VenChar

Kid in a candy store - Freakonomics

Like most of my book referrals, this one came from Chari who is probably the most widely read guy I know.  I borrowed his Freakonomics book yesterday and just devoured it.  Read in that afternoon and could not wait for more.  Turns out that the authors also have a blog in which they write about a variety of topics from the book. 

For those who are not familiar with this book, it joins the canon of books like The Tipping Point and Blink in which the authors use intuition combined with deep analysis of data to make very insightful conclusions. 

Steven Lewitt who is a John Bates Clark Medal winner and a Professor of Economics at University of Chicago is an unusual economist. Instead of poring over mathematics to extend the framework of economics, he instead applies age old economics principles to sociological situations and garners great insights.  He analyzes incentives for real estate agents (surprise - they are really interested only in their commission and not in the interests of the seller) and looks at why school teachers and Sumo wrestlers cheat (the answer my friend is incentives).

Turns out Seth Levine at Mobius is also a big fan of this book . . .

The Stockdale Paradox

Joe Kraus' recent post reminded me of this parable (from 'Good to Great') that I had quite forgotten. I'm just going to quote Joe, because it is an excellent post on the entrepreneurial mindset:

The Stockdale Paradox is named after Admiral Jim Stockdale who was the highest ranking US military officer imprisoned in Vietnam. He was held in the “Hanoi Hilton” and repeatedly tortured over 8 years. Collins describes going to lunch with Stockdale (can you imagine?) and trying to understand how he survived 8 years as a POW while so many died after just months in captivity.
Here’s how Stockdale put it. “I never lost faith in the end of the story. I never doubted not only that I would get out, but also that I would prevail in the end and turn the experience into the defining event of my life, which, in retrospect, I would not trade.”
“Who didn’t make it out”?
“The optimists. They were the ones who said ‘we’re going to be out by Christmas’. And, Christmas would come and Christmas would go. Then they’d say, ‘We’re going to be out by Easter.’ And Easter would come, and Easter would go. And then Thanksgiving, and then it would be Christmas again. Then they died of a broken heart.”
So, on the one hand it was about unswerving faith that one will ultimately prevail while on the other hand it’s about banishing all false hopes? As usual, the guy who lived it says it best.
“You must never confuse faith that you will prevail in the end – which you can never afford to lose – with the discipline to confront the most brutal facts of your current reality, whatever they might be.”
Holding those two seemingly contradictory notions in his head simultaneously was the key to Stockdale surviving, even thriving, in his experience. And, I believe, it is a perfect summary of the mindset you’ve got to have in starting a company. You have to believe that your vision will come to pass. You’ve got to do everything you can to make it happen. But, you can never let your belief and faith cloud your confrontation with reality.

The First Venture Capitalist

Continuing my "casual reading" list, I recently picked up a copy of "The First Venture Capitalist" - a collection of historical materials on General Doriot edited by Udayan Gupta.  For those not familiar with General Doriot, he was a professor at HBS who started the first institutional venture fund called ARD (American Research and Development). 

His most successful deal was DEC.  He provided a seed round  of $70,000 (yes you read it right, seventy thousand dollars) to Ken Olsen and the rest as they say is history.  General Doriot was a true gentleman.  He never collected fees or carry on his funds and actually never made money on DEC himself.  He believed that the process of funding innovative companies and creating jobs was patriotic and was its own reward. 

In these days of Billion dollar funds and executive pay gone crazy, thank you General Doriot for thinking big and thinking long term.  Your legacy lives on . . .

Book Review: America The Vulnerable

Just finished reading Stephen Flynn's excellent 'America the Vulnerable - How our government is failing to protect us from terrorism'. The thrust of the book stems from this diagnosis:

It is a sense of futility, fueled by the lack of vision about what sensible measures are worth pursuing, that lies at the heart of our national inertia on the homeland security issue.

Flynn notes that counter-terrorism measures tend to enacted be reactively rather than proactively. There is a tendency to put countermeasures in place only after a threat has materialized and created extensive damage, rather than anticipating a class of attacks and aiming efforts at preventing them. Linked to this tendency is another:

There is a political price to be paid if politicians are perceived as being negligent or ineffectual in providing security. So when an act of terror takes place, it triggers a powerful political dynamic to leap to decisive protective actions before evaluating the likely costs or consequences. The greater the exploited vulnerability, the more likely the government is to overreach in response.

He goes on to argue that given that our intelligence capabilities are likely to be spotty for some time to come, we cannot expect to uncover specific threats with enough advance warning to protect against them. A better approach is to invest resources in identifying and prioritizing likely terrorist targets and proactively taking measures to protect them and, in addition, create contingency plans to mitigate those risks in the event of a successful attack. Along these lines he lists several critical infrastructure elements and networks that should be targeted for protection including the transportation networks, the food and water supplies, the power grid, etc.

The deterrence strategy he proposes is two-pronged: security measures to decrease the success probability of an attack and contingencies for coping when somethin goes wrong. He makes the useful point that the terrorist will be deterred if either the risk of detection is sufficiently high or if the damage from a successful attack can be well-contained.

He argues for federally mandated security standards in the area of domestic security and critical infrastructure protection since the market will not move to implement the security requirements left to its own devices, especially if the measures require substantial investments. He draws an interesting analogy to safety standards:

Over time Americans have come to view safety not as a government-imposed burden but as a valued necessity. As our society became more urbanized and technically complex, people began to appreciate the benefits of devising and enforcing rules that reduced risk or harm through human error or mechanical failures. Along with the changes in public attitudes, businesses came to realize that there was a market case for making safety investments. Safer factories have higher worker productivity rates and lower insurance costs. Safer products make for happier customers and fewer lawsuits. So while automotive manufacturers, for example, were once bitter opponents of safety mandates, today many try to outdo each other, advertising how their cars beat the safety standards established by the government and exceed the safety record of their competitors.

There is another aspect to this analogy to safety systems, which is a reminder that the focus of security should be managing risk down to acceptable levels, not necessarily eliminating it. His premise is that it is naive to suppose that terrorism can be eliminated but that, on the other hand, the associated risks can certainly be managed and contained. "Automotive safety is about taking steps that allow people to drive while managing the risks that might cause injury or death. If eliminating the risk of automobile fatalities were the goal, we would simply ban people from driving cars."

One of the themes of this book is that many of the most effective tools for combating the terrorist threat often can often provide other useful societal benefits. The challenge is to device security measures that integrate into ways of doing business. For instance, deploying RFID-like tags on shipping containers to track contents can have the added benefit of increased supply chain visibility in addition to the added security and traceability of the contents.

Fooled by randomness

I just finished reading Nassim Taleb's excellent book Fooled by Randomness which combines insights from finance, behavioral economics, probability and statistics. I will write more about this later, but here’s an interesting example from the book on how we lack intuition for basic probability calculations:

You are a doctor. A certain disease tends to afflict one in every thousand individuals in the population. There is a test for the disease, but in 5% of the cases it yields a false positive. A person comes in one day and tests positive. What are the odds he has the disease? Stop for a moment and try to answer the question.

The naïve answer (and the one that most physicians gave when posed this problem) is that he has the disease with 95% certainty. The correct answer is about 2% (notice the wide discrepancy here – the naïve estimate misses the mark by a HUGE amount). Why? Because the test has a markedly higher error rate than the base rate of occurrence of the disease in the population. Consider that in a population of 1000, 1 person on average will have the disease, but the test will generate on average 50 false positives. Therefore the probability that a given individual who tests positive has the disease is 1/51, which is about 2%.

Why does almost everyone venture an answer of 95% as the odds of the subject having the disease? My theory is that people confuse the probability of event A conditional on event B (p(A|B)) with the probability of event B conditional on event A (p(B|A)): the probability of testing positive given that one does not have the disease is 5% whereas the probability of not having the disease given that one tests positive is 98% and the confusion of these probabilities leads to the wrong answer.

This is certainly interesting – no one would expect a physician to intuit the subtlety of the problem, much less pull out a scratchpad and compute the right answer. Now change the framing of the problem. You are a juror. You know that one in every thousand people has committed a criminal act in their lifetime. A crime has been committed and a fingerprint obtained from the crime scene. The fingerprint was correlated against a random collection of fingerprints drawn from people in the city and a positive match was obtained with one individual. The fingerprint matching program has a false positive rate of 5%. What are the odds the individual committed the crime?

This kind of problem can crop up in a number of different real-world decision-making scenarios and our lack of intuition for probability can lead to drastically bad calls. Physicians presumably have some basic grounding in probability and statistics, but it is probably safe to assume most jurors are mathematically illiterate. Makes you wonder how many false positives are sitting out prison sentences.

The problem caught me out the first time it was presented to me, as it did a mathematician friend of mine. I observed a tendency on my part to jump to an answer (the wrong one, in this case). It was only when I discovered how drastically wrong I was, that I sat down and did the calculation. If the problem had been presented to me on a math exam, it would probably have engaged the analytic part of my brain and I would have patiently worked it out and arrived at the right answer. When it jumped out at me out of a context where I wasn’t expecting a tricky calculation, I jumped to an easy, ill-considered and completely wrong answer. This is probably what is referred to as engaging System 1 versus System 2.

Sustaining Innovations - not as bad as Christensen makes them out to be

Following up on Chari's posts on Christensen and his latest book - "The Innovator's Solution," I wanted to offer a different perspective on sustaining innovations. A not so subtle point Christensen and Raynor make in their book over and over again is the superiority of disruptive innovations over sustaining innovations. I agree that if you can find disruptive innovations, you are better off pursuing them than sustaining innovations. However disruptive innovations are hard to come by and there are still a few categories of sustaining innovations that are still worthwhile to pursue.

This is not a comprehensive list but here are some categories:

a. Create a sustaining innovation which has a high time to market value in an unconsolidated industry e.g. telecom equipment startups. Most of the stuff venture backed telecom startups try to make are really sustaining innovations. However if they can create these products fast then the time to market element makes it attractive for one of the bigger players to acquire them. If the industry is consolidated then the time to market element is not strong as the major players can control the rate of innovation.

to be followed

Amazon's Search Inside The Book

I've been waiting for this for a while. Amazon announced today that you can now do full text searches of nearly 120,000 books in the Amazon catalog.

Starting today, you can find books at Amazon.com based on every word inside them, not just on matches to author or title keywords. Search Inside the Book -- the name of this feature -- searches the complete inside text of more than 120,000 books -- all 33 million pages of them.

Wired has an article on this announcement that touches on a couple of the implications of this move from Amazon. It also ranges wider - drawing connections to ambitious attempts like Brewster Kahle's Internet Archive and the Gutenberg Project and commenting on why this move is strategic for Amazon:

This shifts power away from the people who own finite sets of copyrighted material and toward the people who offer access to information about where this material can be found. Information about books, not ownership of copyrights, becomes a new center of power...Amazon's Search Inside the Book is not an ebook project. It is merely a catalog. But a decade of Internet history proves that the catalog is exactly what you want to own.

The contents of books may be the only publicly accessible data set with the potential to match Google's Web index both for size and utility. Search Inside the Book makes Amazon the sole guide to tens and ultimately hundreds of millions of pages of information. And while Google's business is vulnerable to any competitor that builds a better search engine, Amazon's book archive is the product of negotiated contracts with hundreds of publishers. Amazon has cornered the market on information that was once hidden away in books. The burden of the physical – the fact that the database Amazon uses is linked into a complex system involving real things – gives it a stunning, if perhaps temporary, advantage.

Elsewhere, Jon Udell notes that this search feature actually increases the value of the physical books that he owns, by making them searchable. Via Techdirt.

The Innovator's Solution

Clayton Christensen has a new book out: The Innovator's Solution: Creating and Sustaining Successful Growth. Co-authored with Michael Raynor, "this is a book about how to create new growth in business".

From the Boston Globe review (via Emergic):

Christensen and Raynor set out to demystify innovation so that established companies can capitalize on changes and deliberately create disruptions.

Among the tactics they recommend:
- Target only customers and markets that are unappealing to established competitors.
- Pursue customers at the low end of a market or, even better, "nonconsumers" who don't even use a product.
- Help customers find simpler, more cost-effective solutions, rather than inventing new problems for them to solve.
- Be impatient for profits, but patient for growth.
- Work on new ways to keep your company growing while it is still robust .

"A dearth of good ideas is rarely the core problem" for established companies, Christensen and Raynor write. "Potentially innovative new ideas seem inexorably to be recast into attempts to make existing customers still happier. We believe that many of the ideas that emerge from this packaging and shaping process as me-too innovations could just as readily be shaped into business plans that create truly disruptive growth."

From the jacket:

Innovation fails ... because organizations unwittingly strip the disruptive potential from new ideas before they ever see the light of day

None of this is very surprising news, if you've read 'The Innovator's Dilemma' - more an extension of the underlying theoretical model coupled with some prescriptive suggestions. That said, I'm going to get the book and give it a read because I read the interesting excerpt that Rajesh Jain also linked to. The excerpt (in addition to featuring the nice Theodore Levitt quote: "People don't want to buy a quarter-inch drill. They want a quarter-inch hole.") presents a couple of interesting case examples and underlines the importance and limitations of product category definition:

Competing with nonconsumption often offers the biggest source of growth in a world of one-size-fits-all products... RIM got its disruptive foothold competing with nonconsumption by bringing the ability to receive and send e-mail to new contexts such as waiting lines, public transit and conference rooms. But what's next?

One option would be for RIM to believe its market is structured by product categories, as in: "We compete in handheld wireless devices." If so, they'd see the BlackBerry competing with the Palm handheld, Sony's Clié, mobile-telephone handsets made by Nokia, Motorola and Samsung, and Microsoft Pocket-PC-based devices such as Hewlett-Packard's iPAQ.

In order to get ahead of these competitors RIM would need to develop better products faster than the competition. Sony's Clié, for example, has a digital camera. Nokia's phones offer short text messaging. If it defines these as the competition, RIM would need to build some of these features into its next-generation BlackBerry device. RIM's competitors, of course, would be thinking just the same thing. Which would create a headlong, arms-race-like rush toward undifferentiated, one-size-fits-all products that perform poorly any specific jobs that customers might hire them to do. Such products are likely to end up more like the Swiss Army knife: a pretty good knife, terrible scissors, a marginal bottle opener and a crummy screwdriver.

But what if RIM structured the segments of this market according to the jobs that people are trying to get done? Just from watching people who pull out their BlackBerrys, it seems to us that most of them are hiring it to help them be productive in small snippets of time that otherwise would be wasted, like reading e-mails while waiting in line at airports.

What's the BlackBerry competing with? When not using a BlackBerry, people often pick up a wireless phone. Sometimes they pick up the Wall Street Journal. Sometimes they make notes to themselves. Sometimes they stare mindlessly at the CNN Airport Network or sit with glazed eyes in a boring meeting. From the customer's point of view, these are the BlackBerry's most direct competitors.

So in addition to adding wireless telephony, BlackBerry could add financial news headlines and stock quotes to help compete more effectively with the Wall Street Journal. And mindless, single-player games or automatically downloaded Letterman-like top-ten lists might help the BlackBerry gain share against boredom. Features that do not help customers do the job that they hire the BlackBerry for wouldn't be viewed as improvements at all.

My takeaway, though, is not that product categories are, in themselves, a bad way to think but rather that product categories need to be structured around what the customer is trying to get done. Narrow and obvious definitions of the product category can limit the market potential of a new product as well as its usefulness to its intended customers - thinking about the customer's needs and usage scenarios will lead to a better and more valuable reformulation of the product and its features and functionality. In the Blackberry case, substitute the more function-centric definition "on-the-road productivity enhancement tool" for the what-it-is-centric "handheld wireless device".