Startups and the expert opinion fallacy
Imagine 100 people in a stadium. Write down their heights, round it up and take the average. I don’t know what your imaginary stadium looks like. Neither do I know who your imaginary 100 people are, but I can tell you for sure that the average you just wrote down is no more than 8 feet. Now, go back to the beginning and this time write down your contenders’ wealth and take an average. This time, it would be impossible for me to give you a range of this average number. I can make a guess about the average height, because I know it to be impossible for a human being to be so tall to raise the height average of 100 people up by so much to take it over 8 feet. However it’s completely possible to imagine only 1 of your 100 sample to take the average to $100M dollars or more from the global average of well below $10,000. By the way, how did you manage to get Bill Gates into a stadium?
If you are familiar with Nassim Nicholas Taleb’s brilliant book, The Black Swan, you know that the above experiment is based on his book. Height, Taleb says belongs to Mediocristan where things live within normal ranges and events are more or less predictable with reasonably normal impacts. Wealth however belongs to Extremistan where there is no limit to attributes and highly improbable events have a huge impact. Now you can think of quite few attributes that belong to either of those universes: Weight, number of children or siblings and number of pages in a book belong to Mediocristan. Wealth, YouTube viewers and number of book copies sold on the other hand, belong to Extremistan.
The Black Swan, is about the impact of highly improbable. Until the 17th century people used to think swans are only white. It was simply not possible to think of a black swan. However, in 1697 the Dutch explorer Willem de Vlamingh discovered black swans in Australia. Following black swans, Mediocristan and Extremistan, Taleb tells us how predicting the future in Extremistan is impossible, futile and potentially a bad thing. He tells a convincing story of how self proclaimed “experts” fill up the airwaves and newspaper columns to tell us about the markets and other things from Extremistan where their opinions fare no better than a coin toss. In Thinking Fast and Slow, Daniel Kehneman, the Nobel prize laureate in economics, cites numerous experiments where not only the estimates of experts were worse than random guesses but actually worse than of the average population (who fared slightly better than random chance).
What about startups? Which world do they belong to? Repeating the same experiment with 100 startups this time, can you guess their average valuation? Would it be possible for a single startup in your randomly selected group to be as valuable as the rest put together? Common sense and our experience with Ubers, Dropboxes and thousands of failed startups suggests they certainly belong to Extremistan. This is confirmed if you believe how VCs think of their portfolios: most VCs think the Power Law applies to their portfolio where a single portfolio company can be responsible for the desired return of the entire cohort, hence their non-stop talk of the 10x return. Peter Thiel famously said of venture capital: We Don’t Live In A Normal World; We Live Under A Power Law.
Now, don’t get me wrong. I believe in mathematics as much as those VCs and cannot disagree with their logic of trying to find companies that will produce a 10x return for their funds to beat the market. My point is that, in a world so firmly grounded in Extremistan where events are unpredictable, improbable and have huge impacts, how do they pick the winner? More importantly, how do they, and the founders they pick predict the future, forecast it, plan for it and succeed?
Since predicting the future is not my specialty, let me rollback the clock and see how things turned out from no more than 15 years ago. It is 2003. You are an entrepreneur and founder of a new company that helps people connect with their friends online. You are sitting at a beautifully crafted walnut table in an amazingly designed conference room with a view of sycamore trees on Sandhill road, trying to convince a brilliant mind, reputable investor and Harvard MBA to invest in your company. To make your case, you produce charts, numbers and quotes in an attempt to show how the future is going to look like and how that future is going to make that man 10 times more money than he’s investing in your company. This is 2003. Next year Google will be rolling out a social network called Orkut which for some reason will be very popular in a few random countries like Brazil and Iran but not in many other places. You’ve heard of a possible competitor called MySpace but not much more is known about them. Zuckerburg is still a spotty teenager living with his parents and Evan Williams has just sold Blogger to Google and it will be another 4 years for him to start Twitter. Snapchat founders are still asking their older brothers to buy them beer and What’s App founders are in the queue of their local soup kitchen. Now, can you tell me how you predicted the way the world would turn out to be in the next 15 years, expressed your vision to the brilliant MBA in the room and avoided the people in white medical coats he consequently called in from the local mental asylum to take you there “to make you feel a bit better”?
I don’t know the answer. If you are that person who’s pitched a social network in 2003 to a VC, I’d love to hear your story. What I do know however is how things turned out to be, with the benefit of hindsight of course. I know Google abandoned Orkut for unknown reasons shortly after that. I know Facebook became popular with college students, until their parents showed up on the site so they had to leave Facebook for Instagram and Snapchat. I know everyone thought $1B is an insanely high price tag for Instagram until Facebook bought What’s App for $19B and made Instagram founders look like losers. I know none of those who invested in What’s App could give me a reason why they invested in it and more importantly none of those who didn’t invest in What’s App could tell me why they didn’t. I know everyone thought Snapchat founders are rich, spoiled kids out of their minds for refusing a $3B acquisition offer until they went public. I know Twitter finally managed to be a business, more or less, or still is trying, this time in the public eye while Ev Williams started Medium to encourage long-reads, as if to resolve himself from his sins of making people’s attention spans even shorter. I know once they realised they lost the social media game, Google tried to enter the market again with Google+ but didn’t succeed and no one knows why they left the market they were in first and why they didn’t succeed the second time with all their might.
I know all this because we all know it, and we all know it because it is 2018 now. We watched this crazy movie for 15 years and it’s still not over. We don’t know if the 2016 US elections is going to have a lasting impact on how social media advertisement is going to work and regulated. We don’t know where the teenagers of tomorrow are going to hangout next year or if it involves disappearing pictures, enlarged eyeball video effects or cutified bunny ear face changers with voice modifiers that make you sound like a rat in a microwave.
We don’t know these things because we haven’t seen the rest of the movie yet but that’s not the point. The point is there is nothing, absolutely nothing in the past events in this space that can be used as an indicator of what’s coming next. In short, there is no value in history when you operate in Extremistan.
But now that the history has been played out, many “experts” have come out of the woodwork and tell us all about why Microsoft hasn’t created it’s own social media and why Google+ was a flop. If Facebook had sold to Yahoo! for $1B and turned into a social portal / media / advertisement entity with severe identity issues or had flopped and we were living in a Facebook-free world today, the same experts would have written hundreds of inches of OpEds on why and how accompanied by dozens of charts, numbers and quotes, trying to make sense of the highly improbable, high impact events and build their own personal brands and make a buck or two on the way.
The point is, startups are as extreme as Extremistan gets. As a founder, you can — and should — have a vision of the future. You can — and should — have faith in your ability to change the world (and reality) and execute your vision. Without the vision and borderline delusional faith, you won’t be able to make it. You might even want to raise capital from some of those experts, known commonly as VCs to accelerate what’s working for you. But don’t confuse what’s necessary for success with what makes you successful. More importantly, don’t ever listen or believe the experts who weave stories about the past events to convince you they can use those events to predict the future.
Those experts, journalists, investors, MBAs, growth gurus or whatever, are like Turkeys thinking they’ve figured out life just because; today, they were fed great food for the 1000th day in a row just to learn today is this thing called the Thanksgiving! Those who survive, will be writing another story about what happened and how it can be avoided next time, until the next Black Swan event of their lives. Your job as founder is to avoid believing those who try to use the past events as a way to tell you how future would be in Extremistan.
This article was published first here