My Business Canon
Contents
I’ve previously written about my uncertainty canon, as in books that have shaped my thinking on the topic of uncertainty. That was largely a list of psychology books, because I found that subject to provide the best insights regarding uncertainty (second ranked subject was statistics). A straightforward next step is to think about the uncertain world of business, investment, strategy, markets, and so on. Unfortunately, I fooled myself into reading too many books from that humongous genre called “business”, the vast majority of which was useless at best, and utterly untrue at worst. Nevertheless, I’ve settled on three books that taught me a trinity of truths. I have come across nothing that surpasses the insights from these books, nor invalidates their assertions. Hence they now constitute my business canon for the sake of posterity.
The first book is from 1997, titled The Innovator’s Dilemma. It’s written by Clayton Christensen, who is a legendary scholar of management theory and business history from Harvard. The second book is titled The Lean Startup, written by Eric Ries and published in 2011. Ries is an enlightened engineer who managed to firmly embed the scientific method as bedrock foundation into the shaky isle of startups, and subsequently restated anew the same trinity of truths. The final book in my canon is Zero to One, published in 2014 and written by Peter Thiel with help from Blake Masters, who bring the sharp utensils of libertarian philosophy to the table, and reach the same trinity of truths as Christensen and Ries via the contrarian pathway of asking enduring questions. So, the remainder of this post is a paraphrasing of the trinity that I’ve learned from these three books.
Domination begins with humiliation
Christensen observed across a number of industries (particularly the disk drive industry) that well managed companies, which were the market leaders, eventually went bust when the market conditions changed drastically. Moreover, his finding was that the reason for their going belly up was the abundance, not absence, of good management! What usually occurs is that well managed companies become dominant via what he calls sustaining technologies or innovations that lead to incremental market gain and temporary leadership. But then a disruptive technology or innovation (his famous phrase) comes along from the low-end of the market, or from a new market with tiny overlap with the incumbents’ segment, which blindsides these well managed companies. Their fate then becomes a question of either evolution or extinction, depending on what they decide to do next. He observed that well managed companies typically decided to go extinct unwittingly, that is, they could not bring themselves to evolve sufficiently for survival in a changed marketplace.
How does something like this transpire? A good answer is provided by Christensen in the book, which is that it’s pretty much impossible for any existing market leader to adapt using old school ideas of good management, due to the fact that a disruptive technology invalidates old metrics and methods. So his prescription is to dream big but start small. And for large incumbents in a market, he recommends the decision that has now become standard practice: spin off a new company to nimbly navigate a small, risky, emerging market. There is, of course, quite a bit more subtlety to what he says in the book. I’m only summarising the main idea behind this truth that market domination begins with humiliation, both in terms of a large firm falling over and a small startup slowly learning the ropes - because disruption is initially humiliating. The implication is that starting small and evolving endlessly is the key to not just surviving, but thriving as well.
Ries arrives at this truth from an engineering perspective of building products. He proposes the build-measure-learn feedback loop in a startup for navigating an emerging or untapped market. Indeed, even for discovering a new market! The build phase is a minimum viable product that enables measuring relevant new metrics, which subsequently permit learning and either pivoting from or persevering with the startup’s vision plus strategy. His overt emphasis is on small steps, not giant leaps. The minimum viable product is all about testing assumptions and feasibility, which is a good way of rephrasing the old engineering advice to prototype first and prove a concept at a small scale. It’s rather shocking how many startups waste money in the 21st century just because they can, sigh. Ries ends the book with a rallying cry to “waste not”. I certainly agree. And the fact that humility is a viable pathway to future invincibility is underrated as a strategy, particularly in marketing. The macho approach of most startups is to conquer unclaimed markets and forcefully colonise them. These organisations sacrifice hordes of cash in the process, along with the time and energy of their employees. This is a hugely wasteful approach. The refined method of build-measure-learn feedback loop provides a vastly more efficient route to market domination.
Ultimately, this feedback loop requires the courage to release an awful prototype into an unknown marketplace. This is overwhelmingly likely to lead to humiliation, bad press in most cases, and perhaps the wrath of social media monsters. However, this is an extremely brief pain in the 21st century, because news cycles are so fast and people have such short attention spans. Thus, the main point of what Ries says in the book about a minimum viable product is to understand that a good amount of courage and humility is needed to succeed by iterating through his build-measure-learn feedback loop. Once again, market domination awaits those who dare to be humiliated first. Now, of course there are plenty of tactics for dulling the pain of humiliation, which Ries explains in the book. But the key is that one must acknowledge the overwhelming probability of humiliation in order to become comfortable with its consequences. Ignorance may be bliss, but it also kills!
How does Thiel’s book arrive at this truth? He takes a counter-intuitive route through monopolisation. His assertion is that perpetual competition between firms leads to ever decreasing profit margins for all, so much so that in a perfectly competitive marketplace (which is a rather hypothetical scenario, if ever there was one) all profits eventually shrink to zero. He insists, therefore, that a company must start with a monopoly (or near-monopoly) share of a small market (either new or emerging), then defend that share while growing the overall market size en route to domination. Regardless of whether one agrees or not with his implied promotion of monopolistic and anti-competitive marketplaces, the final prescription is identical to what Christensen and Ries have articulated previously - dream big but start small. In essence, all three authors are promoting monopolistic behaviour, because that’s what market domination is, at the end of the day. Hence I find that Thiel’s explicitness is the best aphoristic style, and thus my phrasing of this truth is in terms of domination and humiliation.
Learning comes from risking
If domination is the end, and humiliation is the beginning, then how does one go about charting a course from the latter to the former? The answer is that there’s no map, no beaten track, no light at the end of the tunnel, and absolutely no plug-n-play formula for this challenge. Therefore, one has to take risks and learn from the outcomes, so as to carve out a brand new path. It’s a rather obvious thing to say, not really profound at all. But this truth holds a profound implication when it comes to risk-taking in the real world - uncertainty means unknown. Thus the best we can do is to learn by taking small risks (so that we don’t go extinct), and keep repeating the process at an accelerating rate towards our growth target. All three authors hammer away at this notion of uncertainty and learning from their respective vantage points.
Christensen makes the case that well managed companies have a good chance to cope with disruptive innovations by creating a very different culture of learning, where the focus is on experimentation and nimble decision making at a small scale. It requires acknowledging that a new or emerging market is unknowable using the traditional methods of focus groups and market research. Those tricks work beautifully for existing, well defined, and highly exploitable markets. They do not work for a market that is invisible, or merely emerging on the horizon. The major consequence of this is that conventional accounting measures are hopeless in such an uncertain scenario. It’s fruitless to calculate any kind of growth projection and discounted cashflow when nobody actually knows just how big a market there is to exploit. Of course that would change after one has learned by taking small risks, so that all the conventional wisdom of good management and accounting would become rightly applicable. His point is that it’s imperative to understand that the effect comes after its cause - thus small risks lead to learning the cause(s) first.
Ries borrows from the scientific vocabulary to restate this truth in more familiar terms. For him, decision making in a startup is akin to hypothesis testing in science. The challenge is to state assumptions precisely so that they can be falsified by experiments. If assumptions withstand these tests then they can be treated as reliable foundation for further decision making in a repeat of the scientific method. This is really hard for individuals (if it were easy then we would all be brilliant scientists). So much of our psychology has evolved to be totally unscientific that it takes a lot of training, practice, honesty and integrity to obtain a scientific mindset. What Ries says in his book is again echoing Christensen regarding the fact that learning is the goal of risk taking. In fact, I see it as a causal relationship, in that learning comes from risking. It’s an instructive way of looking at science as well, since scientists are really taking fundamental risks in order to learn a great deal about the world.
What value is there in learning from taking risks? It’s a question that hints at the possibility of a market which actually attaches some kind of tangible (though not necessarily monetary) value to learning by way of risking. Thiel’s book arrives at this point along a curious tangent. He ponders the value of secrecy in terms of knowing something that others do not, as yet, know. Indeed, as he argues, the point of a startup is to capitalise on something secret. The nuance here is that “secret” means merely unnoticed by the rest of humanity but fully noticed by the startup’s founder(s) - which basically makes it no secret at all! The way I see it, he is articulating a long-winded version of the goal to learn by taking risks. He’s inherently taking for granted the fact that the founder(s) of a startup previously learned something that could be exploited. But the learning comes first, exploitation second. As a result, the value of learning lies in how the resulting knowledge can be exploited, whether for capital gains (as in a startup), or for social gains (as in a charity), or for epistemological gains (as in science). In that sense, I can’t fault Thiel’s reasoning and circuitous arrival at this truth, i.e., learning comes from risking.
Strength also defines weakness
The last of the trinity is a truth about asymmetry. Christensen explains it best, which is that the capabilities of an organisation also define its disabilities. He noticed that well managed companies were good at very few things, which they had progressively learned over time. So when they found themselves needing to be good at very new things altogether, they necessarily struggled, and most often they went bankrupt. He discusses various dynamics at play, which bring about such an outcome. The main point is that companies tend to specialise by moving towards the high-end of their favoured markets, which necessarily includes focusing on higher profit margins and accepting the underlying higher cost structures. Then, when disruptive innovators undercut and subsume the previously high-end markets, these well managed companies almost always become extinct.
Ries provides an insightful method of countering the tide of moving upmarket and specialising until extinction. He calls it pivot or persevere milestones. The basic idea is that at the end of each iteration through his build-measure-learn feedback loop, a startup has to decide whether it is going to persevere with current vision/strategy or pivot to something new and different. So he’s putting this stark choice at the centre of the picture for a startup, because the lesson from business history, which Christensen uncovered, is that pivoting is almost always overlooked by established incumbents in a market before going bust. Pivoting, as Ries articulates in the book, is a very difficult thing to pull off initially, for all sorts of cultural and psychological reasons. But it can be learned, and he shares many stories in the book where startups managed to successfully pivot many times. The essential truth that they all acknowledged was the fact that they learned to define their weaknesses by their strengths. It’s the clarity in mapping out one’s capabilities and disabilities that really helps to overcome all manner of biases against evidence-based decision making.
And finally, to round out this truth, Thiel asks a foresighted question: can the current market position be defended a decade or two from now? As hard as the future is to guesstimate, it’s still worth pondering his question because it necessarily focuses on the weaknesses that everyone tends to overlook. What he’s getting at by this question is the same pattern that Christensen observed in various industries, and it is the same argument that Ries is making in favour of quickly pivoting when the evidence points towards extinction. Furthermore, Thiel extends this with an insight about the valuation of a startup, which is that the vast majority of a startup’s profits is assumed to materialise many years into the future. Therefore, any growth strategy ought to worry a great deal about whether or not the current market will provably disappear in the future. For instance, any business built on exploiting very limited earthly resources will suffer when those resources are depleted - just a matter of when, not if. So it doesn’t make sense to invest in such businesses for the long run. Consequently, the short-term strengths of these businesses also define their long-term weaknesses.