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Startup general interest

Helpful cognitive biases and their interplay with rational thought

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In November 2013 I saw the headline Five cognitive distortions of people who get stuff done, and thought “wow – all the cognitive biases I know get in the way of rational thought and are unhelpful”. My surprise at finding that irrational thought could be useful prompted this post at the time.

Since then I’ve been on a (slow) journey to understand the interplay between intuition and rational thought, particularly helped by Daniel Kahneman’s Thinking Fast and Slow and Richard Haidt’s The Righteous Mind. I wrote a number of other blog posts too, most notably Thinking fast and slow at a VC fund, Debating with intuition as well as logic, and How our rational brains justify our intuitive decisions.

The more recent posts are mostly about recognising the role intuition plays in our decision making and how to counter it when appropriate. My understanding of the importance of intuitive thinking was limited to the fact that it helps when decisions need to be faster.

Then this morning I read How Our Delusions Keep Us Sane: The Psychology of Our Essential Self-Enhancement Bias on brainpickings. It took me right back to the November 2013 ‘aha moment’ that in the right places and right doses irrational thought makes us happier and more successful. The article opens with the following paragraph:

“Optimism is the faith that leads to achievement; nothing can be done without hope,” Helen Keller wrote in her 1903 treatise on optimism. But a positive outlook, it turns out, isn’t merely an intellectual disposition we don — it’s a deep-seated component of our evolutionary wiring and the product of powerful, necessary delusions our mind is working around-the-clock to maintain. At the root of that mental machinery lies what psychologists have termed the self-enhancement bias — our systematic tendency to forgo rational evaluation of our own merits and abilities in favor of unrealistic attitudes that keep our ego properly inflated as to avoid sinking into the depths of despair [and keep us motivated when times are good].

There are two points of interest here. Firstly we are wired to be irrationally optimistic about our own abilities. Early primates who kept believing when times were hard survived and mated more often than their more pessimistic brethren. Hence being rational is hard. Secondly, being irrationally optimistic is useful – at least sometimes. Puncturing the bubble with rational analysis might result in a loss of motivation with no discernible gain.

When I think about this in the context of business activities it seems to me we need a switch. The vast majority of our opinions and hence decision making should be rational, but allowing a dose of unconscious irrational optimism helps us motivate ourselves and others. It’s how we achieve the seemingly impossible. However, we need the switch when that irrational optimism stops serving us well. When I was at Reuters Venture Capital, for example, we worked like crazy to raise our second fund in the tech nuclear winter of 2001-2003 and kept believing, but there came a point when we flipped the switch and gave up. That was painful, but it was the right thing to do. To keep trying would have been like banging our heads against a brick wall.

The challenging thing for teams is that different people have different levels of optimism, and it gets really hard when one person wants to flip the switch and others want to keep believing. That’s where the leader needs to carry her organisation (and make sure her switch is in the right place). The example I gave above was literally life and death for us, but the same dynamic plays out all the time at much smaller levels. In VC firms it often relates to whether investments will get made, in startups it often relates to whether partnerships will deliver, sales will be made, and key metrics will move. Establishing clear parameters in advance that will lead to the switch being flipped takes discipline, but is one useful trick.

Fascinating stuff.

If you have a few minutes I heartily recommend you read the full brainpickings article.

How our rational brains justify our intuitive decisions

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I’m sure you’ve heard about how unless we’re careful we very often make our minds up about things in just a few seconds – decisions on candidates in job interviews is a well known example. Here’s how that happens.

  1. We make an intuitive, largely subconscious, decision based on what we’ve seen and learned over the years, a decision that will often display all of our prejudices and biases.
  2. The rational side of our brain seeks justifications for our decision
  3. As soon as it finds a justification the search stops. The case is closed and we move on to thinking about the next thing.
  4. We become resistant to opening up the debate again.

You might have spotted the flaw in this process already. The rational side of our brain doesn’t make a balanced assessment of the evidence it only looks for one piece of evidence to prove the case. There are pros and cons in every complex decision so we are always able to find something to justify our position, even if the weight of the evidence is wholly in the other direction.

If more rational decision making is the goal, and in a business context it generally should be, then the first step is to be aware that we all have this tendency. If you are hit by a wave of irritation when someone presents you with data that suggests you should change your mind try to take that as a signal that your rational brain might be losing out to a faulty piece of intuition.

None of us can get over this problem entirely, and rapid intuitive thinking is often appropriate.

Four reasons why startups fail

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We see a lot of startups that fail, it’s the nature of the beast in an environment that is so incredibly fast moving and competitive. These are some of the more common and avoidable mistakes that we work hard alongside our partner companies to help them avoid.

This post was inspired by John Zeratsky’s post Eight common dysfunctions of design teams. Design is at the heart of a lot of the early important work at a startup, hence the overlap.

  1. Starting with solutions – founders start by having an idea and then most check it’s feasibility by visualising a solution. That’s the right thing to do. However, having established that there’s one potential good solution the best next step is to go back to building a deeper understanding of the problem space and customer to check if there’s a better solution. This applies to everything – product features, visual identity, copy, UX, tech stack and go to market strategy. To avoid this mistake spend time with customers and establish goals and metrics before creating solutions.
  2. Groupthink – these days companies and their products and brands need to be remarkable to win. In Zeratsky’s words: “Groups are no good at making decisions—at least not the way we normally do it. We want everyone to be happy, so we talk and talk until we’ve reached consensus on a decision. And we let social dynamics get in the way: power relationships, seniority, loud mouths, etc. This all leads to decisions that nobody is excited about—decisions that don’t reflect a unique, opinionated perspective.Solution: Use voting to capture everyone’s opinions, then lean on the decider to make the call.”
  3. Polishing a brick – as Zeratsky says, we spend far to long polishing and perfecting unproven solutions. These days a minimum level of quality and design is required before people will take notice of a new solution, but understand what that is and ship as soon as you’ve reached it. If you find yourself believing that your product will only work if it’s fully featured and highly polished you should go back and double check whether your core proposition is strong enough. To avoid this mistake give yourself deadlines that you can’t get out of. Being clear on what you have to achieve by when to get your next round of funding and breaking that down into monthly targets is a great discipline.
  4.  Shaky foundation – every startup is built on a foundation of assumptions about the customer, the product, and the world. Too often founders let those assumptions go untested, even unstated. In The Path Forward we advocate first making sure that the company’s idea is valid – and that requires listing out the assumptions and testing them to know that the fundamentals of the business are strong, that there is a need for the product and that the company has the right skills to prosecute the opportunity. Many companies move too quickly to focus on the product or even on scaling the business, but if the foundations aren’t strong growth will always be more challenging and will eventually falter. Solution: Follow The Path Forward to validate your idea and lay strong foundations that will allow you to build a valuable business.

Evolving “openness” at marketplaces

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I just read the following quote in a post about platform failures:

Because platforms depend on the value created by participants, it’s critical to carefully manage the platform’s “openness” – the degree of access that consumers, producers, and others have to a platform, and what they’re allowed to do there. If platforms are too closed, keeping potentially desirable participants out, network effects stall; if they’re too open there can be other value-destroying effects, such as poor quality contributions or misbehavior of some participants that causes others to defect.

Marketplaces are a type of platform in which Forward Partners routinely makes investments. They make up around one third of our portfolio. We love these companies because (done right) they are better for the supply side and the demand side and because at scale they exhibit significant network effects which make them very valuable.

The early marketplaces were modelled on stock markets and were very open. Companies like ebay offered full visibility over supply and demand, few restrictions on who could use the platform and let the marketplace determine pricing. More recently marketplaces have started operating more curated models with much less transparency and more control over pricing. Uber is one of the more extreme examples – as I imagine you know passengers have to accept the car they are given and Uber decides on the pricing.

Amongst our more recent marketplace investments Lexoo is a good example of a highly curated marketplace. They connect companies with legal services but rather than have an open marketplace where customers browse through lawyer profiles they’ve built a sophisticated matching engine which identifies the best lawyers for a particular job and gets four of them to quote within twenty four hours. Similarly ClickMechanic, another of our partner companies, fixes the price of jobs that mechanics do through the platform and finds the mechanics rather than asking the customer to do the work.

In the Uber, ClickMechanic the Lexoo examples the marketplace is doing much more work than a more traditional model. Companies like ebay find the supply and demand, optimise the browsing and search process, build trust systems, and then process payment, whereas marketplaces like Lexoo, ClickMechanic and Uber are doing that, but also assisting much more with selection and making sure the transaction runs smoothly.

Getting the right level of ‘openness’ is critical to marketplaces’ success. In our experience finding the optimum level starts with the founders’ vision and then evolves following customer research and how the supply and demand side respond to early versions of the product. There’s no generic right answer but rather individual marketplaces need to find the solution that works best for their supply and their demand, as measured by conversion. The less work a marketplace does the cheaper it is to build, of course, so there is a trade-off between cost and time to market on the one side and conversion and customer satisfaction on the other. As marketplace models are moving to new industries with more complicated transactions the trend is definitely towards more cost.

 

When to hire big company people into your startup

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Investors often put pressure on startups to hire senior people from big companies. Sometimes that’s for good reasons, but sometimes it’s because it gives them good sound bites and the illusion of progress. When VCs can say “Our investment just hired the product manager for ‘XYZ important product’ from Facebook” it makes them feel better and look good at cocktail parties. Cynics call these ‘CV hires’, and it’s not just VCs who make this mistake. CEOs and founders do too.

Over the last few years it’s we’ve seen an explosion in the number of European startups that have reached scale, and that’s changing the hiring equation. It used to be that if you wanted a big name on the CV you had to go for a large established business, and probably one that was headquartered in the UK. There are now a good number of sizeable scaleups with people who were there when they grew from being a small company to a larger one and want to go and do it again at another startup. These people combine bigco experience with an understanding of startups and are gold-dust if you can get them.

However, if you can’t, and I’m thinking about companies with up to around 40 people, I would say that generally speaking it only makes sense to go to an established big company when something specific in your business is lacking or broken. If you’re digital marketing is failing, then there’s a good chance that someone from Booking.com or Expedia might be your best bet to fix it. They have large teams of people who live and breathe data and someone there has probably seen your situation before.

Conversely, if the requirement is continuous incremental improvement then hiring for talent over experience is often better. If your digital marketing challenge is more about squeezing the pips or looking for the next leg up for growth then going lighter on experience and longer on raw talent and hunger (and salary) often works better.

Thinking about the general case, the advantage of big company people is that when they work you have a solution that should scale effortlessly with the company for some time to come. The disadvantage is that when they don’t work the cost is much higher – not only will bigco people be on larger salaries, they typically demand more resources and hence waste more money before they leave than less experienced alternatives. Worse, experienced people demand more autonomy and are often more skilled at managing upwards, so it takes longer to know when they aren’t working out and it’s harder to fix when they go.

Finally, and this is the kicker, from what I’ve seen, high salary hires from big companies work out much less often than you would expect. I think that’s because there’s an adverse selection problem – the best people from large companies generally don’t want to work at startups. They prefer to take the high salary and continue with what’s working for them. When people do risk weighted analyses of total comp likely to be earned in a startup vs a bigco it shows that bigco is the rational path.

Additionally, adjusting from big company life to startup life is famously hard. Work at a startup is invariably broad and scrappy. You have to work across the whole product or business and without much admin support of many team members. Big company folk are used to working on narrow subsets of products or on segments of the customer base and they are used to having most of their small problems and tedious admin tasks taken care of for them.

Once startups get bigger than around 40 people they start becoming more like big companies and have more resources, so the calculus changes.

 

 

Debating with intuition as well as logic

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If you’ve ever been frustrated that your neat logical arguments aren’t persuading people, this article is for you…

Daniel Kahneman’s Thinking, Fast and Slow had a strong influence on my thinking last year. He helped me get greater clarity on the difference between instinctual and reasoned thinking and I blogged about how VCs need to switch between thinking fast and thinking slow.

Now I’m reading The Righteous Mind by Jonathan Haidt which offers another take on the subject.

Haidt is interested in how we come to moral judgements and his work shows that most people start by making a snap decision and then afterwards they find a logical argument that supports their position. The point here is that the logic comes second, and it is rare for people to change their initial judgement in the light of rational argument. He then goes on to argue that this is the way most people think about all topics. He explains how western philosophy puts reason on a pedestal and venerates those who are able to think clearly and dispassionately with the result that we have ended up seeing emotion as an impediment to good decision making.

The reason Kahneman is so interesting because he challenges the notion that purely rational thought should be our goal. He shows that for a lot of decisions we rely on intuition and don’t employ reason at all.

I’m interested in Haidt because he goes a step further. He shares Kahneman’s view that most of our decisions are made intuitively, but argues for a more nuanced model of how that happens. He makes an analogy with how we process visual information. First there is a sub-conscious pattern matching and then if the image is ambiguous and resolving that ambiguity is important we add more and more reasoning until we’ve cracked it. Where Kahneman has a dichotomy between intuitive and reasoned thinking Haidt sees a continuum. Moreover, for Haidt, all thinking processes start as intuitive and then reason is added later if needed and to the extent the thinker is inclined to think that way.

Anyone who works in startups has to continually make decisions from relatively small amounts of information. Doing that well not only requires making the right calls, but also having good judgement as to when to make a decision and when to go looking for more data. Good investors and operators have ‘golden guts’ and come quickly to firm judgements. One of the challenges we all face from time to time is that our judgements don’t tally with our partners.

One of the things I like about Haidt’s model is that it helps understand how we come to those judgements and therefore offers an increased chance of resolving differences. Step one is to recognise that opinions on both sides are most likely rooted in an intuitive pattern match of some kind. Step two is to uncover those patterns and look there for the sources of differing views. People’s first answer to ‘why do you believe x?’ will most likely be post hoc rational analyses, and getting to the underlying patterns will require a commitment to the process on both sides and patient use of something like the five whys technique.

If this process is going to work it requires both sides to recognise that their opinions are most likely rooted in intuition as well as logic and to be ready to accept that they might be the one who needs to change.

Alignment before freedom

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There’s a big multi-decade trend towards giving employees more freedom over how they spend their time. There are two drivers. Firstly, as the world changes faster and faster, quick response to new situations has become more of a competitive advantage and companies that empower front line employees to make decisions are winning over companies that have to wait for management to decide. The second, related, and more recent driver is that the best employees increasingly want to work in organisations that give them a large amount of control over their day to day activities. As Dan Pink correctly identified in his seminal book “Drive”, autonomy makes us happy.

The first step many companies took was to start managing by outcome, telling employees what they they should achieve rather than what to do, and then giving them autonomy over how they do it. The OKR system that many of you know is designed for this environment. Management set company goals which are then cascaded down through the organisation to individuals who figure out for themselves how best to achieve their objectives.

In the last five it so years radical CEOs have taken the trend to empowerment to the next level and given staff the power to decide what they do as well as how they do it. These CEOs want their employees to love their companies (and maybe love them) and to maximise productivity by allowing people to work on what they think is most important. Some of these experiments have worked well, most famously at Valve, where they have extraordinary employee loyalty and great creativity.

Other experiments have worked less well, often because the staff they give freedom to haven’t all pulled in the same direction. In other words they have found themselves with an alignment problem. I have seen examples in recent weeks where alignment issues resulted in productivity sapping disagreements over investing in new products and the desirable rate of growth. These are legitimate differences of opinion with no right answer and once someone has been given control over what they do there is little intellectual basis for imposing a product decision or rate of growth on them.

These companies have created a leadership challenge that could have been avoided. They gave their employees freedom before they had alignment and then when they tried to force alignment it was perceived as a removal of freedom that went against the ethos of the company. That contrasts with companies that have forced alignment first and then gave employees freedom afterwards. The experience of workers in these businesses is only one of gain.

The answer then is to only give freedom when employees are aligned.

This post is long enough already so I won’t write about how to gain alignment save to say that one way is to distil what the company does into a couple of simple phrases (at Forward Partners our job is to make great investments and deliver amazing help to our partner companies) and then align company and personal objectives with those phrases.

Pitch investors at the right level of abstraction

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I’ve just read the a truly excellent guide to fundraising from First Round Capital. It’s a long read, but packed full of goodness and I highly recommend reading the whole article.

I’m going to pick out and expand on one point – it’s critical that founders pitch investors at the right level of abstraction. The two common mistakes are:

  • Pitching too much in the weeds, leaving investors unexcited about the big picture
  • Pitching at too high a level, preventing investors from really feeling the opportunity – you’re looking to create a visceral connection

As First Round put it:

The fundraising founder has to operate at the right oxygen level between the soil and the stratosphere. Not in the trenches, but not in rarified air.

Founders who are pitching too much in the weeds focus too much on operations, short term progress, and the mechanics of the business. If investors are worried about market size or exit potential, or if they are simply looking bored, you may be making this mistake.

Conversely, founders who are pitching at too high a level talk too much about market trends (often using poorly defined buzzwords) and don’t properly connect their story with their business. If investors are asking lots of questions about what you actually do or struggle to understand your story, then think about whether you are making this mistake.

The best pitches paint a picture of the future which is easy to understand and grounded in reality. Then they describe the path that will get them there, starting from where they are today.

If you’re not always improving you’re going backwards

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On Tuesday morning I went to see legendary VC Sir Mike Moritz give a talk to launch his new book Leading – thank you Felix for inviting me. Sir Mike has spent time with lots of very successful business leaders over the years and has recently been asking himself what separates those who’s companies stay at the top of their field for multiple decades and those who’s success is more fleeting.

One thing stood out for him above all other factors.

Leaders of companies with enduring success have a relentless thirst for continual improvement. They are restless and never satisfied.

He said modern day tech company leaders Jeff Bezos, Larry Page and Mark Zuckerberg have this quality in spades. Older leaders he name checked included Bill Gates, Steve Jobs and Rupert Murdoch. I’m currently reading a biography of Elon Musk, and he has this attitude too.

Sir Mike also said that Sir Alex Ferguson has a drive to make things better all the time, and that’s what kept him on top at Manchester United for 28 years (Leading tells its story through the story of Sir Alex’s success).

My initial reaction to the idea that continuous improvement begets enduring success was ‘makes sense, companies need to reinvent themselves if they want to stay on top for multiple decades and continuous improvement will do that for you’, but that underplays the importance of the point. An insatiable desire for everything to be the best it can be is key to getting to the top, not just to staying there.

Moreover, as the world changes faster and faster any other attitude is doomed to failure. A solution that’s perfect for today won’t stay perfect for very long, so unless you want to be usurped by someone who finds the solution that’s perfect for tomorrow, you’d better be continuously improving.

In the early days of a startup nothing is perfect, and oftentimes most everything is far from it. Customers might love the core product functionality, but there’s constant firefighting behind the scenes to keep everything working, make more sales, hire more people, raise more money etc. etc. Once again, relentless continuous improvement is the best route to success. Even when things are working really well the best founders aren’t happy – they’re asking themselves questions like ‘how can I grow faster?’, ‘how can I be more profitable?’ and ‘how can I make my customers love us more?’.

This may not need saying, but whilst a relentless desire for continuous improvement is a winning attitude, it is not sufficient on it’s own. It needs to be accompanied by strong leadership skills more generally. Some founders kill their companies by pushing them too hard. That almost happened to Elon Musk’s first two businesses.

Not being tricked by overconfidence

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It seems that lots of people in my network are reading Thinking Fast and Slow by Kahneman at the moment, at least I guess that’s why I keep hearing snippets of his wisdom. The latest is from BrainPickings:

The confidence people have in their beliefs is not a measure of the quality of evidence [but] of the coherence of the story that the mind has managed to construct.

Wow.

Confidence is divorced from evidence.

 

That is a big deal for founders and investors in startups who have to convince themselves to found or invest in companies when there’s little evidence as to whether it’s a good idea or not. We look for trends and patterns amongst the few data points we have at our disposal and form strong views about where the future is going, and then put big money or time behind it. If Kahneman is right, and I suspect he is, then the strength of our conviction is more down to our ability to spin (or swallow) a story than the underlying facts.

The funny thing is that many of the most successful founders and investors simply have great judgement. They look at small amounts of data and make the right calls. They know how to test and evaluate their gut instincts and not fall foul of what I might call the ‘narrative fallacy’.

There are two tricks I use to test my theories and try to keep the quality of my decision making high. Sometimes I do these on my own, other times I involve my partners and colleagues.

  1. I try to have a clear explanation for all of my beliefs. When I’m sitting alone thinking about an investment I often ask myself ‘why do I believe XX?’. When we are discussing deals as a team I always try to explain why I’m thinking something rather than simply assert its truth.
  2. I systematically looks for reasons why I might be wrong. When we are coming close to deciding we want to do a deal we sometimes brainstorm ways the company might fail. That’s a powerful technique for companies that are unusual in any way (companies that aren’t unusual only fail in the usual ways, and we don’t need a special process to catch those).

Underpinning all this is a readiness to admit mistakes and change my mind. I like to have strong convictions, weakly held.