“You are not a lottery ticket”
Some economic incentives for irrational behavior
“It is difficult to get a man to understand something, when his salary depends upon his not understanding it!” — Upton Sinclair
Large companies invest in their own departments and projects in a way similar to venture capital investors: diversifying.1
While the logical or rational choices may be one or few, by relaxing our constraints in the application of logic and reason we may reach more farfetched conclusions and approaches. The result is diversification.2
For entrepreneurs and intrapreneurs3 diversification is not as much of an option. Diversification would split resources into several efforts, potentially jeopardizing all of them. Focus is necessary.
Here is where investors4 provide the incentives for the irrational behavior of the ventures they invest in. For them, diversification may be the most rational approach. For entrepreneurs, with more skin in the game and only one possible thing to do at a time, doing the one thing with the highest probability of success is the most rational choice.
Counterpoint: Investors may avoid the tragedy of the commons that would arise from rational behavior if all efforts concentrated on a few approaches, competing with each other, and reducing the surface of success.
To sum up:
- At the core of the issue, we find the explore-exploit dilemma.
- Diversification in this case implies more exploration, but being done by different people, it is non-ergodic.
- Greater exploitation by several people would result in:
- A tragedy of the commons, competing with each other.
- Possibly saturating the market, obtaining diminishing returns.
- “Overthinking,” several people could reach more similar conclusions.
- The result is more exploitation (the previous point).
- Exploration would decrease. Entrepreneurs are still in a non-ergodic scenario, and investors lose ergodicity too.
- Underthinking is preferred. It is the best approach. It will result in ruin for some people, but they are expendable. The stories will be written about successful lottery tickets.
In the upcoming weeks, I will be covering a few more reasons for irrationality. If you want to receive them in your inbox and you have not subscribed yet, please feel free to subscribe (choose the free option). You can also use RSS.5
Note on ergodic processes. Simplifying, ergodicity implies a level of independence from the order of the events in a stochastic process (non-deterministic). While non-ergodic processes may render events impossible or render states unreachable based on previous events or states. Diversified investment is simultaneous, while concentrated investment is sequential. Therefore, diversification is useful to increase ergodicity.
Not to assume: that most companies or investors have good situational awareness to execute a highly concentrated investment strategy properly. Diversification is not as much of a choice as a necessity to compensate for imperfect information.
With intrapreneurs, I refer to employees with proposals to execute within the companies of their current employers, e.g. research projects, or new products or services to add to the company portfolio.
I include decision-makers within companies in the investor group because technically they are investors. Even if the return of the investment may often be intangible, described in a slide deck, and easily result in bubbles.
Personally, I use RSS with Zapier to send everything to Pocket and listen to it. But I still subscribe to have a backup copy in my inbox. In particular, I started to keep those backups since Art-of-Gig vaporized.
Cross-posted from the Sigmoid newsletter