.” Talent is always desirable, but the talent may have an unfair, even dangerous, advantage over those with less talent. More than a century ago Ralph Waldo Emerson said, “The curse of this country is eloquent men.” The curse can be minimized by using words themselves to point out the danger of words. One of their functions is to act as inhibitors of thought. People need to be made allergic to such thought-stoppers as infinity, sacred, and absolute. The real world is a world of quantified entities: “infinity” and its like are no words for quantities but utterances used to divert attention from quantities and limits.

It is not just innumerate exaggeration we are guarding against, but the literate tendency to replace actors with abstractions, as Hardin calls it. He uses the example of donating money to a poor country (Country X), which on its face sounds noble:

Country X, which is an abstraction, cannot act. Those who act in its name are rich and powerful people. Human nature being what it is, we can be sure that these people will not voluntarily do anything to diminish either their power or their riches…

Not uncommonly, the major part of large quantities of food sent in haste to a poor country in the tropics rot on the docks or is eaten up by rats before it can be moved to the people who need it. The wastage is seldom adequately reported back to the sending country…(remember), those who gain personally from the shipping of food to poor nations gain whether fungi, rats, or people eat the food.

2. The Numerate Filter

Hardin is clear on his approach to numerical fluency: The ability to count, weigh, and compare values in a general or specific way is essential to understanding the claims of experts or assessing any problem rationally:

The numerate temperament is one that habitually looks for approximate dimensions, ratios, proportions, and rates of change in trying to grasp what is going on in the wold. Given effective education–a rare commodity, of course–a numerate orientation is probably within the reach of most people.

[…]

Just as “literacy” is used here to mean more than merely reading and writing, so also will “numeracy” be used to mean more than measuring and counting. Examination of the origins of the sciences shows that many major discoveries were made with very little measuring and counting. The attitude science requires of its practitioners is respect, bordering on reverence, for ration, proportions, and rates of change.

Rough and ready back-of-the-envelope calculations are often sufficient to reveal the outline of a new and important scientific discovery….In truth, the essence of many of the major insights of science can be grasped with no more than child’s ability to measure, count, and calculate.

***

To explain the use of the literate and numerate filters together, Hardin uses the example of the Delaney Amendment, passed in 1958 to restrict food additives. This example should be familiar to us today:

Concerned with the growing evidence that many otherwise useful substances can cause cancer, Congress degreed that henceforth, whenever a chemical at any concentration was found to cause cancer–in any fraction of any species of animal–that substance must be totally banned as an additive to human food.

From a literate standpoint, this sounds logical. The Amendment sought to eradicate harmful food additives that the free market had allowed to surface. However, says Hardin:

The Delaney Amendment is a monument to innumerate thought. “Safe” and “unsafe” are literate distinctions; nature is numerate. Everything is dangerous at some level. Even molecular oxygen, essential to human life, becomes lethal as the concentration approaches 100 percent.

[…]

Sensitivity is ordinarily expressed as “1 part per X,” where X is a large number. If a substance probably increases the incidence of cancer at a concentration of 1 part per 10,000, one should probably ban it at that concentration in food, and perhaps at 1 in 100,000. But what about 1 part per million?…In theory there is no final limit to sensitivity. What about 1 milligram per tank car? Or 1 milligram per terrestrial globe?

Obviously, some numerical limits must be applied. This is the usefulness of the numerate filter. As Charlie Munger says, “Quantify, always quantify.”

3. The Ecolacy Filter

Hardin introduces his final filter by requiring that we ask the question “And then what?”  There is perhaps no better question to prompt second-order thinking.

Even if we understand what is truly being said and have quantified the effects of a proposed policy or solution, it is imperative that we consider the second layer of effects or beyond. Hardin recognizes that this opens the door for potentially unlimited paralysis (the poorly understood and innumerate Butterfly Effect), which he boxes in by introducing his own version of the First Law of Ecology:

We can never merely do one thing.

This is to say, all proposed solutions and interventions will have a multitude of effects, and we must try our best to consider them in their totality. Most unintended consequences are just unanticipated consequences.

In proposing this filter, Hardin is very careful to guard against the Slippery Slope argument or the idea that one step in the wrong direction will lead us directly to Hell. This, he says, is a purely literate but wholly innumerate approach to thinking.

Those who take the wedge (Slippery Slope) argument with the utmost seriousness act as though they think human beings are completely devoid of practical judgment. Countless examples from everyday life show the pessimists are wrong…If we took the wedge argument seriously, we would pass a law forbidding all vehicles to travel at any speed greater than zero. That would be an easy way out of the moral problem. But we pass no such law.

In reality, the ecolate filter helps us understand the layers of unintended consequences. Take inflation:

The consequences of hyperinflation beautifully illustrate the meaning of the First Law of Ecology. A government that is unwilling or unable to stop the escalation of inflation does more than merely change the price of things; it turns loose a cascade of consequences the effects of which reach far into the future.

Prudent citizens who have saved their money in bank accounts and government bonds are ruined. In times of inflation people spend wildly with little care for value, because the choice and price of an object are less important than that one put his money into material things. Fatalism takes over as society sinks down into a culture of poverty….

***

In the end, the filters must be used wisely together. They are ways to understand reality, and cannot be divorced from one another. Hardin’s general approach to thinking sums up much like his multi-disciplinary friend Munger’s:

No single filter is sufficient for reaching a reliable decision, so invidious comparisons between the three is not called for. The well-educated person uses all of them.

Check out our prior posts about Filters Against Folly:

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Biases and Blunders

Reading Time: 8 minutes

Nudge: Improving Decisions About Health, Wealth, and Happiness

You would be hard pressed to come across a reading list on behavioral economics that doesn’t mention Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard Thaler and Cass Sunstein.

It is a fascinating look at how we can create environments or ‘choice architecture’ to help people make better decisions. But one of the reasons it’s been so influential is because it helps us understand why people sometimes make bad decisions in the first place. If we really want to understand how we can nudge people into making better choices, it’s important to understand why they often make such poor ones.

Let’s take a look at how Thaler and Sunstein explain some of our common mistakes in a chapter aptly called ‘Biases and Blunders.’

Anchoring and Adjustment

Humans have a tendency to put too much emphasis on one piece of information when making decisions. When we overweigh one piece of information and make assumptions based on it, we call that an anchor. Say I borrow a 400-page-book from a friend and I think to myself, the last book I read was about 300 pages and I read it in 5 days so I’ll let my friend know I’ll have her book back to her in 7 days. Problem is, I’ve only compared one factor related to me reading books and now I’ve made a decision without taking into account many other factors which could affect the outcome. For example, is the new book a topic I will digest at the same rate? Will I have the same time over those 7 days for reading? I have looked at number of pages but are the number of words per page similar?

As Thaler and Sunstein explain:

This process is called ‘anchoring and adjustment.’ You start with some anchor, the number you know, and adjust in the direction you think is appropriate. So far, so good. The bias occurs because the adjustments are typically insufficient.

Availability Heuristic

This is the tendency of our mind to overweigh information that is recent and readily available. What did you think about the last time you read about a plane crash? Did you start thinking about you being in a plane crash? Imagine how much it would weigh on your mind if you were set to fly the next day.

We assess the likelihood of risks by asking how readily examples come to mind. If people can easily think of relevant examples, they are far more likely to be frightened and concerned than if they cannot.

Accessibility and salience are closely related to availability, and they are important as well. If you have personally experienced a serious earthquake, you’re more likely to believe that an earthquake is likely than if you read about it in a weekly magazine. Thus, vivid and easily imagined causes of death (for example, tornadoes) often receive inflated estimates of probability, and less-vivid causes (for example, asthma attacks) receive low estimates, even if they occur with a far greater frequency (here, by a factor of twenty). Timing counts too: more recent events have a greater impact on our behavior, and on our fears, than earlier ones.

Representativeness Heuristic

Use of the representativeness heuristic can cause serious misperceptions of patterns in everyday life. When events are determined by chance, such as a sequence of coin tosses, people expect the resulting string of heads and tails to be representative of what they think of as random. Unfortunately, people do not have accurate perceptions of what random sequences look like. When they see the outcomes of random processes, they often detect patterns that they think have great meaning but in fact are just due to chance.

It would seem as though we have issues with randomness. Our brains automatically want to see patterns when none may exist. Try a coin toss experiment on yourself. Simply flip a coin and keep track if it’s heads or tails. At some point you will hit ‘a streak’ of either heads or tails and you will notice that you experience a sort of cognitive dissonance; you know that ‘a streak’ at some point is statistically probable but you can’t help but thinking the next toss has to break the streak because for some reason in your head it’s not right. That unwillingness to accept randomness, our need for a pattern, often clouds our judgement when making decisions.

Unrealistic Optimism

We have touched upon optimism bias in the past. Optimism truly is a double-edged sword. On one hand it is extremely important to be able to look past a bad moment and tell yourself that it will get better. Optimism is one of the great drivers of human progress.

On the other hand, if you never take those rose-coloured glasses off, you will make mistakes and take risks that could have been avoided. When assessing the possible negative outcomes associated with risky behaviour we often think ‘it won’t happen to me.’ This is a brain trick: We are often insensitive to the base rate.

Unrealistic optimism is a pervasive feature of human life; it characterizes most people in most social categories. When they overestimate their personal immunity from harm, people may fail to take sensible preventive steps. If people are running risks because of unrealistic optimism, they might be able to benefit from a nudge.

Loss Aversion

When they have to give something up, they are hurt more than they are pleased if they acquire the very same thing.

We are familiar with loss aversion in the context described above but Thaler and Sunstein take the concept a step further and explain how it plays a role in ‘default choices.’ Loss aversion can make us so fearful of making the wrong decision that we don’t make any decision. This explains why so many people settle for default options.

The combination of loss aversion with mindless choosing implies that if an option is designated as the ‘default,’ it will attract a large market share. Default options thus act as powerful nudges. In many contexts defaults have some extra nudging power because consumers may feel, rightly or wrongly, that default options come with an implicit endorsement from the default setter, be it the employer, government, or TV scheduler.

Of course, this is not the only reason default options are so popular. “Anchoring,” which we mentioned above, plays a role here. Our mind anchors immediately to the default option, especially in unfamiliar territory for us.

We also have the tendency towards inertia, given that mental effort is tantamount to physical effort – thinking hard requires physical resources. If we don’t know the difference between two 401(k) plans and they both seem similar, why expend the mental effort to switch away from the default investment option? You may not have that thought consciously; it often happens as a “click, whirr.”

State of Arousal

Our prefered definition requires recognizing that people’s state of arousal varies over time. To simplify things we will consider just the two endpoints: hot and cold. When Sally is very hungry and appetizing aromas are emanating from the kitchen, we can say she is in a hot state. When Sally is thinking abstractly on Tuesday about the right number of cashews she should consume before dinner on Saturday, she is in a cold state. We will call something ‘tempting’ if we consume more of it when hot than when cold. None of this means that decisions made in a cold state are always better. For example, sometimes we have to be in a hot state to overcome our fears about trying new things. Sometimes dessert really is delicious, and we do best to go for it. Sometimes it is best to fall in love. But it is clear that when we are in a hot state, we can often get into a lot of trouble.

For most of us, however, self-control issues arise because we underestimate the effect of arousal. This is something the behavioral economist George Loewenstein (1996) calls the ‘hot-cold empathy gap.’ When in a cold state, we do not appreciate how much our desires and our behavior reflects a certain naivete about the effects that context can have on choice.

The concept of arousal is analogous to mood. At the risk of stating the obvious, our mood can play a definitive role in our decision making. We all know it, but how many among us truly use that insight to make better decisions?

This is one reason we advocate decision journals when it comes to meaningful decisions (probably no need to log in your cashew calculations); a big part of tracking your decisions is your mood when you make them. A zillion contextual clues go into your state of arousal, but taking a quick pause to note which state you’re in as you make a decision can make a difference over time.

Mood is also affected by chemicals. This one may be familiar to you coffee (or tea) addicts out there. Do you recall the last time you felt terrible or uncertain about a decision when you were tired, only to feel confident and spunky about the same topic after a cup of java?

Or, how about alcohol? There’s a reason it’s called a “social lubricant” – our decision making changes when we’ve consumed enough of it.

Lastly, the connection between sleep and mood goes deep. Need we say more?

Peer Pressure

Peer pressure is another tricky nudge that can be both positive or negative. We can be nudged to make better decisions when we think that our peer group is doing the same. If we think our neighbors conserve more energy or recycle more, we start making a better effort to reduce our consumption and recycle. If we think the people around us are eating better and exercising more we tend to do the same. Information we get from peer groups can also help us make better decisions because of ‘collaborative filtering’; the choices of our peer groups help us filter out and narrow down our choices. If your friends who share similar views and tastes as you recommend book X, then you may like it as well. (Google, Amazon and Netflix are built on this principle).

However, if we are all reading the same book because we constantly see people with it, but none of us actually like it, then we all lose. We run off the mountain with the other lemmings.

Social influences come in two basic categories. The first involves information. If many people do something or think something, their actions and their thoughts convey information about what might be best for you to do or think. The second involves peer pressure. If you care about what other people think about you (perhaps in the mistaken belief that they are paying some attention to what you are doing), then you might go along with the crowd to avoid their wrath or curry their favor.

An important problem here is ‘pluralistic ignorance’ – that is, ignorance, on the part of all or most, about what other people think. We may follow a practice or a tradition not because we like it, or even think it defensible, but merely because we think that most other people like it. Many social practices persist for this reason, and a small shock, or nudge, can dislodge them.

How do we beat social influence? It’s very difficult, and not always desirable: If you are about to enter a building a lot of people are running away from, there’s a better than good chance you should too. But this useful instinct leads us awry.

A simple algorithm, when you feel yourself acting out of social proof, is to ask yourself: Would I still do this if everyone else was not?

***

For more, check out Nudge.

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How People Make Big Decisions

Reading Time: 4 minutes

We all go through psychological steps when we make big decisions. Some people call this the “existential cycle,” which really has four stages: doing, contemplating, preparing, and experimenting.

***

Echoing Tolstoy on regret avoidance, Sebastian Bailey and Octavius Black write in Mind Gym: Achieve More by Thinking Differently:

These four stages are much like exercises in risk management. No one wants to look back on his or her life at some point and say I wish I would have or If only I had.

While there are other ways, the existential cycle helps us make life changing decisions — like who to marry, where to work, and where to live.

The first stage, “doing,” is where you spend most of your life: It is your settled, equilibrium position. The doing may be all sorts of things— writing emails, riding horses, reading books, washing up, going to meetings, listening to lectures, cooking, dancing, running, sharing stories with friends, telling jokes, or making love. Of course, these are not done all at the same time (not unless you’re really talented). Whatever the activity may be, and however enjoyable or dull it is, you are doing it and it tends to keep you occupied.

Sometimes we get to “contemplating,” where we consider whether or how things would be different. What would life be like if you move to California? (Hint: It won’t make you happier.)

Then occasionally we move to “preparing.”

You search on the web for real estate agents in San Diego or Key West, find out what property prices are, check weather patterns, possibly even visit your preferred destination on your next vacation. You have moved beyond imagining how things could be different to investigating the practical options for how to make them different.

Finally you make the change.

You leave your job, buy a house, and move all your possessions. This stage is called “experimenting.” After you’ve settled in and started the beachside bar you’d dreamed about, this becomes your normal way of living, and you are once again in a state of doing.

The process isn’t overly complicated or hard. The challenge becomes moving through it at the right pace in a way that aligns with your principles.

How-People-Make-Big-Decisions

The Doing Magnet

As you travel around your cycle, you will have conversations with yourself that stop you from moving on to the next stage and instead take you back to doing.

Sometimes these thoughts can be very sensible and prevent you from wasting time or following the wrong path. But sometimes, unfortunately, they prevent you from both spotting and taking opportunities that could dramatically improve your life. The trick lies in recognizing the internal conversations and being able to make an informed decision about whether to listen to them or to ignore them and move on.

When the Doing Magnet is Weak

Irrational exuberance are those people who are forever saying things like I wish I hadn’t rushed into that or If only I’d thought about it first. Rather than never crossing the Rubicon, they’re happy to head over far too easily— without ever considering the size of the army on the other side. In terms of the existential cycle, their doing magnet is relatively weak— the centrifugal momentum of the next new thing is stronger than the gravitational force of the status quo.

If you find that you can’t hold down a job, you can’t keep a relationship, you spend money on a whim, or you haven’t gotten around to making your home into a place you like living in, and you regret it, then you may be suffering from a form of irrational exuberance. The best advice in this situation is this: spend longer at the preparing stage before wading across your Rubicon.

For example, consider one of these choices:

  • Think through all the possible disadvantages of taking this course of action as well as the advantages— really make an effort to present the case for caution on this occasion.

  • Contrast the allure of the new situation with how your existing life might improve even if you don’t make this big change. People who are always moving on to new jobs often fail to consider how their current jobs could get better. A new job may be attractive, but it is wrong to assume the old one will stay the same. New possibilities could open up. What happens when your boss moves on?

  • Contemplate the bigger and better gains and pleasures you could have if you didn’t always go for instant gratification. Could the gratification get more gratifying?

  • Consider any decisions you made in the past that led to situations you later regretted. What can you learn from these that will help you make a wiser decision this time.

If you Want to Improve, you have to Cross the Rubicon

“Do. Or do not. There is no try.” — Yoda

You have a choice in how you run your life. There is no “can’t,” only “will” and “won’t.” The trick is knowing why you are, or aren’t, moving around the existential cycle and, in particular, crossing your Rubicon. Like we’ve said, the right thing isn’t to always cross or always not cross. The right thing is to understand why you want to cross or don’t want to cross, and then make your decision.

Nevertheless, none of us want to live our lives in a constant state of doing. I might not be in good enough shape today to swim 2.4 miles, but that doesn’t mean I won’t be in the future. Plus, our reasons for remaining in one state may not be strong. At some point, in certain aspects of our lives, if we want to progress, we must cross the Rubicon.

A decision to not cross the Rubicon based on the wrong reasons— when catastrophic fantasies rule our mind-sets— is what causes people to look back on their lives and think If only. … All of us who have looked back and been proud of what we have done have crossed the Rubicon at least once and maybe many times.

There’s a famous Latin maxim, carpe diem, which translated means “seize the day.” The question you have to ask yourself is, When it comes to crossing Rubicons, just how much of a Caesar am I prepared to be?

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