Fortnite, Apple, and the Fate of the Metaverse – A Game Theory Perspective

I woke up Friday morning to see this video trending on Twitter.

I thought it was quite epic. Fortnite mocking Apple with a parody of its own iconic Super Bowl commercial from 1984. (See original below if you haven’t).

Now, I don’t play Fortnite, but I have been following the ongoing war (if only of words, until this week) between Epic Games (the maker of Fortnite) and Apple.

But when the two players took it up a few notches this week (Apple banned Fortnite on the App Store; Epic released the video above, and also started a lawsuit and a PR campaign against Apple), my first thought was: “Such an interesting move!”

Because that’s what this is – one move, in an ongoing battle of wits between the two players.

And like all games, it can be analyzed, to predict the outcome.


But first, an overview of the game board.

If you’re already familiar with Fortnite and the ongoing saga, feel free to skip this section.

But if, like me, you haven’t played Fortnite and are wondering what the fuss is about, read on.

Fortnite is an online video game developed by Epic Games. It’s quite new – launched only in 2017. But it has been a gargantuan success – in just 3 years, it has amassed 350 million users (as of April 2020).

Beyond being just a game, it also doubles up as a virtual world for people to interact. Think Second Life, only much better. Think Metaverse, if you’ve read Snow Crash. Or the Oasis from the movie Ready Player One.

Like most games, it has a mobile app for iPhone and Android. And like all mobile games, it has to pay Apple and Google a cut (30%) on all in-app purchases.

In Fortnite, players can buy skins, “costumes”, or virtual currency called V-bucks (1000 V-bucks for $9.99) for use in the game. This is a substantial source of revenue for Epic Games. Fortnite brought in USD 1.8 Billion in revenue in 2019. Of course it pinches to give Apple 30% on all purchases.

Epic has tried to push Apple to waive this fee for Fortnite in the past, but Apple has stayed firm.

So, this week, Epic snuck in an update in its mobile app, allowing users to purchase V-bucks directly from the company, side-stepping the App Store’s 30% commission. Something Apple prohibits developers from doing.

And so, to nobody’s surprise, Apple banned the app.

And Epic immediately released the video above, announced an anti-trust lawsuit, and started a social media and PR campaign.

And by the way, Epic planned this from the start [1].

I know what you’re thinking. Why would Epic voluntarily get its app banned from the App Store, losing millions of users?

It all makes sense, I promise.

But for that, you need to understand the two players.

Player 1: Epic Games

Epic Games has been going at Apple for a while, regarding the App Store monopoly.

See here, for instance, Tim Sweeney (CEO of Epic Games) comparing Apple to the DMV.

Tencent owns 40% of Epic Games. Having a Chinese company as a significant owner is not an amazing situation to be in, in the US today.

To learn more about Epic Games and its strategy, check out Matthew Ball’s epic (well) six-part primer.

Player 2: Apple

Apple has significant share of the mobile phone market in the US (~60% of mobile phones in the US are iPhones).

It’s embroiled in an anti-trust battle with the US government.

It has a history of arm-twisting and bullying smaller companies. For instance, if your company’s logo is a fruit, even if it’s not an apple, Apple can make your dreams go pear-shaped.

Do these two logos look similar to you? To Apple, they do.

Epic is not the first company at loggerheads with Apple regarding the 30% commission. Netflix and Spotify, among others, have stopped selling subscriptions on the App Store altogether. You can use Spotify and Netflix on iPhones. But if you want to pay for them, you have to visit their websites.

OKAY. Enough talk, let’s get on with the game.


The game begins. Ready Player Two.

Apple has pre-committed to removing an app from the App Store if it tries to bypass its rules. No matter how important the app is.

Given this pre-commitment, Apple had no choice when Epic tried to bypass it with its “sneaky” update.

In a sense, Epic forced Apple’s hand by doing this. It forced Apple to appear aggressive by banning its app. Even though it was the only move Apple could plausibly make.

Epic was already engaged in a PR battle with Apple (accompanied no doubt by closed-door negotiations). Apple wasn’t budging.

Epic could have continued the battle of attrition. But instead, by forcing Apple to carry out its threat, it has constrained the gamespace.

It has made it much harder for Apple to now offer only a symbolic olive branch.

But again, why would Epic want to get its app banned, losing millions of users?

Fact is, as Peter Rojas says in this interview, this is not a exorbitantly expensive threat for Epic to make. Only 20% of Fortnite players are primarily on mobile.

And this number is likely to grow over time, making it harder for Epic to take this approach in the future.

Ergo, the best time to do this was yesterday. The second best time is NOW.

Like Denzel Washington says,

Training Day Denzel Washington GIF - TrainingDay DenzelWashington …

Game Theory Sidebar 1:

Threats and commitments are important tools in strategic games and negotiations.

To quote Thomas Schelling in The Strategy of Conflict [2]:
“The sophisticated negotiator may find it difficult to seem as obstinate as a truly obstinate man. Deterrence won’t work for the truly obstinate.

It’s very easy to keep demanding during a negotiation, because you (a) will always accept less, than not having a deal, and (b) you can always retreat if they don’t accept. But the other side knows this too, so it’s an impasse.

If a man comes to your porch and says he’ll stab himself if you don’t give him $10, you’re more likely to listen if his eyes are bloodshot.

“Bargaining power = the power to bind oneself”.

It’s a voluntary but irreversible sacrifice of freedom of choice, to signal that you can’t retreat from a certain ask.”

If you commit to a path of action, the opposite party has lost all leverage”

Epic just stole Apple’s lunch. And leverage.

The Middle Game

Epic is trying to rally developers to its side. It’s trying to paint the battle as a David vs. Goliath struggle. The meek, tiny developer taking on the formidable bully.

But it’s unlikely to work, for two reasons:

  • Epic is a huge company itself (valued at USD 17 billion), backed by Tencent, a USD 600 billion behemoth. This is like Godzilla fighting King Kong. We don’t care, except the fast-paced action is fun to watch.
  • Small developers might actually prefer the App Store [3], because it gives them a semblance of a level playing field. Consumers trust all apps on the App Store, because they know Apple has vetted and approved them. So, even if you’re a small developer, customers don’t worry about giving you their credit card details. Trust is important!

Epic will no doubt also play up the anti-trust / monopoly angle.

It will ask, “Should one company have so much control on mobile users’ choices?” This line of attack has more promise, as we’ll see in the end game.

Apple, for its part, is trying to tell consumers it’s no big deal (it is).

Image

Before we go to the endgame, a quick interlude.

Game Theory Sidebar 2:

Quoting again from The Strategy of Conflict:

In a negotiation, if you ask for 60% and then go down to 50%, you will be expected to dig your heels in. And so the counter-party will push less. If you say 47%, they’ll assume that you can give up more and will push until you find another persuasive new boundary.

In war, similarly, one cannot satisfy an aggressor by letting him have a few square miles on this side of a boundary. He knows that we both know that we both expect our side to retreat until we find some persuasive new boundary that can be rationalized.

That’s also why “just one more drink” is a very unstable compromise.

Some outcomes have intrinsic magnetism. Outcomes that are prominent, unique, simple, or have a precedent / logic, drive agreement towards them. Often, this eventual compromise point can be predicted in advance.

For example, in a price negotiation: rounding down, splitting the difference, etc. are explicit expectations of counter-offer. And you often have no choice but to follow this drill. Even if you had strong prior reasons to quote 51.5% as your first offer.

These focal points / likely outcomes are called “schelling points”.

Framing the situation in a way that coordinates expectations of the opposite party towards your favored outcome – this schelling point – can multiply the probability of success.


So what’s the “schelling point” of this battle between Apple and Epic Games? Let’s see in the end game.

The End Game

I see three possible outcomes from this impasse.

Outcome 1: Apple gives in and waives the commission for certain in-app purchases.

There is a sort of precedent for this.

McDonald’s doesn’t pay a commission on every in-app purchase of food. Neither does Uber, on every ride booked through the app.

But there’s an important distinction. Food purchases and cab rides have a very real marginal cost of fulfillment.

What about virtual currencies? Not so much. 1000 V-bucks on Fortnite cost Epic exactly zero real bucks to make.

And this is an outcome Apple really does not want.

If they allow this once, the floodgates will open. Every app will move to an in-app purchase model, and frame it in exactly the same way as Epic Games has.

And even Apple accepts this as a special deal with Epic Games, it sets a dangerous precedent. Because Microsoft xCloud and Google Stadia (cloud gaming services) will come next.

No, this is not a hill that Apple wants to die on.

Luckily for Apple, this is also not a position Epic games can defend.

As Ben Evans says,

Moreover, the App store is not all eye-gouging profiteering. It does provide a service, and that does costs money.

  • Users like it – it allows them to trust new apps from unknown developers.
  • Developers like it too, for the same reason. It gives them a level playing field.

Putting it all together:

Probability of Outcome 1: 10%.


Outcome 2: Apple reduces its commission and everyone wins.

Again, this makes sense at a high level.

Apple’s 30% has no basis in logic. Steve Jobs chose 30% because it was the same as iTunes.

What! Let’s get this straight. In 2003, iTunes decided to charge artists 30% of individual song sales. That’s the only reason why the totally unrelated App Store charges 30% for apps!

There is clearly room to go down. And push comes to shove, Apple would be ready to reduce the commission. After all, it already has different slabs of commission for different kinds of products.

Maybe it can reduce it to a new schelling point. 25%? 20%?

However, this is not what Epic wants. They want to pay zero percent commission to Apple.

To Epic, the stand is philosophical. And while this may be a coincidence – it’s also more lucrative 😉.

  • Today, mobile accounts for only 20% of Fortnite users. Epic can afford to reject any sweeteners and fight for the grand prize. Better to fight now, rather than later when the downside of a ban is higher.
  • And there’s an even grander prize waiting. Epic has its own app store (not allowed on iOS yet), where it charges other games a commission of 12%. Seeing how successful Apple’s App Store is, that’s a lucrative business to be in.

So yes, a commission reduction will happen. Apple will make a peace offering. It may even lead to a tenuous peace.

But it won’t end the negotiations. Epic will hold out for Outcome 3.

Probability of Outcome 2: 30%.


Outcome 3: Apple allows other app stores.

This is what the App Store is, to iPhone users. The only bridge crossing into town.

A user cannot download an app to the iPhone from outside the App Store. Android has alternate app stores and also allows you to directly install apps. iPhone does not.

The analogy of the toll bridge is one that trust-busters and anti-monopolists like to use. It came up in antitrust investigations when Buffett acquired the Buffalo Evening News in 1977. And it will come up for Apple.

This is where Apple’s position is weakest, and this is where Epic is hitting it.

As M. G. Siegler says in “The App Store Commandments“, maintaining an “only bridge to the iPhone” approach made sense in 2010. But it’s not acceptable anymore.

This is what Epic is gunning for. Breaking the Apple App Store’s monopoly on the iPhone, and introducing its own Epic app store.

Epic could have held out for a reduction in fees (Outcome 2). It could have negotiated a win-win closed door deal (Outcome 1). But no.

By forcing Apple to ban its app, Epic has bent reality through a new focal point – the inability to reach users if Apple aggressively bans an app.

This then, is the long-term schelling point – alternate app stores for iPhone.

It may take one year. It may take two. It will be fought hotly by Apple, before it capitulates.

All it’ll take is one bad Congressional anti-trust hearing. And then, Apple will look at Android. It’ll see that even though Google allows other app stores, its Play Store still accounts for a huge majority of Android app downloads[4].

It will reason that developers will still prefer the Apple App Store, if only because there will be much fewer users on other app stores.

Probability of Outcome 3: 60%.


And that’s how Apple will finally get a second app store. And a third. And a fourth.

All it takes is one big bite.


Hope you liked the article. If you’d like to receive more such articles directly in your inbox, don’t forget to subscribe to Sunday Reads!


Footnotes:

[1] Read more details in this article from the Verge: “The company behind Fortnite dared Apple to shutter its game on iPhones. Now Apple has gone ahead and sort of done that.

[2] The Strategy of Conflict is a great book on applying Game Theory to the real world. It’s unfortunately not available on Kindle. Don’t worry if you can’t access a physical copy – there are PDFs of the book that you can find on Google.

[3] I said the App Store is more pro-developer than less. But of course, we haven’t heard Tim Cook chant chant “Developers… Developers…” like this guy.

[4] Except in China, where Google Play is banned.

The best of Jitha.me – A Compilation

Today I send out the 100th issue of Sunday Reads. It’s a good time to look back.

So I’m compiling some of the most well-received articles I’ve written over the last few years. On startups, business and management, and on mental models that make us more effective at what we do.

Hope you find the articles useful! Don’t read them all at once. Read whatever catches your fancy. You can always come back later 😊.

[PS. It’s also a good time to subscribe if you haven’t. You’ll get issue #101 next Sunday. I promise you won’t regret it.]

The World of Startups

How to save yourself from a bad startup idea that looks good.

(Go to article).

This is an article I wrote in late 2015, a couple of years into my startup and when I was just starting OperatorVC, the angel fund I invest through.

It struck a chord with readers. It still gets 100+ views a week (and ranks in top 3 on Google for “bad startup idea”) despite being not very optimized for search.

We have plenty of startup ideas. Many of them are bad, and we dismiss them right away (or our friends warn us off the idea).

They’re the easy ones.

The dangerous ones are the ideas that look quite good. The ones that give you goosebumps, and then three wasted years.

In this article, I list some of the common patterns that such plausible (but actually bad) ideas have, so that you can spot them early and save your time.

Read on here.

On a related note: Why describing your startup as the “Uber of X” is a bad idea. Yes, despite what Y-Combinator says.

How Uber solved its Chicken and Egg problem (and you can too!).

(Go to article).

Some of the most exciting companies of the 2000s are multi-sided networks. Think Uber, or Airbnb, or even ecommerce marketplaces. They’re massive, and they have immense defensibility.

Anyone who wants to compete needs to get both suppliers and consumers, at the same time.

That’s the proverbial chicken and egg problem. How do you get consumers when you don’t have suppliers, and vice versa?

Turns out there are four specific ways you can solve the chicken and egg problem.

Read on here for examples of each of these solutions.

I’ve also captured it as a framework on Slideshare, that you can download.

Your Minimum Viable Product can be more minimum than you think.

(Go to article).

Most of us in the startup community understand the concept of a Minimum Viable Product, or MVP. It’s the most basic version of your product that still delivers your core offering.

Aiming for an MVP helps entrepreneurs (especially first-timers) avoid the rookie mistake – building too much product before validating market need. We all want the ten revolutionary features in our first version. But not only will these features take five extra months to build, most users will also not see them.

So that’s the concept of an MVP. Sounds simple, right?

And yet, we slog for 3 months to build the MVP. And congratulate ourselves on finding out it didn’t work, and then spend another 3 months on a pivot.

Three months is way too long! Why does the MVP take so long?

The reason is that we’ve got the notion of an MVP all wrong.

Read on here.


The World of Business and Management

What I learnt from talking toilets in rural Bihar.

(Go to article).

My last project in consulting (back in 2012) was to develop a market-based solution to the problem of sanitation in rural Bihar (one of India’s poorest states).

At that time, less than 20% of households in rural Bihar had toilets. And many of those who did have toilets, didn’t use them – they would defecate in the open instead.

Against this intimidating backdrop, we set out to build a private-sector led solution to the problem.

And we were fairly successful. The project helped over 500K rural households construct toilets in their homes. It increased the number of toilets in our focus districts by 10 percentage points.

This article talks about the timeless lessons I learned through the project, on markets, consumers, and how to sell.

On a related note, the job to be done framework. Or, as they say, “You don’t sell saddles. You sell a better way to ride.”

What doesn’t get measured… doesn’t exist?

(Go to article).

We’ve all heard the saying “What gets measured, gets managed”.

A simple, yet powerful thought. With a simple corollary – what doesn’t get measured, doesn’t get managed.

But in reality, the corollary is far more extreme.

In the eyes of the person responsible, what doesn’t get measured… doesn’t really exist!

Read on here, to see the dark flipside of this common management adage.

On a related note, the Availability heuristic. Or “what you see is all there is”.

How to manage your team LIKE A BOSS (even while working remote).

(Go to article).

This is a more recent, and more topical article.

Effective team management (whether in-person or remote) can be distilled into five key axioms.

Call them the Minimum Effective Dose, or the 80:20 of team management.

Team management 101

Read on here .

Hiring Great People.

(Go to article).

This links back to the previous article. You can only work with people you end up hiring. So, hiring well has an inordinate influence on your team’s future output.

Hire well, and you have an NFL Dream Team. Hire badly, and at best you get a squabbling dysfunctional family. Not much effective team management you can do there.

In the same vein as the previous article, here are 7 key learnings on hiring.

1. Hire only when you absolutely need to.

2. Don’t be too hard on yourself. 1 in 3 hires don’t work out – if you do it right.

3. False Positives are OK. False Negatives are not.

4. What to look for in candidates: drive and self-motivation, innate curiosity, and ethics.

5. A few tips for running an interview process. Most important one – do reference checks.

6. How to let people go. Decisively, but with sensitivity. It’s your fault – not theirs – that you hired them into a role where they can’t succeed.

7. Diversity will not happen on its own. You’ve got to make it happen.

Read on here.


The World of Mental Models

What are “mental models”?

They are tools that help us understand the world faster and better. Instead of approaching every new problem from scratch.

Simple but powerful concepts, that help us understand situations more clearly, and make quicker yet better decisions.

For example, take this core principle from economics: “There ain’t no such thing as a free lunch“. It reminds us to look at every wonderful business deal with care. What’s the catch? There’s always a catch.

In a way, mental models help us think in a more “modular” fashion.

Modular programming makes software much faster. In the same way, mental models are the modules that soup up your decision-making engine.

Mental models are the modules that soup up your decision-making engine.

Over the years, I’ve written about a few powerful mental models, that have helped me think faster (and better) about business problems.

Listing a few of them below.


Hope you like some of these articles!

Do write back or comment with the articles you liked best, and I’ll share more on those topics in the coming weeks.

And don’t forget to subscribe, so you get issue #101 of Sunday Reads!

They will never take… our FREEDOM!

psychological reactance
Mel Gibson in Braveheart, feeling a little blue.

Last Friday, the lockdown in Singapore was lifted. It was a glorious, sunny day. As I looked out of my window and saw a few people swimming in the pool (it was closed through the lockdown), my first thought was, “I’ll go for a swim this evening. It will be amazing.”

My second thought was, “Wait, that doesn’t make sense!”

  1. I hate swimming.
  2. I’m not a good swimmer.
  3. In the two years I’ve lived in this condo, I’ve never used the pool. Not once.

So what the hell happened there?

What happened was, I got some freedom back, and I loved it. Even if I’ve never actually used that freedom, and therefore, its value to me is precisely zero.


This was a benign example. But this yearning for freedom, even when we don’t actually need it, is an intense force driving our behavior.

The term for this is Psychological reactance. Here’s Wikipedia on the subject:

Reactance is an unpleasant motivational arousal (reaction) to offers, persons, rules, or regulations that threaten or eliminate specific behavioral freedoms. Reactance occurs when a person feels that someone or something is taking away their choices or limiting the range of alternatives.

As Dr. Robert Cialdini says in Influence: The Psychology of Persuasion, this is a powerful impulse.

As opportunities become less available, we lose freedoms. And we hate to lose freedoms we already have.

This desire to preserve our established prerogatives is the centerpiece of psychological reactance theory.

According to the theory, whenever free choice is limited or threatened, the need to retain our freedoms makes us desire them (as well as the goods and services associated with them) significantly more than previously. So when increasing scarcity—or anything else—interferes with our prior access to some item, we will react against the interference by wanting and trying to possess the item more than before.

That’s why we have these videos of people rejecting masks in different parts of the US.

In this one, a protester thunders, “I will not be muzzled like a mad dog!”.

And the video in this twitter post has a few strange quotes:

  • “They want to throw God’s wonderful breathing system out the door.” Umm, no.
  • “You, doctor, are going to be arrested for crimes against humanity!” (for saying that people should wear masks).
  • “The mask is literally killing people”.

That’s why young parents experience the “terrible twos”.

Around the age of two, children come to a full recognition of themselves as individuals. This newfound sense of autonomy also brings along the concept of freedom. And the child wants to explore and test (again and again) the boundaries of this freedom.

Much to the chagrin and frustration of the parents.

There’s this hilarious example in Cialdini’s book, about banned detergents in Florida.

Dade County (containing Miami), Florida, imposed an antiphosphate ordinance prohibiting the use—and possession!—of laundry or cleaning products containing phosphates.

A study done to determine the social impact of the law discovered two parallel reactions on the part of Miami residents.

First, in what seems a Florida tradition, many Miamians turned to smuggling. Sometimes with neighbors and friends in large “soap caravans,” they drove to nearby counties to load up on phosphate detergents. Hoarding quickly developed; and in the rush of obsession that frequently characterizes hoarders, families were reported to boast of twenty-year supplies of phosphate cleaners.

The second reaction to the law was more subtle and more general than the deliberate defiance of the smugglers and hoarders. Spurred by the tendency to want what they could no longer have, the majority of Miami consumers came to see phosphate cleaners as better products than before.

That’s also why book censoring doesn’t work.

Or rather, it works too well. It’s every new writer’s dream for their first book to be banned.

Readers not only want the book even more than before, the book also gets a halo effect of “truths they don’t want us to hear”.


Have you noticed other examples of psychological reactance? Of how we overvalue unimportant freedoms we’re about to lose? Hit reply or comment, and let me know!

COVID-19 and Taboo Tradeoffs

COVID-19 Quarantine

Scott Alexander has written a great “where are we now” primer on COVID-19: When all you have is a hammer, everything starts looking like a dance.

Apart from his updates on how we’re doing in our battle against the virus, there were two pieces I wanted to call out. One interesting, and one insightful.


Why are some countries containing COVID-19 better than others?

Scott evaluates the different theories for why some countries are doing better than others.

  • Stay at home orders: Don’t seem to have mattered at all.
  • General government policy: Also seem to matter much less than we’d imagine. We thought Korea and Taiwan are doing well because of their brilliant governments. Japan, on the other hand, denied the problem for a long time so they could still stage the Olympics. Yet, they’re not doing too shabbily.
  • Testing policy: Yes, this matters, as I’ve mentioned before in Sunday Reads #85: Black Swans, Honesty, and Dishonest Statistics. But most (developed) countries are now testing properly, so this doesn’t explain the differences either.

Clearly, there’s still a lot to discover about this virus.


Lockdowns and taboo tradeoffs.

Second, and I found this far more insightful: He also talks about the importance of framing.

Coronavirus has killed about 100,000 Americans so far. How bad is that compared to other things?

Well, on the one hand, it’s about 15% as many Americans as die from heart attacks each year. If 15% more people died from heart attacks in the US next year, that would suck, but most people wouldn’t care that much. If some scientist has a plan to make heart attacks 15% less deadly, then sure, fund the scientist, but you probably wouldn’t want to shut down the entire US economy to fund them. It would just be a marginally good thing.

On the other hand, it’s also about the same number of Americans who died in the Vietnam War plus the Korean War plus 9/11 plus every school shooting ever. How much effort would you exert to prevent the Vietnam War plus the Korean War plus 9/11 plus every school shooting ever? Probably quite a lot!

Sure, you say, “This is a good example. But I already know the importance of framing, and anchoring.”

Great. Then let’s try another one for size.

Suppose you reopened the economy tomorrow. You tried as hard as you could to put profits above people, squeezed every extra dollar out of the world regardless of human cost. And then you put a 1% tax on all that economic activity, and donated it to effective charity. Would that save more people than a strict lockdown?

If a lockdown costs $5 trillion, then the 1% tax would make $50 billion. That’s about how much the Gates Foundation has spent, and they’ve saved about ten million lives.

Ten million is higher than anyone expects US coronavirus deaths to be, so as far as I can tell this is a good deal.

This reminds me of the discussion on Taboo Tradeoffs in the Rationality fan-fic, Harry Potter and the Methods of Rationality. Won’t share any spoilers, but the gist (I paraphrase from Chapters 78-85):

When you compare the value of sacred vs. secular objects (e.g., paying $5M for a liver replacement so a person can live, vs. for improving medical equipment), you make a taboo tradeoff.

Whenever you refuse to pay a certain amount (“I will not donate $2M for upgrading medical equipment”), you set an upper bound on a life.

Whenever you agree to pay a certain amount (“I will pay $5M to get this poor person a liver”), you set a lower bound on a life.

And if these two bounds are inconsistent, it’s an opportunity to move money to achieve a greater good.

Margin of Safety, or why you should always save for a rainy day

[Note: I shared this mental model with my email subscribers on Feb 12, 2017. If you want to receive a new mental model every week, join the club.]

Margin of Safety: You build a bridge that 30,000-pound trucks can go across, and then you drive 10,000-pound trucks across it.

What it is:

Margin of safety is a critical principle in engineering.

Let’s say we’re building a bridge, and the maximum weight of vehicles we expect on the bridge is 5,000 tons. So do we build it to withstand 5,000 tons? 6,000 tons?

No. We build it to withstand 20,000 tons. That’s the margin of safety.

When you save “for a rainy day”, that’s what you’re doing. Building a contingency fund. A margin of safety for your lifestyle, should you lose your job.

As Seth Godin explains in Breakpoints: when laying a sidewalk, workmen don’t put long slabs of concrete in place. Instead, they keep small gaps every few feet. That’s a margin of safety too – in case the concrete breaks or expands in unpredictable ways.

[Tweet “”You build a bridge that 30,000-pound trucks can go across and then drive 10,000-pound trucks on it.”]

Examples from business:

  • Investing: Margin of safety is a core tenet of value investing, popularized by Benjamin Graham and David Dodd. As Warren Buffett, a long-time protege of Ben Graham, says: “If we calculate the value of a stock to be only slightly higher than the price, we’re not interested.”
  • Startup fundraising: You don’t raise just enough capital to get to your next round of funding. If you want to raise your next round at $1Mn in revenue, raise enough now to get to $2Mn. Better still, raise enough to become profitable. Similarly, don’t start looking for investors when you have one month of cash in the bank. Start when you have six.
  • Capacity planning: Most services organizations keep a bench (idle employees) of up to 20% of their total headcount. So that they can service any sudden requirements. Same goes for manufacturing – as they say, if you have 20% spare capacity, you have no spare capacity.
  • Project planning: When drawing out a project plan, always put in a few buffer days / weeks.

[Aside: we almost never do this. There’s even a name for it. The planning fallacy – how we believe that this time, unlike all previous times, we’ll finish the project on time.]

[Tweet “”If you have 20% spare capacity, you have no spare capacity.” #marginofsafety #mentalmodel”]

Rules to follow:

  1. Always build a margin of safety. Whatever you’re doing, estimate how long, how much money, etc. it’ll take. Then add a buffer.
  2. Expect your plans to go awry. Do a premortem. And then build redundancy / backups.

As Seth Godin says in the article above, there’s no doubt the ground will shift. The question is: when it does, will you be ready?

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Further Reading:

 

Linked to: Redundancy, Premortem

Filed Under: Engineering

Cognitive Dissonance, or why it’s so hard to persuade people with facts

[Note: I shared this mental model with my email subscribers on Feb 5, 2017. If you want to receive a new mental model every week, join the club.]

Charlie Munger Quote on Cognitive Dissonance

Why is it so hard to persuade people with facts?

You feel like their argument stands on three key pillars, and you’ve destroyed all of them with hard data. Still, it remains standing. In fact, they’ve dug their heels in even more!

Why does being corrected trigger feelings of anger and dismay?
Short answer: Cognitive dissonance.

 

What it is:

Why does cognitive dissonance happen? As this article says, there are two main reasons:

  • Our brains don’t store facts as standalone pieces of information. We remember data points as a network of interrelated “facts”. So, when one of them is called into question, it feels like the entire network of beliefs is threatened. Loss aversion kicks in.
  • When an argument threatens your world view, self concept, or your very identity, facts can even backfire. You become more convinced of your erroneous stand, when you hear you’re wrong.

Strange things happen when you think your identity is attacked.

See the GMO study in the article above, or this interesting example of cognitive dissonance from the ever-provocative Scott Adams.

And cognitive dissonance isn’t triggered only in an argument. In any setback, you choose the interpretation most favorable to your self esteem. Just ask Aesop:

The Fox & the Grapes - Cognitive Dissonance

[Tweet “”We have a habit of distorting the facts until they become bearable for our own views.””]

Rules to follow:

So, what do you do? Or, as the title of this section says, how do you convince someone when facts fail?

  1. First, articulate the opposite position accurately. Acknowledge that you understand why someone could hold that opinion.
  2. Stick to the facts, and layer them up gradually. First, the raw information. Then, a second order inference. Agree on both. Only then, bring up your controversial conclusion.
  3. Keep emotions out. Discuss, don’t attack. No absurd absolutes. No ad hominem. And definitely no ad Hitlerum.
  4. Don’t activate identity when arguing a point. Show how changing facts doesn’t necessarily mean changing world-views.

If you and your stubborn interlocutor are a little geeky, try the Double Crux method. [I’m still trying to find a fellow geek I disagree with, to try this.]

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Further Reading:

 

Linked to: Confirmation Bias

Filed Under: Psychology & Human Behavior

The Premortem, or how foresight can also be 20:20

[Note: I shared this mental model with my email subscribers on Feb 5, 2017. If you want to receive a new mental model every week, join the club.]

Premortem

Or as more ancient stoics said, “Premeditatio malorum”. Or “premeditation of evils”.

 

What it is:

We’ve all heard of the postmortem in business. When something goes wrong, all the decision-makers get together to diagnose what happened. And learn how to prevent it from happening again.

In theory, at least.

What really happens though, is an advertisement for hindsight bias. Everyone suddenly remembers how they “always knew it wouldn’t work”.

As Amos Tversky said, “The writing may have been on the wall all along. The question is: was the ink invisible?”

[Tweet “”The writing may have been on the wall all along. But was the ink invisible?” #hindsightbias”]

A premortem asks the same question as a postmortem, but before you embark on your endeavor. “It’s two years from today, and our plan has been implemented. But it’s been a disaster. What went wrong?”

Explicitly going through such a thought experiment can help avoid the overconfidence and groupthink that team decisions can suffer from. We all love “playing the devil’s advocate” – here’s an executive license (and order) to do so!

[Tweet “We all love “playing the devil’s advocate” – a #premortem is a clear license to do so! #mentalmodel”]

Examples of premortems / thought experiments:

Here are a few examples of thought experiments to try.

1 Year from Now:

  • We haven’t hit product-market fit yet. We took too long to launch our initial product. What features could we have left out?
  • Half our customers didn’t renew their contracts. Why? What went wrong?

 

3 Years from Now:

  • Our startup has just shut down. We just couldn’t hit a growth trajectory. What are the reasons for this failure?

 

Rules to follow:

  1. When you’re making a big decision, make sure you think about what could go wrong. And protect against it. Don’t only think about what happens when the plan works – you’ll fall prey to the focusing illusion.
  2. Every few months, revisit and repeat the premortem. Have you covered for the main risks? Have any new risks opened up?

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Further Reading:

 

Linked to: Focusing Illusion, Hindsight Bias

Filed Under: Decision-making

The focusing illusion, or why “it’s not really as important as you think it is”

[Note: I shared this mental model with my email subscribers on Jan 29, 2017. If you want to receive a new mental model every week, join the club.]

Focusing Illusion Quote

What it is:

Have you been subjected to this nifty party trick? A person at the party claims to be able to read your psychology from manipulating your hand.

He presses your thumb backward, and says, “Hmm, you look like you’re often stubborn.” You’re surprised – it is true!

Later, you cross paths again. This time, he presses the thumb back and says, “You’re a surprisingly flexible person.” And that seems true too. You can think of several instances when you demonstrated surprising flexibility.

 

So which is it? Probably neither. You, my friend, have been subjected to the focusing illusion.

Just like the respondents to a question, “Are you adventurous?” in a research study. 97% said “yes”.

When you think of or focus on something, your subconscious assumes it’s important. After all, why would you think about it otherwise?

It’s recursive logic, with a healthy dollop of confirmation bias.

You focus on it, therefore it’s worth focusing on.

 

Examples in business (and elsewhere):

What you focus on seems important.

  • When you’re fundraising, it seems like make-or-break for your startup. But it isn’t. Money from customers, not investors, will drive success for you. If you’re building something useful, you’ll find a way.
  • You commit a silly mistake at work on Friday evening, and then you’re in torment all weekend. But your boss – he barely notices it on Monday morning. It wasn’t that important after all.
  • “There’s no such thing as bad publicity.” Fading movie stars crave it – at least it gives them presumed importance in the public’s eyes.

[Tweet “”There’s no such thing as bad publicity.” #focusillusion #mentalmodel”]

What you focus on seems true.

  • The positive test: In deciding whether a possibility is correct, we look for hits rather than misses. Just like the adventurous respondents in the survey above, we can be flexible or stubborn. It depends on the question. This kind of one-sided question (e.g., asking only whether you’re dissatisfied about a situation), is called a positive test. Beware when you hear such a question – maybe your counterpart wants to send you down a specific line of thought.
  • Medical students and their diseases: It’s common for medical students to feel they’ve contracted the latest disease they’ve heard about. They read that pneumonia produces pain in a particular place, concentrate attention on it, and get alarmed at the slightest sensation. This is so common, there’s an aphorism for it in medicine:

“When you hear hoofbeats, think of horses, not zebras.”

  • If 2016’s Brexit and US presidential campaigns have taught us anything, it’s this: Say anything often enough, and people will think it’s true.

[Tweet “”When you hear hoofbeats, think of horses, not zebras.” #focusillusion #mentalmodel”]

What you focus on seems causal.

  • Offer people a lot of money to do something, and they’ll do it for free. The listener automatically assumes the task is very important to you. (That’s why you’re willing to pay so much!). Try this the next time you’re trying to jump ahead in line.
  • The most visible action is assumed to be causal: When a company misses its projections, newspapers attribute it to a recent government announcement. Or a tepid product launch to a bad ad campaign.

 

Rules to follow:

How do we save ourselves from the focusing illusion?

  1. Don’t make big decisions in the heat of the moment. It’s quite likely you’re overestimating the importance of a couple of factors. Calm down, sleep on it, and make the decision later.
  2. Beware of one-sided questions. It’s quite likely that your counterpart is priming you towards an answer they prefer.
  3. Whenever you’re making a big decision, do a premortemMake sure to think about what could go wrong, and protect against it.
  4. In summary, remember Kahneman’s adage: Nothing is as important as you think it is when you’re thinking about it.

[Tweet “Nothing is as important as you think it is when you’re thinking about it. #mentalmodel”]

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Further Reading:

 

Linked to: Confirmation Bias, Availability Heuristic

Filed Under: Psychology & Human Behavior

Occam’s Broom OR “You don’t know what you don’t know”

[Note: I shared this mental model with my email subscribers on Jan 22, 2017. If you want to receive a new mental model every week, join the club.]

Occam's Broom: "You don't know what you don't know"

My wife berated me the other day for forming a strong opinion about something (I forget what) without knowing all the facts. To which I responded with a question: Is it even possible to know all the facts?

Pride at being a smart alec notwithstanding, the conversation reminded me of this mental model. So, thanks hon!

What it is:

Philosopher Daniel Dennett talks about Occam’s Broom, a play on Occam’s Razor (a mental model for another day).

He uses the term to describe how, when we’re making an argument, we have a tendency to whisk inconvenient facts under the carpet.

And this tendency, already questionable, becomes downright insidious when experts present their arguments to the layperson. And completely leave out pertinent (but contrary) evidence.

Or when journalists present only half the story in the garb of “news”. Move over fake news – at least those guys aren’t pretending to themselves that they’re telling the truth!

And the worst thing is – you cannot do anything about Occam’s Broom. You’re helpless. After all, you don’t know what you don’t know!

Examples in business:

  • Evaluating partnerships / acquisitions: When you’re assessing a company to acquire / partner with it, you can only ask so many “right questions”. You never know where a black swan may be lurking. That’s probably why half of M&A deals fail.
  • Deciding on potential product features / business choices: If your team presents a new business opportunity / product feature, you can expect to mainly hear the pros of the choice. Sure there’ll be cons, but most of them will be strawmen.
  • Listening to a sales pitch: Let’s say a salesman presents you the latest software to revolutionize your business, or a “sure” stock pick. You have no way to know what he’s not telling you.
  • To assess whether a hypothesis is true, you need to test it. You can talk to all the experts you want. But you won’t get decisive answers unless you ask the right questions. And you don’t know the right questions!

 

Rules to follow:

OK, we get it. You don’t know what you don’t know. What do you do then?

  1. Whenever you’re making up your mind about something, recognize that you may not know all the relevant factors.
  2. Avoid forming opinions in areas where you’re not an expert. Keep your identity small.
  3. Sometimes, you do have to form opinions based on incomplete facts. In such cases, remember the adage “strong opinions, weakly held”. Form decisive opinions, but change them when the known facts change.
  4. Whenever someone offers you a strong / extreme opinion, get your guard up. Reality is not as stark as Occam’s Razor would argue.
  5. Tread carefully in a new area. Do a “pilot”.  No matter how much you’ve analyzed it. It’s a hypothesis till it proves itself in action.
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Further Reading:

  • Occam’s Broom
  • Intuition Pumps: Daniel Dennett’s book, which introduces this model. [Warning: it’s not an easy read]. Also check out this article for a collection of his critical thinking tools – mental models in their own right.

Linked to: Occam’s Razor

Filed Under: Psychology & Human Behavior


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The Power of Exponential Growth OR Why you are not late

[Note: I shared this mental model with my email subscribers on Jan 15, 2017. If you want to receive a new mental model every week, join the club.]

Exponential Growth

I complain about this often. And I’ve heard others grumble in a similar vein. Whether entrepreneurs, technologists, scientists, economists, you name it – “I wish I was born when all the action was happening.”

But here’s the thing – as Kevin Kelly says in You are not late, you can bet that in 2045, someone will say the same thing about 2015.

The last 30 years have created a platform, from which ever new exciting things can result. Whether it’s AI, virtual reality, nanobots, etc. – it’s likely that the key technologies of 2045 will be very different from the ones today.

So, next time you complain about being too late to create Microsoft or Google or Facebook or string theory, read this. You are not late.

But the article also illustrates a larger point – the power of exponential growth.

What it is:

Exponential Growth - Bill Gates Quote

That’s the best summary of exponential growth I’ve seen. Our brains can think only incrementally. But technology improves exponentially. Advancements pile on each other.

For a long time, nothing seems to be happening. Then all of a sudden, hypergrowth.

Credit: Mother Jones [http://www.motherjones.com/media/2013/05/robots-artificial-intelligence-jobs-automation]

I bet you’ll see the above graphic again and again. The last bit of shooting growth always astounds us. Despite it often being a mathematical certainty.

It’s not for nothing that Einstein (is rumored to have) said, “Compound interest is the 8th wonder of the world.”

 

Examples:

  • Moore’s Law: Gordon Moore’s prediction in 1975 that computing power would double every 18-24 months [I paraphrase] has held remarkably true. This regular doubling has given us PCs, mobiles, smartphones, and now AI.
  • Adoption rates of consumer technologies: As this graph shows, adoption rates of consumer technologies are ever-accelerating.
  • Look at any of the major growth stories of the last few years – Uber, Airbnb, etc. In each new market, they started small. No one noticed them, or worse, they dismissed them as irrelevant, non-scalable, or playthings of the rich. Till, suddenly, their dad started using them.

 

Rules to follow:

  1. When planning your career, try to work in sectors that are growing exponentially. Growth creates options.
  2. Don’t skate to where the puck is. Skate to where it will be. To requisition Wayne Gretzky’s memorable words, go where the future will be. Build skills that will be useful tomorrow.

Bottomline: The future will always be more different from today than today is from the past. The future adds a zero.

Ergo, the best time to start something new is NOW.

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Further Reading:

 

Linked to: Power Law

Filed Under: Mathematics & the Sciences