Survivorship Bias in Venture Capital: Or Why Looking At Unicorns Tells You Very Little

Like the “Seven Habits of Highly Effective People” and the “48 Laws of Power”, “What Did Billion Dollar Companies Look Like at the Series A” relies on a fundamentally flawed assumption.

It’s familiar to statisticians as survivor’s bias. Abraham Wald, a mathematician who worked for the Department of War Math during World War II, encountered precisely this phenomenon. Short of retelling the story, I’ve attached a very excellent article.

Survivorship Bias is defined as “the logical error of concentrating on the people or things that ‘survived’ some process and inadvertently overlooking those that did not because of their lack of visibility.” It’s also known as sampling bias. This is the problem that plagues and negates the arguments made by Francis.

He argues that the following are factors of success. We aim to show that this argument is false and that in many cases the unicorns succeeded in spite of these factors.

1. Easy-to-Dismiss Ideas

Francis argues that “the biggest ideas are not clear when you first see or hear them…”. In fact, “many billion dollar companies have ideas that were easy to dismiss at first”.

Your local groceries cashier pitches you an idea. An app that keeps track of where your car is parked. All you have to do is write it down. How is that any different from using the notes app, you ask. Because it’s for the smartphone, stupid!

Not all dumb ideas will make it big. In fact, the vast majority never do. They trip over the tiniest of critical examinations and fall face flat against the truth that what sounds stupid usually is.

The few that survive and defy the convention may make it big. But that doesn’t mean they were successful because of the seeming stupidity or improbability of their idea. They were successful in spite of it. That they could find willing investors in something so astonishingly likely to lose its entire capital investment is a miracle per se. One of Francis’s examples, Airbnb, failed to impress Paul Graham with its idea. The investment was made mostly because of the likability of the team and their resourcefulness of selling campaign posters during the ’08 presidential election to keep the company afloat.

2. Competitive Markets

Francis says that “many billion dollar companies we examined are in highly competitive markets.” In fact, “highly competitive markets are ripe for disruption…”

Economists understand that in an industry with high economic profits and low barriers to entry that other firms pile head first into the industry, drawn by the scent of money. This is the case here. Let’s take WhatsApp as an example. The potential profits in messaging apps is enormous. I concede that WhatsApp didn’t focus on marketing or advertising as a source of revenue. But its founders, Jan Koum and Brian Acton, knew exactly what they were getting into. The story goes, getting their hands on the iPhone, that they knew a app market place would take off and growth would be astronomical. This is synonymous to economic profits. There was money to be earned.

But purposefully piling into an already crowded market is not a motivator for success. Competition in this case means that any one firm is more likely to fail for any variety of reasons: poaching of talent, price wars, service inferiority, commoditisation of service or product, etc. The unicorns survived in spite of competition, not because of it.

3. Reinventing Existing Consumer Behaviour

Francis argues that “billion dollar consumer companies generally reinvent existing behaviour with a superior consumer experience, rather than bringing something radical and novel to the market”.

We are resistant to change. Inertia drives us. Routines rule the vast majority of our lives. This is the case for adoption of new technologies. It’s the axiom undergirding Roger’s innovation curve.

Only a tiny minority of the population will bother with your “revolutionary” aka behaviour changing technology. If and only if it survives that gauntlet, and few do, will others start to take notice.

Only those that actually changed our behaviour manage to survive. The countless others who failed haven’t left a mark on our daily routine nor our consciousness.

4. Untested Founders

Francis finds that “most often untested founders, rather than experienced entrepreneurs, who are at the helm of large, fast growing companies.”

Out of 1000 new companies dreamt up by untested founders, only 10 will survive to the billion dollar stage. In that sample of 10 surviving companies, we will find that 100% are run by untested founders. Is this evidence for advocating for the green and inexperienced as CEOs? No. The overall survival rate is 1%. If you want to most likely run your company into the ground, hire the next passerby on the street and appoint him CEO.

Consider also that all the experienced technology executives would much rather stay with their cushy seven figure salaries and similar bonuses, rather than risk their time and money on ventures with survival rates that average <1%.

[Estimate taken optimistically as more than 10% of 5% of the acceptance rate of YCombinator]

5. Zero Monetization

Francis states “that many of the billion dollar companies were not monetizing their customers at the time of their Series A round”.

This may be an anomaly of the current times. As it was during the dot-com bubble of 2000. As the Silicon Valley has pointed out: “no one cares about revenue!”

But we know that no company can survive forever without generating cash flow. That necessarily means monetization. If the unicorns are not making money by series A, they’d better be doing so soon.

I wonder: how many companies have failed because its founders failed to find a business model which could at at least breakeven the initial investment?

What we find is that instead of insight, all we have are traits exhibited by the survivors that fail to tell us very much about why they’ve survived and thrived. And the truth is: no one really knows.