Failure in Business is (Mathematically) A Lot More Likely Than You Think

Sometimes someone tells you something that is so ridiculously obvious but so dramatic to everything you have ever thought about, that it kind of shocks the heck out of you.  So here is something that just sent me for a loop.  It is a certainly philosophical in nature, so that fits in well in this publication – and it concerns the juxtaposition between luck and skill and how the two are intertwined.

Consider if someone has a strategy for starting, growing and succeeding in a business.  His strategy is to be brutally honest with everyone about everything all the time and insist that every single person in the company do the same.  Anyone who deviates – even the slightest – is immediately terminated.

Possibly to your surprise – or maybe not at all – it works!  And it doesn’t just work – it works incredibly well.  It is a runaway success.

By the way, my belief is that there is a company that has exactly this strategy, which is Ray Dalio’s Bridgewater Associates.  Many believe it is an extraordinarily successful hedge fund with an exceptional track record.  On information and belief, the culture just “clicks” for some people who thrive in it and is awful for others who quickly depart one way or another.  It is self-selecting for those who will be optimal for the business.

So what are the implications of this?

Well, others starting businesses might consider whether this is a great strategy?  After all, it worked at one place and that implies it might work at another place too.  But then, let’s do the math……

Let us pretend 100 such businesses were started with this exact strategy.  Most businesses fail, but for the sake of argument, let us pretend half succeed and half fail.

So now we are out in the world with 50 businesses that use this strategy that we know about – that the newspapers are reporting on – and that we can analyze for our determination on optimal business strategies.

But what about the other 50?  We kind of don’t know about them any more since they are just…….gone.  And presumably the reason they are gone is that they used this strategy and failed!

So we are – foolishly, or worse than foolishly – evaluating a business strategy only by looking at the businesses that succeed with the strategy and ignoring those that failed with the same strategy!

How stupid is that?  We evaluate a strategy by only looking at those who succeed with it?

We do this all the time for a very simple reason, which is that it is super easy to find examples of successful strategies, but very difficult and close to impossible to find examples of failed strategies, since the failures just disappear.

I feel entitled to kick myself because I myself fall into this trap all the time.  I eagerly read articles about Google and other great companies and much of the time conclude that my law firm should emulate their (successful) strategies, without considering whether maybe Google – or Ray Dalio – just got lucky.  Maybe 99% of those who try Ray Dalio’s brutal-honesty strategy fail!!!  How do I know?  The answer is I don’t have a clue because I am under-evaluating failure when assessing a strategy.

I give credit for this line of thinking to Michael J. Mauboussin in his book The Success Equation (Untangling Skill and Luck in Business, Sports and Investing).  He is very insightful and, among other things, teaches at Columbia Graduate School of Business.  Also, from my daughter — a mathematics major and neuroscientist working for Google — she says that in the science world this is referred to as a variant of the well-known concept of “selection bias”.

So how does this apply in the real estate world?  It applies just about everywhere.  For example, if you are an investor you presumably have your own investment style and your own manner of evaluating deals, hiring people, putting a team together, etc., but unless you are incredibly arrogant you will naturally look at the strategies of others that have succeeded and evaluate what you think they are doing right for possible emulation.  Have you considered that maybe those parties you are looking at were just lucky and others that tried that particular strategy aren’t around to be evaluated any more?

So what should you do with this knowledge?  The answer is simple – take emulation of successful strategies with a couple of grains of salt.  Maybe the strategy is excellent, or maybe the strategist just got lucky…..

Fail Dammit!

I was reading this morning about a superstar Olympic hopeful. A woman named Simone Biles (check her out). She is the top gymnast in the world right now – and the United States has high hopes for her in Rio. During her rise to greatness, she fell a lot (off the balance beam and in other places), but she kept on winning because she kept on doing things – and taking chances — that no one else could do, or dared to try. Maybe she fell a lot because she was pushing the edge of possibility in gymnastics rather than playing it safe. Maybe that is why she is the top gymnast in the world – because she was not afraid to fall – and to fail?

To move closer to the business world, in recent years I followed Ron Johnson’s attempt to revamp JC Penny. He was running a company that had only one certainty and that was that if they kept on doing what they were doing the company would slow and inexorably die off. It was a dead husk of a company that was slowly succumbing to irrelevance and everyone knew it. So Johnson, who had previously started the incredibly successful Apple store, joined up as CEO to try something completely different. He up-scaled the stores and brought in brands and created a completely different shopping experience. The idea ended up backfiring. Customers were lost and it just didn’t work, or at least it didn’t work quickly enough. In other words, it failed! Johnson was fired in early 2013. After that, everyone jumped on him. The media was relentless. The guy who had created the half trillion dollars of value in the Apple store had now blown it with the JC Penney store. Fortune wrote an aftermath article – writers Marty Jones and Susan Kramer — they ended the article with these words:

“It’s impossible to know if Johnson’s reforms could have succeeded but he does leave one legacy: Nobody will be attempting something similar for a very long time”

Wow. Think about this. The company was dying. Someone had the guts to try something new to save it and it didn’t work out. So let’s not only damn him for eternity but let’s publicly humiliate him and, for good measure, make as sure as possible no one ever tries anything like it again. After reading this would you want to take a chance like Johnson did? The downside of failure is so huge!

Consider this basic emotion we have, which is fear of failure and maybe even worse, fear of being humiliated and laughed at. Every time we try something new we have this fear. It is a natural emotion. And if this is what happens when you fail, there is good reason for this fear.

So how would this work in (most) organizations if someone has a new idea that no one else has done before?

First – she would bring the idea to management – to investors – to lenders – to partners. What would they say? Well, in most of these situations, you know exactly what they would say. They would come up with every possible objection. We are all awesome at that. They would poke holes and say “but what if this happened” [as a result of your idea]? We could be laughed at – we could lose money – this could harm our reputation – we wouldn’t be able to get future lenders, partners, deals – or (gasp) it could hurt the vaunted track record we have that we tout all the time and we can’t risk that – etc. The list of concerns would be endless and the more the idea was outside of the parties’ comfort zones the worse it would be.

Second – if she had major guts, she would fight everyone on this. She would point out that the issue is not whether there was a risk of failure, but whether the rewards outweighed the risks, coupled with the probability of a successful or failed outcome. Maybe after a great deal of back and forth, expenditure of political capital, and alienating the most fearful parties (maybe permanently), she would finally get her way.

Keep in mind that she doesn’t know if the idea will work. It is a new idea and by definition risky.

Third – she tries out the idea and – bummer – it flops completely! Now what? You know what happens next. All of the parties involved have different versions of “toldyaso”. They bring it up forever and ever. They roll their eyes. They say they “knew” it was a bad idea. They were naysayers and triumphantly proved right. The humiliation is complete and never-ending. The various people she confronted along the way are pleased, although they might not publicly admit it. Those who supported the idea are chagrined and think “that’s the last time I do something like that.”

Fourth – it gets worse. The person who brought up the new idea will certainly not bring up another one. Even if she had the guts to take a risk of the foregoing again – and how many of us have that much fortitude – she would never be able to win the political capital to make it happen. So she is out of the new ideas game for good. And maybe even out of a job….

Fifth – and to make it worse yet – everyone else who is watching from the sidelines, how are they going to feel about trying out something new? I think we know the answer to that too, and that is that there is no way they would make such an attempt, because the downside of a failed idea is obviously so high.

Now the organization has created a culture of no one ever doing, or even suggesting, anything new! No one ever innovating or trying things out. Certainly no cutting edge thinking will go on at this organization.

So I ask you, does the foregoing describe the company you work for – or the company you run – in the real estate world. We all know the real estate world is changing, and maybe even dramatically, what with all the technological changes and the increasing sophistication of the various counterparties with whom we all deal. No one can afford to have an organization that crushes the spirit of someone with the “guts” to push for trying something new.

As an aside, I note that my point here applies to new ideas as small as trying a new brand of coconut water in the cafeteria fridge to changing the “usual” place you go to lunch to moving your company into a new line of business. Big and small changes always make people nervous and ruffle their feathers.

I came to this realization many years ago for my law firm. If I tried to make my law firm just like all the other law firms, but better – there was only one thing for sure – and that was that we would fail – we would fail slowly – we would never realize why we were failing – we would just slowly go out of business – but the good news is that we would never be embarrassed along the way.

I didn’t like that outcome and decided we would have to try new things, and try a lot of new things, and when we tried them we would certainly fail. Indeed, the list of failures at my firm with new ideas I have tried out is endless. But there were a lot of successes too – and it is now possibly a surprise to many that little firm that few have heard of outside NYC is now one of the largest real estate law practices in NYC.

People often ask me – at interviews and otherwise – what is the secret to my success? How did I get where I am? I always answer the same thing and it is 100% true – that is that for some reason I just don’t mind making a fool of myself. In other words I am happy to try – again and again – and fail!

I can’t tumble like Simone Biles – although I can do a cartwheel – but one thing I share with her is willingness to try things neither I – nor anyone else – has ever done before. The bottom line is that it is awfully hard to have great success without a whole string of solid failures along the way.

So next time someone throws out a new idea at work – maybe timidly – treat the idea with respect. Thank the proponent heartily. When the new idea is evaluated, consider the risk and the reward of the idea, rather than everyone ganging up to poke holes in it. Then when the idea is ultimately tried out and turns out to be a complete flop, throw a party for the colleague who had the guts to try the new idea and make it clear how thankful the group is that she really took one for the team.

And maybe – just maybe – your organization will become one of the great players in the real estate world. Maybe – just maybe – you will always be on the cutting edge and out ahead of your competition, with new ideas that are rewarding to your employees and to the counterparties you deal with.

I will end by noting that John Wooden (one of the greatest coaches of all-time) is famous for saying that the team that makes the most mistakes is the team that is likely to win.

So go ahead – make some mistakes – and fail! Who knows what will happen.

Uniqueness – The Bane of Fundraising

I have seen this time and again. Someone uses their brainpower to come up with a cutting-edge idea for real estate investment. It is a niche (a “Power Niche” as I call it), or a way of looking at real estate that no one has done before. It seems pretty cool, but the lament is that “investors won’t go for it”, so, alas it is just not viable.

If the fundraiser doesn’t just throw in the towel at this point, the next question is whether the fundraiser should “tweak” the business model (or maybe in other words ruin the cool and cutting-edge part of it) so it will look like other investments and thereby become appealing to the target investors; or stick to his guns and try to find investors, even though most prospective investors will not be willing to take the plunge. That sounds kind of terrible too – like the sheepherder throwing in the towel and just deciding to follow the sheep.

As an aside, I don’t mean to imply that the investors who reject the new ideas are foolish. They are not dumb at all. Indeed, the prospective investors are smart to avoid the newfangled investment idea for the simple reason that if they all stick together and perform in an “average” manner, they will remain employed and their lives will continue on (probably happily) as they were before. If, however, they take on the risk of the new idea (and all new ideas have enhanced risk as well as enhanced reward), and it goes poorly, they may be out of a job.

I had been noticing and thinking of this irony – or paradox – for years, but then Todd Zenger wrote a really interesting article in The Harvard Business Review called The Uniqueness Challenge, which explains this conundrum in a very readable and understandable manner. He calls it the “Uniqueness Challenge” and that does describe it very well, as it is always a “challenge” to be “unique”.

I note that my law firm took this Uniqueness Challenge by making the determination to be The Pure Play in Real Estate Law®, thereby taking the enormous downside risk of being different (and unique). We “burned the ships” with this strategy and, fortunately, it worked out exceptionally well. At the time we did it, we were very nervous about it, but now looking at where we stand in the marketplace it seems so obvious – what were we worrying about?

So hats off to Mr. Zenger for his article – it is well worth reading.

Now we have this conundrum—this irony—this paradox. The question is how to solve it. Here is my best shot at it:

At the outset, I wouldn’t tweak (i.e. ruin) the business idea to appeal to investors. That is just like the sheepherder throwing in the towel to follow the sheep – and, in this case, even the sheep would (sheepishly) maybe admit privately that they don’t disagree with the strategy – they just don’t want to take a risk where the risk/reward isn’t to their benefit.

I will – very reluctantly – admit that tweaking/ruining the strategy’s novelty might be the optimal short-term economic strategy, and may result in more immediate fund-raising success. But where is the fun in that? What is the point? Where is the break-out upside? It isn’t there. You are just conforming to be like everyone else.

However, I wouldn’t waste a lot of time on a strategy that is doomed to failure either. If you know that the main investor group just can’t invest in your idea, probably for the reasons I outlined above, don’t spend two years with a fruitless private placement memo trying and failing to raise a billion dollar fund that is doomed to failure or, worse yet, that a Blackstone-type party will do itself if they like the idea. Nor would I use a straight-down-the-middle fund-raising advisor either, as such an advisor would advocate you soliciting the mainstream investors who will likely not be able to say “yes” for the reasons outlined above. Overall, the odds are stacked against you and you could waste two or more years of your life being essentially jerked around and come up empty.

What I would do is approach those who are outside the normal channels, i.e. instead of pension funds, insurance companies, endowments, and similar parties, I would look towards high net worth individuals, family offices, and investment funds that make it their bread and butter to seek alternative investments and that are deliberately set up to not follow the herd. There are a lot fewer of these parties, and the way forward will be tortured, like following a narrow bending path up a mountain; however, I think the chances of success are much higher.

As an outgrowth of this strategy, I would also dial down my fund-raising size dramatically. Instead of visions of billion dollar funds dancing in your head, consider a fund of, say, $25,000,000. All you would want is the bare minimum for a “proof of concept” and an amount you can invest quickly to confirm the strategy is doable. Once you have that, it will likely be a very different story when you go back to the mainstream investors. They will likely change from skittish to eager very quickly.

If you follow this strategy, the only thing you can be sure of is that you don’t know what will happen. However, a strategy where you don’t know what will happen is a lot better than a strategy that is likely doomed to failure (as is the straight-down-the-middle strategy), so mathematically, this strategy is optimal. Also, if things go badly, you will spend a lot less time and money failing.

By the way, if “you” mainstream investors are reading this when you are visited with a Uniqueness Challenge, consider giving the guy presenting to you a break. Maybe this is your big chance to stand out from the herd yourself. Maybe this is a time for you to take a chance too…

If you are a reader of The Real Estate Philosopher and have thoughts on this, feel free to email your thoughts to me and maybe I will put them out in the next article as a follow-up piece.

Finally, if you have an outside-the-box idea in the real estate world that perhaps rises to the level of a Uniqueness Challenge, I hope you will give me a call or shoot me an email. There is nothing I like better than trying to figure out how to make unusual, different and unique ideas successful.