By Jim Collins and Morten T. Hansen

Definition “10Xers” (pronounced “ten-EXers”):

Enterprise that…

1. sustained truly spectacular results for an era of 15+ years relative to the general stock market and relative to its industry.
2. achieved these results in a particularly turbulent environment, full of events that were uncontrollable, fast moving, uncertain, and potentially harmful.
3. began its rise to greatness from a position of vulnerability, being young and/or small at the start of its 10X journey.

Contrary findings…

• 10Xers did not have a visionary ability to predict the future.
• 10Xers were not necessarily more innovative than their less successful comparisons.
• The overall ethos of “Fast! Fast! Fast!” is a good way to get killed.
• 10Xers changed less in reaction to their changing world than the comparisons cases.
• 10Xers did not generally have more luck than the comparisons.
• 10Xers were not more creative than their less successful comparisons.
• 10X leaders were not more charismatic than their less successful comparisons.
• 10Xers were not more ambitious than their less successful comparisons.
• 10Xers were not more risk seeking than their less successful comparisons.
• 10Xers were not more heroic than their less successful comparisons.
• 10Xers were not more prone to making big, bold moves than their less successful comparisons.

10Xers

10Xers understand that…

• they face continuous uncertainty.
• they cannot control, and cannot accurately predict, significant aspects of the world around them.
• they reject the idea that forces outside their control or chance events will determine their results.
• they accept full responsibility for their own fate.

10Xers bring this understanding to life by a triad of core behaviors:

1. Fanatic discipline
2. Empirical creativity
3. Productive paranoia

Animating these three core behaviors is a central force:

• Level 5 ambition

Fanatic discipline

True discipline requires the independence of mind to reject pressures to conform in ways incompatible with values, performance standards, and long-term aspiration.

The only legitimate discipline is self-discipline, having the inner will to do whatever it takes to create a great outcome, no matter how difficult.

In an uncertain and unforgiving environment, following the madness of crowds is a good way to get killed.

Fanatic discipline: The 20 mile march

The 20 mile march is about having concrete, clear, intelligent, and rigorously pursued performance mechanisms that keep you on track.

The 20 mile march creates two types of self-imposed discomfort:

1. The discomfort of unwavering commitment to high performance in difficult conditions, and
2. the discomfort of holding back in good conditions.

Elements of a good 20 mile march are:

1. Performance markers that delineate a lower bound of acceptable achievements.
2. Self-imposed constrains… upper bound how far you’ll march in good times (a ceiling that you will not rise)… lower bound of acceptable achievements (a hurdle that you have to jump over).
3. Tailored to the enterprise and its environment.
4. Largely within the company’s control to achieve.
5. A proper timeframe – long enough to manage, yet short enough to have teeth.
6. Imposed by the company itself, not from the outside.
7. Achieved with great consistency – in good times and bad times.

The 20 mile march

• Builds confidence in the ability to perform well in adverse circumstances.
• Reduces the likelihood of catastrophe when hit by turbulent disruption.
• Helps exert self-control in an out-of-control environment.

Empirical creativity

Being “empirical” means relying upon direct observation, conduction practical experiments, and/or engaging directly with evidence rather than relying upon opinion, whim, conventional wisdom, authority, or untested ideas.

10Xers made their bold, creative moves from a sound empirical base.

Empirical creativity: Fire bullets, then cannonballs

10X companies were not necessarily more innovative than their less successful comparisons.

Each environment has a level of “threshold innovation” that you need to meet to be a contender in the game.

Once you’re above the threshold of innovation necessary for survival and success in a given environment… being more innovative doesn’t seem to matter very much… it needs a mixture of other elements to become a 10X company – in particular, the mixture of creativity and discipline.

Innovation without discipline leads to disaster… the combination of discipline and creativity makes greatness.

Bullets, then cannonballs:

• First, you fire bullets to figure out what works.
• Then once you have empirical confidence based on the bullets, you concentrate your resources and fire a cannonball – a calibrated cannonball.

a. Don’t fire uncalibrated cannonballs! If you do, learn from your mistakes as expensive tuition and return to a bullet-then-cannonballs approach.

b. Terminate bullets that show no evidence of eventual success!

• After the cannonball hits, you keep 20 mile marching to make the most of your big success.

What makes a bullet?

A bullet is an empirical test aimed at learning what works and that meets three criteria:

1. A bullet is low cost.
2. A bullet is low risk – there are minimal consequences if the bullet goes awry or hits nothing.
3. A bullet is low distraction – low distraction for the overall company, may be high distraction for one or a few individuals.

A big, successful venture can look in retrospect like a single-step creative breakthrough when, in fact, it came about as a multistep iterative process based more upon empirical validation than visionary genius.

Productive paranoia

10Xers maintain hypervigilance in good time as well as bad. They constantly consider the possibility that events could turn against them at any moment.

By embracing the myriad of possible dangers, they put themselves in a superior position to overcome danger. They succeed in an uncertain and unforgiving environment through deliberate, methodical, and systematic preparation, always asking, “What if? What if? What if?”. They cannel their fear and worry into action, preparing, developing contingency plans, building buffers, and maintaining large margins of safety.

Productive paranoia: Leading above the death line

The only mistakes you can learn from are the once you survive.  “Hitting the death line” means, you end the journey – game over.

Three key dimensions of productive paranoia:

1. Build cash reserves, buffers to prepare for unexpected events and bad luck before it happen.
2. Bound risk – death risk, asymmetric risk, and uncontrollable risk – and manage time-based risk.
   a. Death risk: risk that could kill or severely damage the enterprise.
   b. Asymmetric risk: risk for which the potential downside is much bigger than the potential upside.
   c. Uncontrollable risk: risk that has little ability to manager or control.
   d. Time-based risk: risk that it tied to the pace of events and the speed of decision and action.
3. Zoom out, then zoom in, remaining hypervigilant to sense changing conditions and respond effectively.

10Xers remain productively paranoid in good times, recognizing that it’s what they do before the storm comes that matters most.

10Xers bound, managed, and avoid risks. They asked the key question: “How much time before our risk profile changes?”

10Xers remain obsessively focused on their objectives and hypervigilant about changes in their environment (they zoom out) and asked “How much time before our risk profile changes?” They push for perfect execution of plans and objectives and adjust to changing conditions (they zoom in).

10Xers think first, even when they need to think fast!

Level 5 ambition

10Xers leader’s most important trait: they are incredibly ambitious, but their ambition is first and foremost for the cause, for the company, for the work, not themselves.

Level 5 ambition: SMaC

A “SMaC recipe” is a set of durable operating practices that create a replicable and consistent success formula. SMaC stand for Specific, Methodical, and Consistent.

A SMaC practice is not the same as a strategy, culture, core values, purpose, or tactics. A solid SMaC recipe is the operating code for turning strategic concepts into reality, a set of practices more enduring than mere tactics. It includes practices “what to do” and “what not to do”.

The signature of mediocrity is not the unwillingness to change, the signature of mediocrity is chronic inconsistency.

A great company must evolve its recipe, revising selected elements when conditions merit, while keeping most of its recipe intact.

There are two healthy approaches to amending the SMaC recipe, depending on the situation:

1. Exercising empirical creativity: Firing bullets to discover and test new practices before making it part of the recipe.
2. Exercising productive paranoia: Zoom out to perceive and assess a change in conditions, than zoom in to implement amendments as needed.

Far more difficult than implementing change is figuring out what works, understanding why it works, grasping when to change, and knowing when not to.

Return on luck

Luck happens, good or bad, to everyone, whether we like it or not. The real difference between 10X and the comparison cases wasn’t luck per se but what they did with the luck they got.

It is the 10Xers ability to get a high return on luck at pivotal moments that distinguished them and this is a huge multiplicative effect. They zoom out to recognize when a luck event has happened and to consider whether they should let it disrupt their plans… Then they zoon in and throw theirselves at the luck event with ferocious intensity, not letting up…

10Xers shine when turning bad luck into good results… Resilience, not luck, is the signature of greatness… “What did not kill them, made them stronger”.

10Xers exercise productive paranoia, combined with empirical creativity and fanatic discipline, to create huge margins of safety. If you stay in the game long enough, good luck tends to return… Luck favors the persistent, but you can persist only if you survive.

Luck did not cause 10X success. People do! People are disciplined fanatics. People are empirical. People are creative. People are productively paranoid. People lead. People build teams. People build organizations. People build cultures. People exemplify values, and achieve big hairy audacious goals. Of all the luck we can get, people luck – finding the right mentor, partner, teammate, leader, or friend – is one of the most important!

Source: Great By Choice (XXX)

Newsweek, essay by Niall Ferguson

Civilizations don’t rise, fall, and then gently decline, as inevitably and predictably as the four seasons or the seven ages of man. History isn’t one smooth, parabolic curve after another. Its shape is more like an exponentially steepening slope that quite suddenly drops off like a cliff.

Examples:

• The Incas… The Roman Empire… The Ming dynasty’s in China… The Soviet Union… The postcolonial dictatorships of North Africa and the Middle East…

What all these collapsed powers have in common is that the complex social systems that underpinned them suddenly ceased to function.

The West first surged ahead of the Rest after about 1500 thanks to a series of institutional innovations that I call the “killer applications“:

• Competition
• The Scientific Revolution
• The Rule of Law and Representative Governmen
• Modern Medicine
• The Consumer Society
• The Work Ethic

The tendency of Western societies to delete their own killer apps:

Ask yourself: who’s got the work ethic now? The average South Korean works about 39 percent more hours per week than the average American. The school year in South Korea is 220 days long, compared with 180 days here…

The consumer society? Did you know that 26 of the 30 biggest shopping malls in the world are now in emerging markets, mostly in Asia?…

Modern medicine? Life expectancy in the U.S. has risen from 70 to 78 in the past 50 years, compared with leaps from 68 to 83 in Japan and from 43 to 73 in China…

The rule of law? The U.S. makes the global top 20 in only one area: investor protection. On every other count, its reputation is shockingly bad…

What about science? Nobel winners are old men. The future belongs not to them but to today’s teenagers… more patents originate in Japan than in the U.S., ….South Korea overtook Germany to take third place in 2005, and that China is poised to overtake Germany too…

Finally, there’s competition… since adopted in 2004, the United States’ average competitiveness score has fallen from 5.82 to 5.43, one of the steepest declines among developed economies… Perhaps more disturbing is the decline of meaningful competition at home, as the social mobility of the postwar era has given way to an extraordinary social polarization… you don’t have to be an Occupy Wall Street leftist to believe that the American super-rich elite—the 1 percent that collects 20 percent of the income—has become dangerously divorced from the rest of society…

Far more than in Europe, most Americans remain instinctively loyal to the killer applications of Western ascendancy…

1. What we need to do is to delete the viruses that have crept into our system: the anticompetitive quasi monopolies that blight everything from banking to public education; the politically correct pseudosciences and soft subjects that deflect good students away from hard science; the lobbyists who subvert the rule of law for the sake of the special interests they represent—to say nothing of our crazily dysfunctional system of health care, our overleveraged personal finances, and our newfound unemployment ethic.
2. Then we need to download the updates that are running more successfully in other countries, from Finland to New Zealand, from Denmark to Hong Kong, from Singapore to Sweden.
3. And finally we need to reboot our whole system.

Source: Newsweek (XXX)

This essay is adapted from Niall Ferguson’s new book, Civilization: The West and the Rest, published by Penguin Press. The accompanying television series will air on PBS in 2012.

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Western Civilization’s Killer Apps:

COMPETITION

• Western societies divided into competing factions, leading to progressive improvements.

THE SCIENTIFIC REVOLUTION

• Breakthroughs in mathematics, astronomy, physics, chemistry, and biology.

THE RULE OF LAW

• Representative government based on private-property rights and democratic elections.

MODERN MEDICINE

• 19th- and 20th-century advances in germ theory, antibiotics, and anesthesia.

THE CONSUMER SOCIETY

• Leaps in productivity combined with widespread demand for more, better, and cheaper goods.

THE WORK ETHIC

• Combination of intensive labor with higher savings rates, permitting sustained capital accumulation

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Newsweek, by Sharon Begley and Jean Chatzky

“Pleasure now is worth more to us than pleasure later,” says economist William Dickens of Northeastern University. “We much prefer current consumption to future consumption. It may even be wired into us.”…

Research has also shown that having a good short-term (or “working”) memory is associated with being able to project yourself into the future and plan for it, which is a prerequisite of saving…

“Being unable to delay gratification is not something we’re stuck with for life,” says psychologist Walter Mischel (now at Columbia University). And a public that is infatuated with brain scans should know that just because a brain behaves in a particular way does not mean that it is hard-wired to do so…

“You develop willpower and patience through practice,” he says. “If you defer gratification, the payoff can be greater than with immediate gratification,” says neuroeconomist Paul Zak of Claremont Graduate University, “but your brain has to learn that.”…

Economists are waiting to see how the entitled, indulged children of helicopter parents will behave… for many of those raised in two-career households, “no” was a word they seldom heard from their parents…

Today’s culture of one-click shopping and instant messaging doesn’t merely satisfy our desire for instant gratification, it encourages it.

Source: Newsweek (XXX)

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Optimistic Bias

Bloomberg OP-EDS, by Daniel Kahneman

Most of us view the world as more benign than it really is, our own attributes as more favorable than they truly are, and the goals we adopt as more achievable than they are likely to be. We also tend to exaggerate our ability to forecast the future, which fosters overconfidence…

Because optimistic bias is both a blessing and a risk, you should be both happy and wary if you are temperamentally optimistic…

Optimistic people play a disproportionate role in shaping our lives. Their decisions make a difference; they are inventors, entrepreneurs, political and military leaders — not average people. They got to where they are by seeking challenges and taking risks. They are talented and they have been lucky, almost certainly luckier than they acknowledge…

If you only think about your own business, you think, “I’ve got a good story department, I’ve got a good marketing department” … and you don’t think that everybody else is thinking the same way.” The competition isn’t part of the decision. In other words, a difficult question has been replaced by an easier one…

As Nassim Taleb, the author of “The Black Swan,” has argued, inadequate appreciation of the uncertainty of the environment inevitably leads economic agents to take risks they should avoid. However, optimism is highly valued; people and companies reward the providers of misleading information more than they reward truth tellers. An unbiased appreciation of uncertainty is a cornerstone of rationality — but it isn’t what organizations want…

Source: Bloomberg OP-EDS (part1)

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Bias, Blindness and How We Truly Think (II)

Daniel Bernoulli

Bloomberg OP-EDS, by Daniel Kahneman

In 1738, the Swiss scientist Daniel Bernoulli argued that a gift of 10 ducats has the same utility to someone who already has 100 ducats as a gift of 20 ducats to someone whose current wealth is 200 ducats….

•  a 30 percent raise may evoke a fairly similar psychological response for the rich and for the poor, which an increase of $100 will not do.
•  people’s choices are based not on dollar values but on the psychological values of outcomes, their utilities.
•  a decision maker with diminishing marginal utility for wealth will be risk-averse

Bernoulli’s theory assumes that the utility of their wealth is what makes people more or less happy.

Theory-Induced Blindness

Bernoulli is wrong:

Because Bernoulli’s model lacks the idea of a reference point, expected utility theory does not account for the obvious fact that the outcome that is good… [(gains) for one…]  and is bad … [(losses) for another]…. His model… can’t explain risk-seeking behavior… that is often observed in entrepreneurs and in generals when all their options are bad…

Examples:

• Today, Jack and Jill each have wealth of $5 million. Yesterday, Jack had $1 million, and Jill had $9 million. Are they equally happy? (Do they have the same utility?)
• Anthony, whose current wealth is $1 million, and Betty, whose current wealth is $4 million, are both offered a choice between a gamble and a sure thing: equal chances to end up with $1 million or $4 million or end up with $2 million for sure.

Source: Bloomberg OP-EDS (part2)

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Bias, Blindness and How We Truly Think (III)

Bad Is Stronger Than Good

Bloomberg OP-EDS, by Daniel Kahneman

Bad emotions, bad parents and bad feedback have more impact than good ones, and bad information is processed more thoroughly than good. The self is more motivated to avoid bad self-definitions than to pursue good ones. Bad impressions and bad stereotypes are quicker to form and more resistant to disconfirmation than good ones…

Loss aversion refers to the relative strength of two motives: We are driven more strongly to avoid losses than to achieve gains. A reference point is sometimes the status quo, but it can also be a goal in the future: not achieving a goal is a loss; exceeding it is a gain….

More recent research has also shown that fairness concerns are economically significant. Employers who violate rules of fairness are punished by reduced productivity, and merchants who follow unfair pricing policies can expect to lose sales.

Source: Bloomberg OP-EDS (part3)

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Bias, Blindness and How We Truly Think (IV)

The remembering self and the experiencing self

Bloomberg OP-EDS, by Daniel Kahneman

A story is about significant events and memorable moments, not about time passing. This is how the remembering self works: It composes stories and keeps them for future reference…

• We all care intensely for the narrative of our own life and very much want it to be a good story, with a decent hero…
• In intuitive evaluations of lives, peaks and ends matter, but duration does not…

I am my remembering self, and the experiencing self, who does my living, is like a stranger to me…

Source: Bloomberg OP-EDS (part4)

(Daniel Kahneman, a professor of psychology emeritus at Princeton University and professor of psychology and public affairs emeritus at Princeton’s Woodrow Wilson School of Public and International Affairs, received the Nobel Memorial Prize in Economic Sciences for his work with Amos Tverksy on decision making. This is a four-part series of condensed excerpts from his new book, “Thinking Fast and Slow,” just published by Farrar, Straus and Giroux. The opinions expressed are his own.)

NYT, by Daniel Kahneman, October 19, 2011

WYSIATI = “What you see is all there is”. We had made up a story from the little we knew but had no way to allow for what we did not know about the individual’s future, which was almost everything that would actually matter…

We are prone to think that the world is more regular and predictable than it really is, because our memory automatically and continuously maintains a story about what is going on, and because the rules of memory tend to make that story as coherent as possible and to suppress alternatives. Fast thinking is not prone to doubt…

Confidence is a feeling, one determined mostly by the coherence of the story and by the ease with which it comes to mind, even when the evidence for the story is sparse and unreliable. The bias toward coherence favors overconfidence. An individual who expresses high confidence probably has a good story, which may or may not be true…

When a compelling impression of a particular event clashes with general knowledge, the impression commonly prevails.

• Individual investors like to lock in their gains; they sell “winners,” stocks whose prices have gone up, and they hang on to their losers. Unfortunately for them, in the short run going forward recent winners tend to do better than recent losers, so individuals sell the wrong stocks. They also buy the wrong stocks. Individual investors predictably flock to stocks in companies that are in the news.

• Mutual funds are run by highly experienced and hard-working professionals who buy and sell stocks to achieve the best possible results for their clients. Nevertheless, the evidence from more than 50 years of research is conclusive: for a large majority of fund managers, the selection of stocks is more like rolling dice than like playing poker. At least two out of every three mutual funds underperform the overall market in any given year.

The subjective experience of traders is that they are making sensible, educated guesses in a situation of great uncertainty. In highly efficient markets, however, educated guesses are not more accurate than blind guesses…

What we told the directors of the firm (firm that provided financial advice and other services to very wealthy clients) was that, at least when it came to building portfolios, the firm was rewarding luck as if it were skill. This should have been shocking news to them, but it was not…

The illusion of skill is not only an individual aberration; it is deeply ingrained in the culture of the industry. Facts that challenge such basic assumptions — and thereby threaten people’s livelihood and self-esteem — are simply not absorbed…

People come up with coherent stories and confident predictions even when they know little or nothing. Overconfidence arises because people are often blind to their own blindness…

True intuitive expertise is learned from prolonged experience with good feedback on mistakes…

To know whether you can trust a particular intuitive judgment, there are two questions you should ask:

1. Is the environment in which the judgment is made sufficiently regular to enable predictions from the available evidence? The answer is yes for diagnosticians, no for stock pickers.
2. Do the professionals have an adequate opportunity to learn the cues and the regularities? The answer here depends on the professionals’ experience and on the quality and speed with which they discover their mistakes.

In general, however, you should not take assertive and confident people at their own evaluation unless you have independent reason to believe that they know what they are talking about. Unfortunately, this advice is difficult to follow: overconfident professionals sincerely believe they have expertise, act as experts and look like experts.

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Source: NYT,

By Allan Sloan, senior editor-at-large at Fortune. Reporter Associate Doris Burke.

Our current mess is different from the Lehman-related horror because it stems primarily from politics, not economics…

Today’s crisis was completely avoidable. You can blame it directly on the fools who brought our country to the brink of defaulting on its debts in the name of saving us from … I’m not sure what. Yes, the Tea Party types bear primary responsibility — but they couldn’t have done it without the cowardice and incompetence of the Obama administration, which let things get way out of hand…

So why is today scarier than 2008-09? Because this time not only have we got troubled financial institutions to deal with, but we have serious, substantial countries facing possible default on their debts. Including, heaven help us, the U.S. …

The root of our current problem is that there are no grownups in positions of serious power in Washington… I never felt there was a total absence of adult supervision in our nation’s capital. Now I do…

We need more jobs, more growth, and more tax revenue… cut rates, eliminate the alternative minimum tax, and broaden the tax base by drastically reducing itemized deductions… modify Social Security and Medicare formulas, imposing higher costs on higher-end retirees…

Yes, rationality is out of style, and fanaticism is the new normal. But do we really want a national life like the one we’ve had the past few years? All shrieking and no thinking?

Source: Fortune Term Sheet / Article is from the September 5, 2011 issue of Fortune (XXX)

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Another Opinion:

The Debt Ceiling Deal: The Case for Caving

Washington’s deal satisfied no one.

Game theory explains why it couldn’t have turned out any other way

Bloomberg Businessweek by By Brendan Greeley

The outcome of the debt ceiling talks left everyone in a foul mood, not least the President himself…

Looked at through the prism of game theory, it’s hard to see how the outcome could have turned out any other way.

Game theorists distinguish between “cooperative” and “noncooperative” games. A cooperative game looks to divide a pie in a way that leaves both sides with trust in the process. Binding arbitration, where two sides are obliged by law to submit to a judge’s decision, is a cooperative game.

The two parties in Washington pretended to be playing a cooperative game this summer.

Washington, as a game theorist would describe it, is noncooperative… A noncooperative game lacks a higher authority to impose agreements on both sides… A game theorist would say that the President is trying to play a cooperative game in a town that can’t play along with him…

Everyone, however, is playing a game called “election,” and the only possible goal in that game is to win the next one.

Obama and the House Republicans, says Steven Brams, were playing chicken this summer, a noncooperative, non-zero-sum game in which both players can lose. A compromise outcome is difficult to achieve in chicken, because it’s not stable…

Frustration can actually turn a noncooperative game cooperative. In the Aristophanes play Lysistrata, the women of Athens and Sparta withhold sex until their men sue for peace…

Like the women in Lysistrata, the Tea Partiers, in effect, have withheld their affections from both the Democrats and the Republican leadership. That has forced Congress into what may prove to be a cooperative game: the next round of deficit negotiations, with a super committee composed of members from both parties charged with finding consensus.

Source: Bloomberg Businessweek (XXX)

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The Art of Asking Questions

by Ron Ashkenas

There are three areas where improved “questioning” can strengthen managerial effectiveness; and it might be worth considering how you can improve your skills in each one.

• ask questions about yourself… about what they could do better or differently.

• ask questions about plans and projects… in the spirit of accelerating progress, illuminating unconscious assumptions and solving problems.

• asking questions about the organization… look for ways that the organization as a whole can function more effectively.

source: HBR

Learn to Ask Better Questions

by John Baldoni

• Be curious. Being curious is essential to asking good questions.

• Be open-ended. Open-ended questions prevent you from making judgments based on assumptions, and can elicit some surprising answers.

• Be engaged. Act — show that you are interested with affirmative facial expressions and engaged body language

• Dig deeper. Get the whole story.

Asking good questions, and doing so in spirit of honest information gathering and eventual collaboration, is good practice for leaders.

Source: HBR

Bonus:

• see also my blog enries:
  The golden rules of “just asking”… part 1 and part 2

• …think that the big mysteries in the universe are the stars, or maybe molecular biology – things that are outside our reach. But the more we get into it, the more we realise how little we know about the things around us, which can include eating a bowl of soup or what’s happening to us at work.
  .
• …think we see with our eyes, but the reality is that we largely see with our brains. Our brain is a master at giving us what we expect to see.
  .
• …think about the financial crisis, it was to some degree caused by conflicts of interest. You pay a group of people a lot of money to see reality in a distorted way, and lo and behold they are able to do it… people saw reality as they wanted to see it, not as it really was…
  .
• …think about the market economy in this way – almost nobody wants you to do something that is good for you in the long term. The incentive of everybody else is to do something that is good for them in the short term.
  .
• …think we are making decisions,… when the reality it is that the environment in which we make decisions determines a lot of what we do.

. source:  FiveBooks Interview

HBR, by Yochai Benkler

The widespread conviction about the power of self-interest is based on two long-standing, partly erroneous, and opposing assumptions about getting people to cooperate.

One of them inspired the philosopher Thomas Hobbes’s Leviathan in 1651: Humans are fundamentally and universally selfish, and governments must control them so that they don’t destroy one another in the shortsighted pursuit of self-interest.

The second is Adam Smith’s alternative solution: the invisible hand. Smith’s 1776 book, The Wealth of Nations, argued that because humans are self-interested and their decision making is driven by the rational weighing of costs and benefits, their actions in a free market tend to serve the common good.

Though their prescriptions are very different, both the Leviathan and the invisible hand have the same starting point: a belief in humankind’s selfishness…

Yet, all around us, we see people cooperating and working in collaboration, doing the right thing, behaving fairly, acting generously, caring about their group or team, and trying to behave like decent people who reciprocate kindness with kindness. The adoption of cooperative systems in many fields has been paralleled by a renewed interest in the mechanics of cooperation among researchers in the social and behavioral sciences. Through the work of many scientists, we have begun to see evidence across several disciplines that people are in fact more cooperative and selfless—or behave far less selfishly—than we have assumed. Perhaps humankind is not so inherently selfish after all…

The Building Blocks of Cooperative Systems:

Communication

Nothing is more important in a cooperative system than communication among participants.

Framing and authenticity

People react differently depending on how situations are framed, but they aren’t stupid. It’s important that the frame fit reality.

Empathy and solidarity

For reasons biological and social, the more empathy and solidarity we feel with others, the more likely we are to account for their interests. Similarly, solidarity with a group makes us more likely to sacrifice our interest for that of the collective.

Fairness and morality

People care about being treated fairly.

Rewards and punishment

In order to foster cooperation, it is critical to set up systems that appeal to participants’ intrinsic motivations—that is, what they want to do from within—instead of systems based on monitoring people and rewarding or punishing them according to their behavior.

Reputation and reciprocity

One extremely important form of cooperation hinges on long-term reciprocity, both direct and indirect… reputation is the most powerful tool…

Diversity

Systems that harness diverse motivations are more productive than are those built for people who care only about material payoffs.

Why does self-interested rationalitystill dominate?

Partial truth

The myth of universal selfishness endures in part because it isn’t entirely wrong—only mostly so.

History

The roots of the assumption about universal selfishness are probably as old as human culture.

Simplicity

Human beings tend to seek simple and neat explanations for a complex world.

Habit

Almost two generations of human beings have been educated and socialized to think in terms of universal selfishness

In today’s world, adaptability, creativity, and innovativeness appear to be preconditions for organizations and individuals to thrive. These qualities don’t fit well with the industrial business model; they aren’t amenable to monitoring and pricing. We need people who aren’t focused only on payoffs but do the best they can to learn, adapt, improve, and deliver results for the organization.

Being internally motivated to bring these qualities to bear in a world where insight, creativity, and innovation can come from anyone, anywhere, at any time is more important than being able to calculate the costs, benefits, risks, and rewards of well-understood actions in well-specified contexts. Alongside creativity, drive, flexibility, and diversity, we must include social conscience and authentic humanity when trying to design cooperative systems.

Source: HBR, or here

By James Montier

You are your own worst enemy

All humans are prone to decision-making using the X-system (the emotional approach, “Dr. McCoy”), and this is often unchecked by the more logical C-system (the logical way of processing information, “Mr. Spock”).

“Success in investing doesn’t correlate with IQ once you’re above the level of 100. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing” (Warren Buffett)…. Self control (the ability to override urge) is like a muscle – after use it needs time to recharge.

Prepare, plan and pre-commit to a strategy

The inability to predict our own future behavior under emotional strains is called an empathy gap.

Investors should learn to follow the seven P’s: Perfect planning and preparation prevent piss poor performance.

Re-investing when terrified

Fear causes people to ignore bargains when they are available in the market, especially if they have previously suffered a loss… “terminal paralysis”… there is only one cure for terminal paralysis: you absolutely must have a battle plan for reinvestment and stick to it… what I recommend a few large steps.

Be aware that the market does not return when it sees light at the end of the tunnel. It turns when all looks black, but just a sublet shade less black than the day before… thinks will likely to get worse before they get better.

But, why should I own this investment?

Optimism seems ingrained in the human psyche… humans tend to abandon tasks associated with negative consequences, so it was biologically adaptive for humans to develop a sense of optimism.

The tendency to overrate our abilities is amplified by the illusion of control – we think we can influence an outcome… the illusion of control seems most likely to occur when lots of choices are available, when you have early success at the task, the task you are undertaking is familiar to you, the amount of information is high, and your have a personal involvement.

Beating over-optimism… by asking “must I believe this?”, rather than “can I believe this?” and “why should I own this investment?”, rather than “why shouldn’t I own this stock?”…

Be clinically depressed at work, but happy and deluded when you go home.

Stop listening to experts

We are generally far too confident in our abilities… experts are even worse.

Not only do we like our experts to sound confident, but our brain actually switches off some natural defences when we are told someone is an expert.

The good news is we don’t need to outsmart everyone else. We need to stick to our investment discipline, ignore the action of others, and stop listening to the so-called experts.

Prepare – don’t predigt

„Those who have knowledge don’t predict. Those who predict don’t have knowledge“ (Lao Tzu)… the consensus of economists has completely failed to predict any of the last four recessions… analysts don’t have a clue about the future.

When given a number we tend to cling to it, even subconsciously – a trait known as anchoring.

“Forecasting security prices is not properly a part of a security analysis… analysis should be penetrating not prophetic…” (Ben Graham). Analysts are called analysts and not forecasters. All investors should devote themselves to understanding the nature of the business and its intrinsic value, rather than wasting their time trying to guess the unknowable future.

Distinguishing the signal from the noise

“The greatest obstacle to discovery is not ignorance; it is the illusion of knowledge” (Daniel J. Boorstin).

All the information wasn’t making… any more accurate, but it was making them increasingly overconfident.

We would be far better off analysing the… three or five… things we really need to know about an investment, rather than trying to know absolutely everything about everything concerned with the investment…

Volatility equals opportunity

We actually find even useless information soothing and we process it mindlessly… when people see information in a format with which they are familiar, they will unquestionably process it…

More than half of the larges moves in markets are totally unrelated to anything that might be classed as fundamentals.

It’s time to prove yourself wrong

We are twice as likely to look for information that agrees with us than we are to seek out disconfirming evidence. We need to learn to look for evidence that would prove our own analysis wrong.

When facts change, change your mind

The job of a money manager is not to be dogmatic… neither is it to make friends; it is to make money.

We are displaying classic conservatism – hanging on our views too long and adjusting them slowly… simply because we spend time and effort in coming up with those views in the first place.

Focusing on facts

We all abandon evidence in favour of a good story.

Your biggest advantage over the pros

You don’t have to be a slave to an arbitrary benchmark… prevents you from over-optimism, illusion of control, self-serving bias (interpret information and act in ways that are supportive of your own self-interest), myopia (short-sightedness, an overt focus on the short term), and inattentional blindness (don’t expect to see what we are not looking for).

Writing your mistakes and biasis

Self-attribution bias is our habit of attributing good outcomes to our skill an investors, while blaming bad outcomes to something or somebody else.

Once we know the outcome we tend to think we knew it all the time.

To combat the pervasive problem of self-attribution we really need to keep written record of the decision we take and reason behind those decision – an investment diary, if you will… it helps to holds us true to our thoughts at the actual point of time, rather than our reassessed version of events after we know the outcomes.

Never underestimate the value of doing nothing

A focus on the short term (myopia) is hard to reconcile with any fundamental view of investing.

At a one year time horizon, the vast majority of our total return comes from changes in valuation – which are effectively random fluctuations in price. However, at a five year time horizon, 80 percent of your total return is generated by the price of pay for the investment plus the growth in the underlying cash flow.

When dealing with losses, the urge to reach for an action bias is exceptionally high.

If you can’t find something to invest in, then you are best off doing nothing at all.

Part of the problem for investors is that they expect investing to be exciting… “Investing should be dull” (Paul Samuelson).

“All men’s miseries derive from not being able to sit in a quiet room alone” (Blaise Pascal).

Becoming a contrarian investor

The evidence casts serious doubt on people’s ability to maintain their independence in the face of pressure.

Groupthink tends to have eight symptoms: 1. an illusion of invulnerability; 2. collective rationalization; 3. belief in inherent morality (rightness of their cause); 4. stereotyped (negative) views or out-groups; 5. direct pressure on dissenters; 6.self censorship; 7. illusion of unanimity; 8. mind guards are appointed (protection from information that is problematic or contradictory).

Nonconformity triggers… fear… social exclusion… physical pain… in people.

It is impossible to produce superior performance unless you do something different from the majority.

It isn’t easy being a contrarian… have the courage to be different… be a critical thinker… have the perseverance and grit to stick to your principles.

When it’s time to sell an investment

People hate losses somewhere between two and two-and-a-half times as much as they enjoy equivalent gains. This is a property known as loss aversion.

The more you check your portfolio the more likely you are to encounter a loss simply because of the volatile nature of stock prices.

Putting the dislike of losses and the willingness to gamble in the face of a potential loss together gives us some insights into investors’ behaviour.

Disposition effect = holding onto losing stocks and selling winning stocks.

Endowment effect = once you own something you start to place a higher value on it than others would.

That one thing you can control

Focus in the process, not on the outcome!

We obsess with outcomes over which we have no direct control. However, we can and do control the process by which we invest.

The management of return is impossible, the management of risk is illusory, but process is the one thing we can exert an influence over.

People often judge a past decision by its ultimate outcome rather than basing it on the quality of the decision at the time it was made, give what was known at that time. This is outcome bias.

Unfortunately, focusing on the process and its long-term benefits won’t necessarily help you in the short term.

Why promising to be good just isn’t enough

Knowledge doesn’t translate into better behavior.

Simple promises to be good or to behave better are unlikely to be enough.

The key lesson… is that we must concentrate on process… the set of rules that govern how we go about investing!

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Source: amazon (xxx)

more: Behavioural Investing Blog by James Montier (XXX)

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