Thursday, April 17, 2008

Analogy #173: Vote for your Favorite Pi

When I was younger, I tried to memorize pi out to a number of digits. I ended up memorizing pi out to seven digits to the right of the decimal point: 3.1415926.

There is an urban legend that the state legislature in Alabama passed a law decreeing that henceforth pi would be equal to three. In reality, it was a hoax posted on the internet back on April 1, 1998 (which is April Fool’s Day, not to be confused with Pi Day on March 14th, for those of you always looking for another excuse for a celebration). Once it got on the internet, the story got into all sorts of people’s hands without the warning that it was a hoax.

What is true, however, is that the Indiana legislature back in 1897 tried to pass a law to make pi equal 3.2. Apparently, there was this mathematical quack named William Goodwin who came up with the faulty logic. Goodwin had this notion that he could charge a royalty whenever people used his version of pi. To give his idea credibility, he got House Bill No. 246 introduced into the Indiana legislature, which would make pi equal 3.2 throughout Indiana.

The Indiana House of Representatives didn’t know what to do with the bill, so they gave it to the Committee on Swamp Lands to review. They couldn’t see anything wrong with it, so it was placed to a vote and passed in the house by a vote of 67 to 0.

The next step was to take the bill to the Senate. They gave it to the Committee on Temperance to review. This committee also found no fault with it and approved it for passage. However, by this time, a credible mathematician named Clarence Waldo got wind of what was going on and set the records straight on the truth about pi. As a result, the Indiana Senate postponed indefinitely any action on the bill.

For more information on this story, see here and here.

In a democracy, there is this idea that if you can get enough people to vote in favor of something, it can become a reality. Well, let me tell you. It wouldn’t matter how many democracies passed a law to make pi equal to 3 or to 3.2. Pi would still be that long and complicated number which I memorized out to seven digits. The natural laws of Euclidian mathematics cannot be altered by the vote of some state senators.

As silly as it sounds, a lot of businesses act like this example of the Indiana legislature. Forces within the company try to convince the leadership to accept a particular point of view. The leadership votes to accept this point of view and then builds a strategy around it.

However, just because the executives declared this point of view to be truth does not make it so (just as declaring pi to equal 3.2 does not make it so). When reality settles in, the strategy’s flaws come to light and it fails.

The principle here is to be careful about placing too much confidence in your assumptions about the future. Just because you may all believe it to be so does not automatically make it so. Here are some points to keep in mind.

1) Nobody can be absolutely certain about what the future holds.
Through proper research and analysis, one can become more accurate about predicting the future. However, you will never be 100% accurate about the future because it is an unknown. A venture capitalist once told me that when evaluating a project for investment, he primarily looks for two things.

First, does the business space being entered look big? The bigger the space, the more tolerance there can be for a little inaccuracy in the other assumptions. You know that the assumptions will be off a little, and if the market potential is small, being off a little could mean the difference between success and failure.

Second, are the people running the business smart and adaptable? The ultimate goal is not to be 100% correct at the beginning but to be correct at the end. People who continue to monitor the situation and adapt will have more success than the ones who blindly continue down the same path regardless of new information.

2) The most persuasive voice may not be the most accurate voice.
Just because an executive can persuade someone to believe something does not make it so. We all come with our own biases. For example, career aspirations can cloud our judgment. Other factors can also bias our thinking. As a result, we may push for an agenda which is wrong (such as making pi = 3.2).

It is important not to let shear force of persuasion rule. Be skeptical at first and listen to other viewpoints.

3) Other people outside your company also get a vote about the future.
As it turns out, your votes are not the only ones that count. The competition and the consumer also get to vote on how the future evolves. When building scenarios of the future, be sure to accurately reflect how consumers and competitors would react to your strategy. They won’t just stand still. They will react. And it may not be the way you expect them to react.

For example, Ford now touts the fact that its cars have similar quality levels to that of Toyota. This may be true to an academic scientist, but to the average consumer, they do not believe this. They have voted to believe that Ford is not a good as Toyota, regardless of what Ford executives believe.

Similarly, even though Target stores have very competitive prices, consumers have voted to believe that Wal-Mart has significantly lower prices. Target is not getting credit in the marketplace for its pricing strategy.

4) There are some basic economic principles that are rarely broken, regardless of your confidence.
Just as the Indiana legislature cannot break the laws of Euclidian mathematics, businesses cannot break the laws of economics. Here are a few points to keep in mind when examining points of view:

a) If your strategy has the potential for success, assume that those businesses being threatened will do everything they can to stop you. In addition, they (or others) will try to imitate your successful move, thereby reducing the potential market share available to your firm. For more on this, see my blog “Bombs Start Wars.”

b) Eventually, market forces will create enough competition that returns on investment will fall to levels near the cost of capital. Above average returns are temporary. Don’t count on them for a long time.

c) Being first to market does not automatically lead to success. Fast followers often win in the long run. For more on this, see my blog “Gimme Shelter."

When someone tries to tell you that the old laws of economics no longer apply, be very nervous. Bubble economies, such as the dot-com bubble of the 1990s and the housing bubble of the 2000s, were based on faulty assumptions which defied the laws of economics. Eventually, the laws will win out and the bubble will burst.

So where does that lead us? Should we give up on making predictions? Of course not. Total ignorance is never the best alternative. Here are a few pointers:

1) Don’t assume you have perfect information. Even after starting down the strategic path, continue to collect information and adapt.

2) Don’t wait for perfect information before taking action. You will never have perfect information about the future until the future becomes the past. The goal is not perfect knowledge, but knowledge good enough to point you in the proper general direction.

3) Don’t abandon the laws of economics in your assumptions.

4) Have healthy debates in the beginning and consider minority and outsider points of view. The best strategy may not always be the one that first comes to mind (just as the best point of view on pi did not come from the first mathematician to approach the Indiana legislature).

Actions are based on assumptions. The more accurate the assumptions, the greater the likelihood that your strategy will succeed. Although the idea of achieving total accuracy on assumptions about the future is a myth, thoughtful and adaptive organizations can get accurate enough to have an advantage.

Although new information could lead to a need to adapt a strategy, it should rarely lead one to abandon a strategy. If you find yourself continually making radical changes to your strategy, then either you are not doing enough homework up-front, or you have not done an effective job of applying knowledge to strategy creation.

Target’s overall strategy is to “Expect More, Pay Less.” Depending upon conditions, they will sometimes adapt to put a little more emphasis on the “expect more.” At other times, they adapt a bit more in the direction of “pay less.” But they do not abandon the overall thrust behind their brand. Strategies (like Target’s) should transcend minor changes in the environment.

No comments:

Post a Comment