Is Business Success a Coin Flip?September 2009
Jason Cohen recently wrote a great post about Survivor Bias, the tendency to focus on learning only from successful companies. I think much of what he says is on the money, but I couldn't help but question the comparison of repeated business success to a series of coin flips:
"So I put 1000 people in a room and tell them to flip a coin ten times. Sure enough, a woman named Margaret makes "heads" ten times in a row! The chance of her getting heads ten times in a row is only 1-in-1024, so I conclude Margret has special abilities.
The chance that somebody in a crowd of a thousand would flip heads ten times is a whopping 62%! Because so many people are attempting the feat, some normally-unlikely events will happen. This isn't a test of Margaret's abilities at all!"
This is similar to the coin tossing experiment described by Warren Buffett when talking about investing. It's easy to see the comparison here — when picking stocks, the decisions are limited and creativity is minimal:
- Pick a stock
- Choose when to buy
- Choose when to sell.
You can simplify the process enough to automate it or delegate to your 3-year old son. Sure, your 3-year old will probably lose all your money and resent you for the rest of his life, but the point is that somebody's 3-year old will make millions, grace the cover of Forbes, and become praised world-wide for his genius.
Starting and running a business is so much more complex, and there are many many ways you can screw it up: hire the wrong people, choose the wrong partners, build a bad product, choose the wrong market, undercapitalize, overcapitalize, set the wrong company culture, spend too much on launch parties, spend too little on legal counsel ... the list is near-infinite.
There are also varying degrees of execution. Putting together your marketing strategy or designing your product isn't a simple on/off switch like it is with a sell order on a stock. You can follow all the right steps, but execute poorly and results will be dramatically worse.
If you normalized all these decisions into coin flips, the number of flips in the lifetime of a business would be too many to count. You don't have to flip heads thousands of times in a row, but you have to get most of the important flips right.
By the way, I think the same can be said about successful career investors. I hardly think Warren Buffet's success just came from luck, whether or not any stock picks paid off because he flipped heads 10 times in a row.