Tag: Charlie Munger

The Human Mind has a Shut-Off Device

This passage is from Ryan Holiday in Trust Me, I’m Lying:

Once the mind has accepted a plausible explanation for something, it becomes a framework for all the information that is perceived after it. We’re drawn, subconsciously, to fit and contort all the subsequent knowledge we receive into our framework, whether it fits or not. Psychologists call this “cognitive rigidity”. The facts that built an original premise are gone, but the conclusion remains—the general feeling of our opinion floats over the collapsed foundation that established it.

Information overload, “busyness,” speed, and emotion all exacerbate this phenomenon. They make it even harder to update our beliefs or remain open-minded.

Reminds me of this quote from Charlie Munger:

[W]hat I’m saying here is that the human mind is a lot like the human egg, and the human egg has a shut-off device. When one sperm gets in, it shuts down so the next one can’t get in. The human mind has a big tendency of the same sort. And here again, it doesn’t just catch ordinary mortals; it catches the deans of physics. According to Max Planck, the really innovative, important new physics was never really accepted by the old guard. Instead a new guard came along that was less brain-blocked by its previous conclusions. And if Max Planck’s crowd had this consistency and commitment tendency that kept their old inclusions intact in spite of disconfirming evidence, you can imagine what the crowd that you and I are part of behaves like.

If we get most of our plausible explanations from headlines—that is newspapers, tweets, facebook—we’re in trouble. Conclusions based not on well-reasoned arguments, deep fluency, or facts but headlines are the most troublesome. Map that to how hard it is to update our beliefs and you can start to see the structural problem.


May The Odds Be Ever in Your Favor

In Mobs, Messiahs, and Markets: Surviving the Public Spectacle in Finance and Politics, Will Bonner writes:

…you don’t win by predicting the future; you win by getting the odds right. You can be right about the future and still not make any money. At the racetrack, for example, the favorite horse may be the one most likely to win, but since everyone wants to bet on the favorite, how likely is it that betting on the favorite will make you money? The horse to bet on is the one more likely to win than most people expect. That’s the one that gives you the best odds. That’s the bet that pays off over time.

And here is Charlie Munger speaking about the same topic:

The model I like to sort of simplify the notion of what goes o­n in a market for common stocks is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based o­n what’s bet. That’s what happens in the stock market.

Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so o­n and so on. But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then it’s not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it’s very hard to beat the system.

And then the track is taking 17% off the top. So not only do you have to outwit all the other betters, but you’ve got to outwit them by such a big margin that on average, you can afford to take 17% of your gross bets off the top and give it to the house before the rest of your money can be put to work.

Become A Learning Machine

I always find it interesting and revealing when different people offer the same advice. Especially when those pople are not connected and come from different fundamental disciplines.

Charlie Munger, Carol Dweck, and Susan Cain all offer the same advice: Become a Learning Machine.

Charlie Munger says:

I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines. They go to bed every night a little wiser than they were when they got up and boy does that help, particularly when you have a long run ahead of you.

Carol Dweck says:

You have to apply yourself each day to becoming a little better. By applying yourself to the task of becoming a little better each and every day over a period of time, you will become a lot better.

And this tidbit from Susan Cain, also fits:

…identify the tasks or knowledge that are just out of your reach, strive to upgrade your performance, monitor your progress, and revise accordingly.

How Raising Prices Can Increase Sales

I have posed at two different business schools the following problem. I say, “You have studied supply and demand curves. You have learned that when you raise the price, ordinarily the volume you can sell goes down, and when you reduce the price, the volume you can sell goes up. Is that right? That’s what you’ve learned?” They all nod yes. And I say, “Now tell me several instances when, if you want the physical volume to go up, the correct answer is to increase the price?” And there’s this long and ghastly pause. And finally, in each of the two business schools in which I’ve tried this, maybe one person in fifty could name one instance. They come up with the idea that occasionally a higher price acts as a rough indicator of quality and thereby increases sales volumes.

This happened in the case of my friend Bill Ballhaus. When he was head of Beckman Instruments it produced some complicated product where if it failed it caused enormous damage to the purchaser. It wasn’t a pump at the bottom of an oil well, but that’s a good mental example. And he realized that the reason this thing was selling so poorly, even though it was better than anybody else’s product, was because it was priced lower. It made people think it was a low quality gizmo. So he raised the price by 20% or so and the volume went way up.

That’s from a 2003 talk by Charlie Munger.

I was reminded of that lecture when I came across this recent article in Forbes:

Social psychologist Robert Cialdini suggests that in some cases, businesses can actually increase their sales by raising prices. The reason behind this surprising phenomenon, he revealed in a recent podcast interview, is that in “markets in which people are not completely sure of how to assess quality, they use price as a stand-in for quality.” While most customers wouldn’t pay $20 for paper towels because it’s easy to compare them to other products on the store shelves, it’s much harder to evaluate certain categories of products or services.

Art is notoriously challenging – what makes a Damien Hirst sell for millions while a similar piece by someone else might languish? Consulting or other professional services are also hard to compare, because practitioners may have different approaches or skill levels, so you’re not comparing apples to apples. Thus, says Cialdini, “especially when they’re not very confident about being able to discern quality in their own right, people who are unfamiliar with a market will be especially led by price increases to go in that direction [and purchase more expensive offerings].”

Pricing is such an important signifier, says Cialdini, that “organizations will sometimes raise their prices and as a consequence, will be seen as the quality leader in their market,” regardless of whether they’ve upgraded their offerings.

Still curious? Robert Cialdini’s is the author of two books: Yes!: 50 Scientifically Proven Ways to be Persuasive and Influence: The Psychology of Persuasion.

An Introduction to the Mental Model of Redundancy (with examples)

“The reliability that matters is not the simple reliability of one component of a system,
but the final reliability of the total control system.”

Garrett Hardin


We learn from Engineering that critical systems often require back up systems to guarantee a certain level of performance and minimize downtime. These systems are resilient to adverse conditions and if one fails there is spare capacity or a backup system.

A simple example where you want to factor in a large margin of safety is a bridge. David Dodd, a longtime colleague of Benjamin Graham, observed “You build a bridge that 30,000-pound trucks can go across and then you drive 10,000-pound trucks across it. That is the way I like to go across bridges.”

Looking at failure, we can see many insights into redundancy.

There are many cases of failures where the presence of redundant systems would have averted catastrophe. On the other hand, there are cases of failure where the presence of redundancy caused failure.

How can redundancy cause failure?

First, in certain cases, the added benefits of redundancy are outweighed by the risks of added complexity. Since adding redundancy increases the complexity of a system, efforts to increase reliability and safety through redundant systems may backfire and inadvertently make systems more susceptible to failure. An example of how adding complexity to a system can increase the odds of failure can be found in the near-meltdown of the Femi reactor in 1996. This incident was caused by an emergency safety device which broke off and blocked a pipe stopping the flow of coolants into the reactor core. Luckily this was before the plant was active.

Second, redundancy with people can lead to social diffusion where people always assume it was someone else who had the responsibility.

Third, redundancy can lead to increasingly risky behavior.

* * *

In Reliability Engineering for Electronic Design, Norman Fuqua gives a great introduction to the concept of redundancy.

Websters defines redundancy as needless repetition. In reliability engineering, however, redundancy is defined as the existence of more than one means for accomplishing a given task. Thus all of these means must fail before there is a system failure.

Under certain circumstance during system design, it may become necessary to consider the use of redundancy to reduce the probability of system failure–to enhance systems reliability–by providing more than one functional path or operating element in areas that are critically important to system success. The use of redundancy is not a panacea to solve all reliability problems, nor is it a substitute for good initial design. By its very nature, redundancy implies increased complexity, increased weight and space, increased power consumption, and usually a more complicated system …

In Seeking Wisdom, Peter Bevelin mentioned some interesting quotes from Buffett and Munger that speak to the concept of redundancy/resilience from the perspective of business:

Charlie Munger
Of course you prefer a business that will prosper even if it is not managed well. We are not looking for mismanagement; we like the capacity to withstand it if we stumble into it….We try and operate so that it wouldn’t be too awful for us if something really extreme happened – like interest rates at 1% or interest rates at 20%… We try to arrange [our affairs] so that no matter what happens, we’ll never have to “go back to go.”

Warren Buffett uses the concept of margin of safety for investing and insurance:
We insist on a margin of safety in our purchase price. If we calculate the value of a common stock to be only slightly higher than its price, we’re not interested in buying. We believe this margin-of-safety principle, so strongly emphasized by Ben Graham, to be the cornerstone of investment success.

David Dodd, on the same topic, writes:

You don’t try to buy something for $80 million that you think is worth $83,400,000.

Buffett on Insurance:

If we can’t tolerate a possible consequence, remote though it may be, we steer clear of planting its seeds.

The pitfalls of this business mandate an operating principle that too often is ignored: Though certain long-tail lines may prove profitable at combined ratios of 110 or 115, insurers will invariably find it unprofitable to price using those ratios as targets. Instead, prices must provide a healthy margin of safety against the societal trends that are forever springing expensive surprises on the insurance industry.

Confucius comments:

The superior man, when resting in safety, does not forget that danger may come. When in a state of security he does not forget the possibility of ruin. When all is orderly, he does not forget that disorder may come. Thus his person is not endangered, and his States and all their clans are preserved.

Warren Buffett talked about redundancy from a business perspective at the 2009 shareholder meeting:

Question: You’ve talked a lot about opportunity-costs. Can you discuss more important decisions over the past year?

Buffett: When both prices are moving and in certain cases intrinsic business value moving at a pace that’s far greater than we’ve seen – it’s tougher, more interesting and more challenging and can be more profitable. But, it’s a different task than when things were moving at more leisurely pace. We faced that problem in September and October. We want to always keep a lot of money around. We have so many extra levels of safety we follow at Berkshire.

We got a call on Goldman on a Wednesday – that couldn’t have been done the previous Wednesday or the next Wednesday. We were faced with opportunity-cost – and we sold something that under normal circumstances we wouldn’t.

Jonathan Bendor, writing in Parallel Systems: Redundancy in Government, provides an example of how redundancy can reduce the risk of failure on cars.

Suppose an automobile had dual breaking (sic) circuits: each circuit can stop the car, and the circuits operate independently so that if one malfunctions it does not impair the other. If the probability of either one failing is 1/10, the probability of both failing simultaneously is (1/10)^2, or 1/100. Add a third independent circuit and the probability of the catastrophic failure of no brakes at all drops to (1/10)^3, or 1/1,000.

Airplane Design provides an insightful example. From the code of federal regulations:

The airplane systems and associated components, considered separately and in relation to other systems, must be designed so that the occurrence of any failure condition which would prevent the continued safe flight and landing of the airplane is extremely improbable, and the occurrence of any other failure conditions which would reduce the capacity of the airplane or the ability of the crew to cope with adverse operating conditions is improbable.

* * *

Ways redundancy can fail

In The Problem of Redundancy Problem: Why More Nuclear Security Forces May Produce Less Nuclear Security, Scott Sagan writes:

The first problem with redundancy is that adding extra components can inadvertently create a catastrophic common-mode error (a fault that causes all the components to fail). In complex systems, independence in theory (or in design) is not necessarily independence in fact. As long as there is some possibility of unplanned interactions between the components leading to common-mode errors, however, there will be inherent limits to the effectiveness of redundancy as a solution to reliability problems. The counterproductive effects of redundancy when extra components present even a small chance of producing a catastrophic common-mode error can be dramatic.

This danger is perhaps most easily understood through a simple example from the commercial aircraft industry. Aircraft manufacturers have to determine how many engines to use on jumbo jets. Cost is clearly an important factor entering their calculations. Yet so is safety, since each additional engine on an aircraft both increases the likelihood that the redundant engine will keep the plane in the air if all others fail in flight and increases the probability that a single engine will cause an accident, by blowing up or starting a fire that destroys all the other engines and the aircraft itself.

In (the image below) I assume that 40% of the time that each engine fails, it does so in a way (such as starting a catastrophic fire) that causes all the other engines to fail as well.

Aircraft manufacturers make similar calculations in order to estimate how many engines would maximize safety. Boeing, for example, used such an analysis to determine that, given the reliability of modern jet engines, putting two engines on the Boeing 777, rather than three or more engines as exist on many other long-range aircraft, would result in lower risks of serious accidents.

In more complex systems or organizations, however, it is often difficult to know when to stop adding redundant safety devices because of the inherent problem of predicting the probabilities of exceedingly rare events.

The second way in which redundancy can backfire is when diffusion of responsibility leads to “social shirking.”

This common phenomenon—in which individuals or groups reduce their reliability in the belief that others will take up the slack—is rarely examined in the technical literature on safety and reliability because of a “translation problem” that exists when transferring redundancy theory from purely mechanical systems to complex organizations. In mechanical engineering, the redundant units are usually inanimate objects, unaware of each other’s existence. In organizations, however, we are usually analyzing redundant individuals, groups, or agencies, backup systems that are aware of one another.

The third basic way in which redundancy can be counterproductive is when the addition of extra components encourages individuals or organizations to increase production in dangerous ways. In most settings, individuals and organizations face both production pressures and pressure to be safe and secure. If improvements in safety and security, however, lead individuals to engage in inherently risky behavior—driving faster, flying higher, producing more nuclear energy, etc.—then expected increases in system reliability could be reduced or even eliminated. Research demonstrates, for example, that laws requiring “baby-proof” safety caps on aspirin bottles have led to an increase in child poisoning because parents leave the bottles outside the medicine cabinet.

* * *

Another example of people over-confident in redundant systems can be found in the Challenger Disaster:

A dramatic case in point is the January 1986 space shuttle Challenger explosion. A strong consensus about the basic technical cause of the accident emerged soon afterward with the publication of the Rogers Commission report: the unprecedented cold temperature at the Kennedy Space Center at the time of launch caused the failure of two critical O-rings on a joint in the shuttle’s solid rocket booster, producing a plume of hot propellant gases that penetrated the shuttle’s external fuel tank and ignited its mixture of liquid hydrogen and oxygen. In contrast to the technical consensus, a full understanding of why NASA officials and Morton Thiokol engineers decided to launch the shuttle that day, despite the dangerously cold weather, has been elusive.

The Challenger launch decision can be understood as a set of individuals overcompensating for improvements in space shuttle safety that had been produced through the use of redundant O-rings. This overcompensation interpretation differs significantly from both the traditional arguments that “production pressures” forced officials to break safety rules and consciously accept an increased risk of an accident to permit the launch to take place and Diane Vaughan’s more recent argument, which focuses instead on how complex rules and engineering culture in NASA created “the normalization of deviance” in which risky operations were accepted unless it could be proven that they were extremely unsafe. The production pressures explanation—that high-ranking officials deliberately stretched the shuttle flight safety rules because of political pressure to have a successful launch that month—was an underlying theme of the Rogers Commission report and is still a widely held view today.(35) The problem with the simple production pressure explanation is that Thiokol engineers and NASA officials were perfectly aware that the resilience of an O-ring could be reduced by cold temperature and that the potential effects of the cold weather on shuttle safety were raised and analyzed, following the existing NASA safety rules, on the night of the Challenger launch decision.

Vaughan’s argument focuses on a deeper organizational pathology: “the normalization of deviance.” Engineers and high-ranking officials had developed elaborate procedures for determining “acceptable risk” in all aspects of shuttle operations. These organizational procedures included detailed decision-making rules among launch officials and the development of specific criteria by which to judge what kinds of technical evidence could be used as an input to the decision. The Thiokol engineers who warned of the O-ring failure on the night before the launch lacked proper engineering data to support their views and, upon consideration of the existing evidence, key managers, therefore, unanimously voted to go ahead with the launch.

Production pressures were not the culprits, Vaughan insists.Well-meaning individuals were seeking to keep the risks of an accident to a minimum, and were just following the rules (p. 386). The problem with Vaughan’s argument, however, is that she does not adequately explain why the engineers and mangers followed the rules that night. Why did they not demand more time to gather data, or protest the vote in favor of a launch, or more vigorously call for a postponement until that afternoon when the weather was expected to improve?

The answer is that the Challenger accident appears to be a tragic example of overcompensation. There were two O-rings present in the critical rocket booster joint: the primary O-ring and the secondary O-ring were listed as redundant safety components because they were designed so that the secondary O-ring would seal even if the first leaked because of “burn through” by hot gasses during a shuttle launch. One of the Marshall space center officials summarized the resulting belief: “We had faith in the tests. The data said that the primary would always push into the joint and seal . . . . And if we didn’t have a primary seal in the worst case scenario, we had faith in the secondary” (p. 105).

This assumption was critical on the night of January 27, 1986 for all four senior Thiokol managers reversed their initial support for postponing the launch when a Marshall Space Center official reminded them of the backup secondary O-ring. “We were spending all of our time figuring out the probability of the primary seating,” one of the Thiokol managers later noted: “[t]he engineers, Boisjoly and Thompson, had expressed some question about how long it would take that [primary] O-ring to move, [had] accepted that as a possibility, not a probability, but it was possible. So, if their concern was a valid concern, what would happen? And the answer was, the secondary O-ring would seat”(p. 320).

In short, the Challenger decision makers failed to consider the possibility that the cold temperature would reduce the resilience of both O-rings in the booster joint since that low probability event had not been witnessed in the numerous tests that had been conducted. That is, however, exactly what happened on the night of unprecedented cold temperatures. Like many automobile drivers, these decision makers falsely believed that redundant safety devices allowed them to operate in more dangerous conditions without increasing the risk of a catastrophe.

Redundancy is part of the Farnam Street latticework of mental models.

Ethical Breakdowns: Why Good People often Let Bad Things Happen

When Charlie Munger recommended reading Max Bazerman’s Judgment in Managerial Decision Making I had never hear of the HBS professor. A lot of reading later and I’m a huge fan.

In the HBR article below Bazerman covers some of the ground from his new book Blind Spots (see my notes).

These days, many of us are instructed to make decisions from a business perspective (thereby reducing or eliminating the ethical implications of our decisions). The Ford Pinto example below is very telling:

Consider an infamous case that, when it broke, had all the earmarks of conscious top-down corruption. The Ford Pinto, a compact car produced during the 1970s, became notorious for its tendency in rear-end collisions to leak fuel and explode into flames. More than two dozen people were killed or injured in Pinto fires before the company issued a recall to correct the problem. Scrutiny of the decision process behind the model’s launch revealed that under intense competition from Volkswagen and other small-car manufacturers, Ford had rushed the Pinto into production. Engineers had discovered the potential danger of ruptured fuel tanks in preproduction crash tests, but the assembly line was ready to go, and the company’s leaders decided to proceed. Many saw the decision as evidence of the callousness, greed, and mendacity of Ford’s leaders—in short, their deep unethicality.

But looking at their decision through a modern lens—one that takes into account a growing understanding of how cognitive biases distort ethical decision making—we come to a different conclusion. We suspect that few if any of the executives involved in the Pinto decision believed that they were making an unethical choice. Why? Apparently because they thought of it as purely a business decision rather than an ethical one.

Taking an approach heralded as rational in most business school curricula, they conducted a formal cost-benefit analysis—putting dollar amounts on a redesign, potential lawsuits, and even lives—and determined that it would be cheaper to pay off lawsuits than to make the repair. That methodical process colored how they viewed and made their choice. The moral dimension was not part of the equation. Such “ethical fading,” a phenomenon first described by Ann Tenbrunsel and her colleague David Messick, takes ethics out of consideration and even increases unconscious unethical behavior.

Continue Reading at HBR.

I recommend you purchase Judgment in Managerial Decision Making and Blind Spots.