Understanding policy through politics

3df4ad3In 1977 when Janata government first came to power on the back of a majority it messed the plot in about two and a half years. As heartwarming its success was (if the defeat of Indira Gandhi was considered the defeat of civil right suppression), its failure was not a surprise. It was the first time India had a non Congress government at the center. It was also the first time coalition politics came up. As much deft governing a country like India requires, so much more skill managing a boat running on coalition fuel demands.

At the backdrop of this, it is not surprising that Janata government had little to no institutional memory to draw its lessons from. It had no reservoir of prior experience and thus no skills in managing the country.

In 2011 Trinamool Congress(TMC) swept the Bengal Assembly elections. Poriborton or “a structural change” became the rallying war cry of TMC. Hopes of better governance and a steering away from leftist politics inspired the masses, on the back of which TMC registered its first assembly victory. It was the first time in 25 years Bengal had a non Leftist government. It was also the first time a non-Congress, non Left party won. It was the first time TMC had a major role to play in state politics. As much intellectual capital steering Bengal away from the embraces of leftism requires, even more so forging new policies (in a new political paradigm of cooperative federalism) demands.

Cut it any way which, TMC had a patchy record at best in governance.Ranging from  Ambika Mohapatro case to delaying of Teesta accord- spanning from refusal of FDI in retail and insurance to a general breakdown in civil rights in the state- TMC remains an immature political party at its best.

And it is not surprising because like Janata government- it is the first time for TMC- and it has no organisational knowledge to build upon.

In 2013 December, Aam Aadmi Party poised a significant challenge in the assembly elections with a stunning 28 out of 70 seats in its pocket. It was the first time a political party was handed the mandate to rule within a year of formation. Not only was it a 1 year old party but had no “repository” of politics and political management to draw from. It was an empty reservoir in terms of organisational knowledge.

And no doubt, that its failures were stark and serious- from its numerous skirmishes with the Centre to its abdication of Delhi on drop of a hat it was an unmitigated disaster in governance.Its janata durbars, a much touted governance measure on the lines of direct democracy had to be kept aside because of mismanagement; Somnath Bharti’s vigilantism to dharna politics – all were the hallmarks of a party wonderfully bereft of ideas.

However AAP defying history (abdications have very low success rate when judged by history) came to power in 2015 assembly elections with 67 seats. This time the general expectation was even a prodigal son should be given a second chance. But AAP has bungled and in large measure the last 5 months have ranged high on decibals low on intent.

Modi government is in many ways straddling the mean between these failures. BJP government in general has a reservoir of experience in administration. Modi himself has administered a state. But then their strengths are also their weaknesses. It has been 10 years that BJP administered country last and like anything time also depreciates experience by removing able hands from the gene pool/ service pool (e.g. Vajpayee, Shourie etc)

So if Modi government has had successes it was because of this past experience and its failures nevertheless are undoubtedly in areas where it never had new ideas in its repository and those areas which are uniquely belonging to Centre- “civil rights”, “education” etc (nitpickers may find fault in me classifying them as Central subjects while they are concurrent but think of crowding out effect- Centre’s precense renders state inconsequential)

It is not a surprise that in large measure knowledge acts like a muscle. And soft skills/managerial skills are even more so. Lets call them managerial muscle in short.

What are the areas where India has developed managerial muscle?

1. We are slowly learning to tackle public health – we have learned to tackle and eradicate polio- a big milestone in my dictionary. I believe in the next 10 years a lot of other public health mess will get taken care of : TB for example.

Just to think in 2009 we had the highest burden of polio victims. In 2012 we were polio free!

2. Learning mountain warfare- we have a big advantage over China in the sense that our defence forces have a much deeper experience of combat while China doesnt have it.

3. Disaster management- no explanations needed. Very strong and deep managerial skills and organisational knowledge here.

The deepest of social understandings should be fertile. And it is no different in this case. The idea of knowledge muscle can be very well built inside the framework of capitalism as well.

An entrepreneur who learns by successive failures  is a prime example of this- the same reason why venture capitalist firms discount first time entrepreneurs more aggressively than seasoned ones. A CEO who has gone through at least one trough in a business cycle also falls into this category.

And finally when Sanjay Bakshi mentioned that one of the causes of market myopia is a higher discounting of past managerial setbacks (Point 5 )- he was bang on because market is unable to tease out the nuances between corporate misgovernance and genuine setback.

Strangely this very same “mental model” can be used to separate the wheat from the chaff. Judge the man based on his access to “managerial muscle”.

Case in point will be to study the potential turnarounds:

1. Eicher Ltd.

In 1994 Eicher bought out Royal Enfield (RE), a high end motorbike maker and yet till 2000 Eicher continued to bleed in this segment. For an annual capacity of 6000, Eicher continued to churn out barely 2000 bikes.

Faced with a question of coast or shut, the iconic motorbike maker received a shot in its arm in the form of Siddharth Lal. A 26 year old die hard fan of Bullet (the iconic range of bikes from RE)  with substantial backing from the promoter family.

You see, he was a young scion of the promoter family.

He realised one thing very quickly. Tractor makers will have very low “knowledge/managerial muscle” to turnaround an iconic bike brand. He roped in R.L. Ravichandran- an able hand with deep experience in bike segment (earlier experience in Bajaj Auto and TVS Motors)

Reference: Business Today profile of the Eicher Turnaround

2. Ajay Piramal 

Ajay Piramal was a man who is the epitome of a managerial learning machine. His knowledge muscle got honed by repeatedly engaging in tough business situations- of management buy in, industrial conflict resolution and the works. Today he uses it to his advantage in solving simpler but more rewarding problems – like how to buy companies with able management.

3….

I wanted to add a third and fourth and fifth example to the list. But I am tempted to turn the mic towards you.

Where all, have you come across examples of “knowledge muscle” working its charm?

Competition Sutra #9: The games companies play-II

(…Or bringing disparate ideas together)

This blog post will try to connect multiple ideas together, some of the ideas are old but just that I understood them enough to appreciate them quite late, some of the themes discussed here are quite famous business episodes and of course how incomplete is an blog post on competition without invoking some old and famous Chinese thinkers.

Míng xiū zhàn dào, àn dù chén cāng

(Openly repair the gallery roads, but sneak through the passage of Chencang)

The less famous cousin of The Art of War is 36 Strategems- a Chinese essay to reflect on the tactics used in politics,war and also civil interaction.Notice an idea here- both politics and war renders beautifully to a game theoretic representation at least in the bare minimum complexity.

One of the key strategem in these competitive games is deception.

This is idea #1.

This is November 27,2003 and Reliance has just announced its foray in telecom with a national roaming feature, directly pitting against the encumbent Bharti Airtel. This is a major move and Reliance never takes any prisoners.

Bharti Airtel’s collar grew damp. Sunil Mittal’s collar grew damp. These guys are known to pick up a competitor, chew them alive and spit them out. The leadership team’s mood was sombre. Mittal at this point is reported to have given a Churchillian speech, something on the lines of-

We shall go on to the end. We shall fight in France, we shall fight on the seas and oceans, we shall fight with growing confidence and growing strength in the air, we shall defend our island, whatever the cost may be. We shall fight on the beaches, we shall fight on the landing grounds, we shall fight in the fields and in the streets, we shall fight in the hills; we shall never surrender

Mittal reportedly saw inspirational movies every day to feel and look like a fighter- even though he was deflated inside- (Rocky series being his favourite)

Exactly one year later- when the leadership team met once again to take stock- they knew one thing- they have stood up to the Goliath and stared it down.

Idea #2

I once read Prof Bakshi descibe an Aesopian lesson as an important mental model. The lesson being – “A hare runs for its life, while the hound only for its lunch”. I always dismissed it as a flight of fancy- “huh, an aesop fable as an investing mental model- what next? Mullah Naseruddin’s wittisms?”

While I do agree they can provide a nice operating system to live a life, but now I also do agree on the fact that it can be a very interesting mental model as well.

The following business case provides ample context

In 1993- HUL announced its entry into toothpaste business by introducing Pepsodent brand in Indian markets. Prior to that almost 80% of the market was ruled by Colgate-Palmolive.

The stocks of Colgate-Palmolive quickly fell. And fell as if it has been dropped by investors like it was hot!

Savvy investors muttered to themselves -Colgate is the hare and HUL is the hound and I am Aesop. They bought the shares on truckloads and eventually after a year or two when market realized that Colgate is taking the fight back to the HUL, the price of shares eventually corrected upwards.

Truth to be told, I never understood how can someone use such a subjective idea into backing up their own conviction. Doesnt it look like stretching the facts to fit the story?

Herein lies the kernel of our next idea. Ladies and Gentlemen- here is our idea #3. Or better word here will be  case snippet.

Three disparate ideas in one blog post. If your head was still not spinning, then let me add a fourth one here. Allow me to discuss the few key takeaways from the Chapter 11 of Competition Demystified.

Few takeaways:

#1: In the previous post, we discussed an important but albeit incomplete version of competition- pricing and localised expansion. This post will more specifically talk about entry/pre-emption.

I.E the different scenarios which arise when a new competitor decides to enter an arena, where already one or a few incumbents exist.

As such, the nature of quantity competition differs in fundamental ways from that of price competition.

#2: The first non-obvious difference between quantity competition and price competition is timing. While pricing change can often be executed within a short notice- entry/pre-emption cannot be . Significant lead times are needed to set up a plant and start production.

Its implications are clear.

While in price wars anyone can be a follower or a leader and thus all players are pitted almost equally (hence the matrix system and the Nash equilibrium plays out so beautifully in this form of games- zero sum games), in entry/pre-emption games one can almost always put his finger and say – “here Joe is the entrant and Harry is the incumbent”

Another non-obvious difference is the “permanence” of the decisions. Just like price cuts can be achieved very easily, so can the decisions to reverse it.But a decision to reverse a previously taken market entry decision will likely attract a lot more attention (“unwelcome” and “media” are helpful adjectives here), costly write offs (when Berkshire exited the textile industry finally by selling all the machinery in one swoop- WEB commented that anyone winding up will realised how big a gulf exists between realizable value of fixed assets and the amount that is carried in the books. I just can’t help but show you this link. Thank you for your patience! ) and most strikingly some rolling off the heads.

Given all of this- the propensity of an entrant to resort to aggressive decisions are reduced.

 

#3: What makes things even more complicated – is the “rules” of the game change with every slightest development. Let me explain:

The decision to enter is to be taken by a challenger, and all the defender can do in a general way is to resist the incursion. Assuming that the entrant chooses between two possible entry moves – full frontal assault and avoid, the world looks markedly different for the incumbent in both the cases. When an entry has taken place- by definition deterrence has failed. An aggressive reaction to repel the entrant can lead to expensive,drawn out conflicts involving price wars, costly advertising expenses and extensive promotions.

In such cases the decision to compete needs to be balanced with the idea of accommodation as well. Balancing here implies the cost-benefit checked.

#4  These kind of dynamical situations yield themselves particularly well to tree form of analysis(we will discuss this in a later post). The matrix form is suitable for pricing, marketing and product feature decisions which in general are more easily revocable and can be adjusted many times.

#5. The first step in a simulation is to identify the actors, their motivations and the initial choices that informs them.

Once the incumbent has made its choice- the entrant has limited flexibility. It can either retreat or advance from its initial position. In the extreme it may decide to back out altogether. But the nature of such a simulation implies that a large part of the outcome will be determined by the incumbent’s reaction to entry.

So if an entrant has to maximise his chances of survival, it can do everything possible to avoid provoking an aggressive response by the incumbent.

The following strategies can work to alleviate this problem:

  1. Avoid head-to-head competition (both RCOM and HUL were guilty of this). Focus on niches.
  2. Proceed quietly. Taking one small step at a time. Dont go all out on TV  openly proclaiming to capture incumbent’s market share.

The lobster dropped suddenly into a pot of boiling water struggles and tries to jump out. Lobsters eased into a pot of cold water which is then heated gradually, remain passive, even as they become dinner.

3a. Signalling works. Use signalling to send out non-confrontational message out. A single store is less threatening than five. A single plant that satisfies only 5% is less threatening that 15%. Idiosyncratic financing works- large and visible war chests do not. Note both RCOM and HUL were guilty of breaking all of them.

Startups working away in garages busying themselves not only in stealing an incumbent’s market shares but also killing their business models attracts nothing but derision and board room laughter.

3b.  An incumbent who has only one specialization, who has only one line of income will be that much more vehement in his response than those who have a hundred eggs to watch. (Note Bharti and CP both met this criteria and thats why Bharti and CP ran like a hare, or rather fought like lions while the entrant was merely a bloodhound.)

4. Move in one market and not all at a time.

5. If there are multiple incumbents an entrant should spread the impact of its entry as widely among them as it can. Doing a little damage to all is far better than doing total damage to one.

6. Keep your fixed costs low for the time being.

Any attempt by the incumbent to hit back will likely lead to a huge collateral damage because the incumbents have a lot more to lose (because quantity of incumbents >> quantity produced by entrant. So profits foregone by price cuts is that much larger)

At all times- the entrant must openly repair the gallery roads but secretly sneak in through the passage to Chencang. Which was our idea #1.

“The Gun” by C.J.Chivers

Every once in a while a book arrives which leaves you spinning, disoriented and exhilirated at the same time. This is that kind of a book.

This book is also one of those, which deftly switches narrative styles- traverses time and contexts and yet keeps an unerring focus on the underlying theme- the Automat Kalashnikova -47. Otherwise known as AK-47.

The journalism is sweeping, the research intensive and history rich- C J Chivers, its author,  at once makes “The Gun” a combined narrative of human fantasies, intentions, values, ingenuity and follies.

From the fantasy of Dr Gatling to produce an efficient weapon of war to end all wars to Leonid Minin who was the modern day merchant of death, lord of war arming insurgencies aroundthe_gun-tfb
the world – the scope and revelations of C J Chivers is broad and comprehensive.

The price of a Kalashnikov is the barometer of a society’s fears”

Chivers  covers the eclectic personalities of gun history from Gatling, to Maxim to Hugo Schmeisser inventor of sturmgewehr(German assault rifle of WW-II fame), finally to firmly focus on Mikhail Kalashnikov- the inventor of the AK-47. But deep within the story also lies the failure of the Soviet state and the paradoxes it gives birth to. Rarely in mankind’s history an invention has been made by deliberation by committees and finetuned and improved upon by an entire nation. AK-47 is an exception. AK-47 though was initially conceived by Kalashnikov and yet the final product which we today see is a gun made by committees, by deliberative bodies and push and pull of Cold War politics. AK-47 long ceased to be Kalashnikov’s gun and instead took a turn towards being the Soviet Union’s gun.

The Gun is also a story of the insurgency and unrest that mars the 21st century. As Cummings, a gun runner remarked, that the demand of AK-47 remains- “an index of human follies”

One idea that repeatedly repeats itself in the book is the apparent simplicity of design, the huge margins of safety attributed to the major operating system of the gun which decided its longevity.  Stories of child soldiers retrieving caches of AK-47 years after being buried and then testing them successfully tells a story of its durability. What made the AK-47 so robust?

Neither nature’s ravages nor human stress tests were able to find a fault in it?

In many ways- the core takeaway for me was simplicity trumps. American made M-16, were a shattering and embarrassing failure against AK-47 in Vietnam. They jammed!

But why did they? Weren’t American manufacturing processes better than Soviet ? Wasnt American industry more innovative than Soviet?

M-16 had a lot of flaws.And these flaws were a combination of misguided institutional preferences and blindfolded trudging in strategic space. But from the perspective of engineering- it was too perfect!

It used modern manufacturing techniques which used precision cutting, very high level of calibration and tolerance levels. It was tightly fit and the gap between moving parts was so less that only modern automation could assemble such an engineering marvel.

The idea of engineering precision which enabled man to reach moon (equivalent to firing an intercontinental missile to land on a precise volleyball) was put to use. Tolerance levels shrunk to millimeters and even fractions of that.

When compared to M-16, AK-47 was an abomination of craftsmanship. When one removed its spring, the entire mechanism rattled and jangled. The cartridge feeder system was so designed that when a bullet was fired, the bolt action which expelled the cartridge pulled back a full 150% of a cartridge’s length.

Now what does it mean?

Think about a gun- and the soldier wielding it. Like the soldier- the gun also will travel to various climates, operate in various punishing environments and in extremely stressful combat situations. The gun had to be robust enough to keep operating in all circumstances.

For an automatic, one of the major problems is “failure to extract”. Failurefailure to extract to extract implies a gun’s inability to eject out the spent cartridge( like below, resulting in jamming of guns like in right). This implied that the gun had to keep ejecting cartridges at all times. Now being an automatic machine gun – it comes with its own uniqueness. The gun has to keep operating in long bursts thus the temperature inside a barrel can go extremely high.

In such cases, metal expands in unpredictable ways and any “precision” casting part will soon jam. In contrast, AK-47 because of its huge margins of safety- operated without any hitch at all times.

Long operations also meant accumulation of soot, possible accumulation of dirt etc. AK-47 was so ably designed with enough tolerances that Soviet gun testers had difficulty in making it jam. It was dragged through sand, soaked in salt water and dipped in bog and yet it fired. In one revealing place- Chivers discusses how a friend of Kalshnikov described the tests after it was dragged through sand

Look, look, sand is flying away in all directions- like a dog shaking of water from its fur”

The system due to its inherent margin of safety was self-correcting.

The implications and lessons for an investor are clear:

1. Maintain adequate tolerance level in your thinking- account for stresses in your viewpoint.

2. Adaptability of mind (because of high margin of safety he has gained in being flexible) renders an investor profitable and less prone to adverse events.

 

As one reads through the book- the motif is clear. While Soviets were time and again ready to challenge status quo and imitate their opponents, America found itself hobbled and paralysed by remnants of past and blind shutting out of any criticism for self. For once- the Soviets became free thinkers and the Westerns became ossified thinkers.

And free thinkers- won again!

A commentary on Competition Sutra #8

This is an analysis and commentary of the case study posed in the previous post.

For Vikram Monga, the scenario is completely skewed against him. He can’t win. And any victory will be merely pyrrhic( hollow). Plus, the choices shown here reflect only one iteration of moves. But real life is a string of moves – each joining with the next, caused by the previous. While a rational choice suggests to move to the Nash Equilibrium i.e. move towards price cuts and let the game play out. If Sam turns out to be truly wise he will also respond with his cuts. Not cutting will steal his customers, expanding physically to gain them back is suboptimal. Which implies there is only one action left for Sam to respond – price cut of his own.

As a result, a price cut will be matched by a price cut. But lets think from a different perspective. This game can be played once more, and again the same decisions will be taken – price cut matched by a price cut (perhaps this time Sam will cut the price first to force Vik’s hands).

When you set out to dig a grave for someone, dig two.

What looks optimal in short term, may turn disastrous in the long run. Having a long run perspective is perhaps the most important skill for a successful leader. If Vik realises that a price cut will initiate a chain reaction, then he can very well intrapolate that one day the margins left will be as thin as a wet tissue paper. He may walk into the sunset as a gung-ho leader who played a “no-holds-barred” game with his competitors and who knows the business media might celebrate it as well- and yet his successor will none the less be worse off.

A simple thing for Vikram to do is to choose to not to do something. That is- don’t disturb the apple cart, do nothing, choose nothing, let the status quo be maintained et al. However if he must he can try to completely change the nature of the game:

When you can’t win, change the rules

One of the big takeaway from this game is that there are certain rules at play. However real life is varied and different with its own dynamics. Vikram should try to change the rules of the engagement altogether

a. Invent itself as a platform: Can B&M increase the engagement of an average customer with its products and services? Can it make the average customer interact with the existing setup? And in the process can it give some value to her? Think how Target drives its business. It doesn’t see itself as a dispenser of products, it sees itself as a dispenser of retailing experience. That way it can turn the rules of the game on its head by imposing a psychological switching cost on the customers and monetizing it by raising the prices.
b. Niche, Niche, nice! : Can B&M and Jubilant Retail come to an unwritten, tacit understanding with the help of (plenty of) signalling to divide the offerrings completely among themselves? One of them completely focusses on the home and kitchen appliances, while the other stocks it minimally (else regulators will catch hold of them) and focusses completely on entertainment.
c. Loyalty Programs: Airlines do it, so can retail. Vikram should focus on increasing the psychological switching cost for his customers. Cutting price is also a kind of imposing a switching cost on the customer- but it is the feeblest and the weakest cost because anyone else can come in and undercut your price.

Competition Sutra #8: The games companies play

 

Vikram “Vik” Monga is thinking hard. And if he isn’t, he should be.

For Vik the piece of paper lying in front of his was telling everything he needed to know. And he was right. The situation is messed up- with no avoiding of the blood bath that lay ahead.

 

52 year old Vik was the CEO of Bentham & Martin – one of the largest retail chains in India and the largest in Eastern India. However for Vik, life wasn’t easy. He had Jubilant Retail snapping up at his heels.

Jubilant Retail was the new kid on the retailing block. Started merely 12 years back, aggressive expansion was in its DNA. It was almost as if the entire team of Jubilant were a bunch of toughened gun slinging westerners. There was Samarth “Sam” Prakash- their CEO, a young man with a taste for hard negotiation, close competition and fast expansion. 8 years back, Sam broke the back of a local suppliers cartel by acquiring a Bangladeshi supplier. At that time, the local suppliers scoffed at the move. But by the time they  scrambled to prevent the damage, their demise was cast in stone. Since then local suppliers stopped holding their prices high and Sam got cheap inventory.

Till now the Bentham & Martin had 450 stores in Eastern India. Jubilant Retail has 390 stores. 8 years back it was an expansion machine, but today it has settled down into an uneasy truce with Bentham & Martin. However, the low number of stores shouldn’t be judged as a giving up by Jubilant Retail. Bentham& Mills and Jubilant Retail were competing store for store in the most profitable circles of Eastern India. If anything, it didn’t compete in the sub 450 circles (Circles are divided as per the average billing rate of an individual customer unit- even a family shopping together will be counted as one customer. 450 implied here the average billing rate. It stretched to maximum 980 evident in metros to a minimum of 300 evident in tier 3 and 4 cities).

For Vik the problem was two fold. Western India was slowing down and to maintain the profitability he had to milk the Eastern cow. But milking the eastern cow was not easy. Any move to break the uneasy truce in East will lead to a bitter tooth and nail fight for market share.

It was a dicey situation indeed.

What in the hell is brewing here mate, muttered Vik to himself. If he opens new stores, Sam will mirror each move with his own store in every new circle. Result, driving real estate prices preventing further expansion, a decline in footfalls. This will kill the profits for both the firms and the net profitability per customer for both will fall to Rs 15/cust. However if Jubilant Retail decides to cut the prices- Bentham & Martin will be left holding the bag – Jubilant’s per customer profitability will outstrip Bentham’s.

 

For Vik Monga- the situation was worse than it looked. Any move to cut prices can create a converse situation where Jubilant responds by building new stores ( which will create the exact converse replica of the case where Bentham expands physically and Jubilant cuts prices, with the exact concomitant result) or matches the price cut by a price cut. In the later case, a price cut when matched by a price cut will give them both a near about the same net profitability per customer. Only, the  profitability difference between the two will shrink from 8% to 4%.

But for Vik – it was both a blessing and a curse that most probably Sam was also doing the same calculation. The blessing it was because in such a wafer thin margin business a dumb competition can kill the entire sector. Curse because dumb competition also meant easy lunch for the smart. And for Vik the balance was completely skewed. While he was given four choices – two of them were just decoys. And he understood it very well. If he played the game for a long time where each of them chose differing choices (i.e. not mirroring each other) then the resultant payoff for each player will  be sum of probability weighted profits ( in this case 50% of 30 + 50% of 20 = 25).

Bloody decoys. 

 

Vikram Monga looked up at the clock. It was 5.30 pm already. His  8 year old grandson had a school play today and he wont be missing it. He took off his jacket off from the chair, swooped his arms in. But his mind was still racing, he was thinking about the situation and mess both of the companies are staring into.

It’s a cesspool of blood, mud and filth. All the choices lead to either one of them.

If you are the advisor to Vikram Monga, what advise would you give him ?

The onus is on us to think better

Who are you?

A fox or a hedgehog?

Do you tend to take rapid decisions even if faced with low evidence?
Or mull and deliberate over possibilities?
Perhaps you think through the circumstances, even though people are losing their head.

Quick decision making is valued in our modern civilization. We have subconsciously associated itself with confidence, life-force and ‘tenacity’. However, decision making in reality is not a race. It is a game of chess. And like any game of strategy, one has to think deeply through the options.

We seldom do.

I myself have fallen to this serious flaw in my past. And as I write this, I am trying to completely uproot this vice in me. Its hard, because thinking rationally is tough. Our brains which operate on that level are lazy, demand lots of energy and are prone to fatigue.

But as they say- in the land of blinds, the one eyed man is the king. In a land of System 1 thinkers, a barely decent System 2 thinker is the king.

But has our education trained us to think rationally? Has the responsibility entrusted to our knowledge providers, to our teachers, parents, schools worked for our benefit?

The answer is a vehement NO.

We have failed ourselves in learning to think well and we have failed in teaching the same.

Tetlock

Philip Tetlock in his book Expert Political Judgements: How good is it?How can we know? presents a mind boggling finding. Over a course of thousands of decision making problems (easily running to north of 10,000) he analysed the ability of people to make decisions. He categorised them on the basis of their dominant framework of thinking.

That is, whether a certain group tends to take extreme positions, lacks the ability to rationally account for contradictory evidence etc (hedgehogs), or they take very calculated, thoughtful decisions always recognising that there are pitfalls in everything (foxes).

In short, hedgehogs have a single dominant frame of thinking, foxes have multiple framework of thinking which are often mutually contradictory. With the foxes because they are able to not only understand the differing forces shaping an event, but also judge the relative strength of such ‘forces’ they tend to take a ‘centrist’ position. Probability guides their actions and not beliefs.

Tetlock involves even more categories of people – hedge-foxes (a combination of two , with hedgehogs dominating), or fox-hogs (foxes dominating), mindless algorithms or even the base rate exploration which Daniel Kahnemann explores in his book Thinking Fast and Slow . Then he considers, how does a moderate amount of “case recognition” look like (that is mindless algorithms + some amount of human intelligence to consider whether this is an extreme case or not).

And lastly he considers the hallowed students of Berkeley University. The result is for everyone to see.

The Philip Tetlock finding on the efficacy of judgements- calibration and discrimination (explained below)

The Philip Tetlock finding on the efficacy of judgements- calibration and discrimination (explained below)

What does calibration mean?

It is the difference between the subjective probability and objective reality. In other words prediction versus reality. Expectation vs Truth… and so on.The author plots the graph on the basis of the “Improving Calibration”. That is the closer the predictor is to truth, more towards the right he will lie.

What does discrimination mean?

It implies the ability of a person to discriminate between cases. Not all cases are same, yet people who cant develop the nuance to understand the difference will have low amounts of discrimination. In other words they will lie lower in the graph than others. It is obvious that discrimination will be lower for a person who sees everything through “one lens”. He will be more prone to take extreme positions.

Drumrolls please!

Foxes trump hedgehogs. Hands down. In every metric.
But the foxes are not the big-daddy in the decision making world. They get serious competition from algorithms with even a slight amount of discerning power (point 35,36). And trumping even that, is the power of formal models (point 37).

Imagine a fox maintaining a ‘latticework’ of mental models in his mind, following a checklist in his hand and a collection of formal models which sits along with the mental models!

I think he will be a formidable competition.

The formal model mentioned by Tetlock doesn’t imply anything fancy. It can be as simple and robust as regession equation.

And can you spot the Berkeley students in the chart? These undergraduates, the brightest of America rank even worse than the hedgehogs.

Ladies and gentlemen, our education has failed us.

No matter where we live and which university we study in, we are not adept at making the decisions we are expected to make in real life.

The onus is on us to move from the lower leftmost corner to upper- rightmost corner.

Replicator Dynamics: A Mental Model

Replicator Dynamics as a mental model is an interesting concept. And it is pretty easy as well to apply. This phenomenon is observed so abundantly in real world and is so fertile (i.e. it can be used in different fields) that I can’t imagine not knowing it before.

Throughout the animal and plant kingdoms nature has sprinkled replicator dynamics abundantly. So much so that, even though we humans have evolved to the highest peak of civilization, we still rely on our instincts of following this phenomenon.
The central actor in this system is an ecosystem of species. In such an ecosystem, the animals are able to replicate or mimic the behaviors of others. However they would always like to maximise their own ‘profit’ or benefit from following any behaviour. Let us consider this as [Payoff 1].
But the animals in these species wont like to be following a particular strategy which has a certain payoff but loses the benefit of staying in a herd. So lets call the benefits of staying in a herd as [Payoff 2].
Species would like to maximise their net payoff, hence they will try to maximize the combination of both the payoffs.Let us try to understand it with an example.sttk01

Humans follow the dressing norms of the culture they live in. That is they are replicating what their their society is doing. Since ‘norm’ implies that a particular dressing style is accepted by a large number of people, hence sticking to the norm has very high payoff of the second kind [Payoff2 i.e.]. This behaviour offers them psychological comfort in ‘sticking to the herd’.

However, if a particular dressing style is started by a celebrity [think: meat gown of Lady Gaga] people will be thinking and trying to estimate their benefit derived by following such a radical fashion style.

The famous meat gown of Lady Gaga

Now any person will be asking these questions to himself:

1. What material benefit does wearing a meat gown offers me? [estimating Payoff 1 of new strategy]

2. What psychological benefit will I receive by switching to a meat gown? [ estimating Payoff 2 of the new strategy]

3. What psychological benefit am I receiving by sticking to our current dressing norms [ Payoff 2 of current strategy]

4. What material benefit am I receiving by sticking to the current dressing norm.[Payoff 1 of current strategy]

So if benefits estimated of Question 1 and Question 2 is greater than Question 3 and 4 then switch.

  Now say we have a host of strategies and some percentage of population following it. The evolution in the population will depend on these four questions asked by their individual members to themselves.

Hence we see an evolutionary dynamic being set up. This leads to a change in the population of animals following the strategies. They can co-exist, if the material benefits by switching is not too high, or they can lead to winner takes all kind of a situation.

 

Martin A Nowak

Nowak_SuperCooperators1
It’s the same idea which led the famous biologist/mathematician Martin A Nowak to set up his ideas in his book SuperCooperators to explain the various evolutionary/ social /cultural observations like:

1. “Winners Don’t Punish”

2. Evolution of Human Language

3. Generous tit for tat behaviours etc.

Take a look at the following video of Drongos and their superb evolutionary ability. See if you can find out the replicator dynamics which led them to be such superbly clever birds.

 

For a business side of it, take a look at how I tried to predict and think of potential future of the Wells Fargo credit card here

I will end this post by mentioning one last idea. Turns out, if in an ecosystem there are lots of strategies surviving then it is far more robust and can survive a far greater number of shocks. So you can now think, why in the peaks of the bull runs, where only one strategy survives [that of ‘greater fool’ strategy] the stock market becomes highly fragile and any change in the macroeconomic condition [like liquidity squeeze due to higher inflation] sends the stock markets in a tizzy.

The Trust Factor: The Piramal way of doing business

Ajay Piramal channels Warren Buffett. He follows him in his entirety. With all his warts and moles; idiosyncrasies and ingenuity.

A copycat? What’s wrong in it though?

But it will be an insult to Piramal to merely call him a blind follower. He is a true believer in the ethos of Buffett and Munger.
He just doesn’t limit their teachings in business, but mixes it liberally in his life and the way he conducts himself.

Take a moment to think about it. Why do we exactly adore Buffett?
We may adore Munger for his extreme wisdom, rapier wit and piercing observations.

But why Buffett?

Because he is a billionaire?
Because he is the most successful investor- a true rags to riches story?
Because he embodies self-sufficiency?

Perhaps. And perhaps not. There are umpteen other people with similar stories. We might not accept it but we adore him because he inspires trust.

He shows amazing consistency in his behavior, words and belief. He surrounds himself with people of similar impeccable integrity and prevents the use of legalese as a crutch for trust.

This is perhaps the least highlighted aspect of Buffett. He is extreme in identifying and cutting needless costs. And legal experts, consultants are nothing but that.

He rightly understands that human beings can and will game the system, and a legal document cannot protect him. What he employs is empathy, trust and marks human relationships as the bedrock of business.

He is known to acquire companies based on mere handshake. In contrast compare that with Daiichi -Ranbaxy deal. Plenty of investment consultants, plenty of legal documents and still plenty of hassles.

In economics there is a concept called signalling mechanism. Someones actions not only has a direct outcome to it, but also gives off an information.  That is every action also implies something.

Legal documents signal something as well. It implies- “I don’t trust you”. It implies- “I trust the legal guys, the investment consultants with skewed incentives far more than the person on the other end of the table.”. Humans are born with a superb skill set to game existing systems. Call it ingenuity, call it creativity. You just dont want to be on the receiving side of it.

And this signal subconsciously “inspires” unethical behaviour.  Traditional  ideas of buyers beware kicks in. The seller subconsciously understands  that trust is not expected of him. And he might as well game it.

Which brings us to two important mental models–  Expectation and Seamless web of deserved trust.

As natural beings, we are programmed to reciprocate.  And when we tell someone not only in words but also in action that we trust and thus we expect him to cooperate and trust us back- we don’t make him/her our adversary- we make that person our ally.

And what does lack of trust do?

Lack of trust led to World War I.
Lack of trust lead to arms races.
Lack of trust is costly.

Seamless web of deserved trust ought to be the bedrock of business. What does it mean? It means trust generated through one’s own action, and hence deserving. “Seamless web” means consistency. Consistency in every aspect of one’s conduct. So trust generated through consistency.

Its a tough way, especially when perverse incentives exist; but try distrust once and you will understand what I mean.

Which brings us to Ajay Piramal’s knack of doing business efficiently.

Take a look at this article:

Specifically this line:

When they met, Pirmal, who had stitched more than 20 deals without using any bankers, expressed reservations.

20 deals without using any bankers! That’s a substantial confidence, huge amount of trust and an inordinate amount of cost saving.

Cost saving not only in banker fees, but in potential headache down the line. This action signals something.
It signals- “I trust you”

The article continues:

It also marked the beginning of a personal relationship that was rooted in financial services, but routinely sidetracked into business values, classical music, maths and spirituality, among other things.

Whoa!  How many business deals take place like this? I have seen hardball i-bankers conduct negotiations with their one hand sms-ing under the table .

Why?
To do course correction on ball busting !

Swati Piramal says her husband also has a unique ability to bring a personal touch to business relationships. For instance, on the eve of the deal with Shriram Capital, the Piramals hosted Thyagarajan and his family to a meal of South Indian delicacies prepared at home in Piramal House. Many of the deals he does are based on a personal equation, she says.”

Emphasis mine. Last quote taken from here

Markov Inequality: A mental model

Markov Inequality is one of the most useful mental model I have ever come across. In my opinion, a good mental model not only helps us to draw good predictions (nice but not the most important thing), but it holds a mirror to our estimations and ideas.

  • What is the probability that political party ‘A’ gains above 273 seats in the House of Commons when the expected* number of seats is about 200.
  • What is the probability that the Acme Inc will beat the market estimates in topline, when the expected* sales in such economic scenario is about 1/3 of market estimates?

 If such questions can be answered with relative confidence (approximately and not necessarily precisely) then as investors, as wise citizens of the world we will be better disposed.

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