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The maths of success

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How can you become more successful?

One answer was inside a TED talk by Damian Kulash, the lead singer and director of OK Go, an American rock band known for its elaborate and quirky videos.

Damian explained that in one of their videos, a giant Rube Goldberg machine, there were 130 sequences that had to take place one after the other where each sequence triggered the next.

In each sequence, something fairly simple takes place. For example, a ball rolls down an incline, a counterweight lowers an object or an object something swivels on its axis and hits something else.

If each sequence works 9 out of 10 times then its probability of working correctly is 90% or 0.9.

How likely is it the band will be successful at filming the entire set of sequences in one take?

The maths of probability is used to work this out. In the equation P^n, P stands for probability and n is the number of events.

Plugging this into the equation, the probability of each sequence working is P = 0.9 and the number of sequences is n = 130.

0.9 raised to the power of 130 is 0.000001125.

That means there is literally one chance in a million that the series of sequences will work.

In life and work, we often have to do things that follow a process, where one thing needs to be done after another.

If we aim to be quite good at each thing – and get it right 9 out of 10 times, then the more things we have to do, the less often we will be successful.

For example, if an operation in a business takes 10 steps and you are 90% sucessful at each step, the probability of success is 0.9^10= 35%.

That means two-thirds of your customers are likely to be unhappy with what they get from you.

You can improve your chances of success by doing two things.

First, increase P. Get better at doing each thing.

If you get things right 99% of the time, 0.99^10 = 0.9, which means your customers are happy 90% of the time.

Only 1 out of 10 walks away unhappy. Still not great.

Second, reduce n, the number of things you have to do.

If n was 4 rather than 10, then you would get 0.99^10 = 96%.

Now 96% of your customers are happy.

In summary, the maths of success says work on optimising the formula P^n so that the answer tends to 1.

In other words: Do less, and do it better.

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The Chasm: Every innovator’s challenge

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Why do some innovative products and services succeed while others fail?

The answer may lie in how they navigate the chasm, an idea talked about in Crossing the Chasm by Geoffrey Moore, first published in 1991 but still relevant today.

The basic roadmap for bringing a new product or service to market follows a lifecycle.

First, innovators get excited about a new opportunity and create the first version of the product.

Then visionaries, the people who see how this could be different, useful, life changing – they get involved and the innovator starts to make early sales.

This is good because it validates the product and shows there is a market for it – however small.

The product develops, gets better, gets case studies and a small customer base happy to recommend it to others. At this point, the early majority start to get interested.

The product continues to be used and developed. With a strong base of customers, the rest of the market sees this as a strong option or alternative to existing solutions.

Sales take off and the company enters a period of hyper-growth.

Now the product is considered safe, reliable and the first choice. It’s now a mass market product.

Finally, the people who have been holding off, the sceptics and laggards turn up and start to use the product.

Where companies fail is in making the move from selling to visionaries to selling to the early majority.

This is the chasm, a point where the company is running out of visionaries to approach – the people with the early interest but the early majority are not ready to commit because the product is still relatively new, immature and not widely used.

Existing providers, threatened by the new product, can use fear, uncertainty and doubt (FUD) to protect their own businesses.

The chasm is the most challenging period for a new product or service.

There are no easy answers to get across it.

The point, however, is that ignoring the chasm will most likely lead to failure.

A winning strategy will think about ways to bridge the chasm – and go from a product that visionaries will use because they can see the benefits to ones that the early majority will use because you have removed the risks.

This shift in thinking – moving from selling the benefits to removing the risks is likely to be the deciding factor in getting from one side of the chasm to the other and entering the next stage of growth.

In summary, sucess or failure for companies and products is often a result of how well they cross the chasm.

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Why forecasting is for cows

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McKinsey talked what they called one of the ugliest and most common charts in strategy at the start of the year – the hairy back.

At the start of any process – a startup pitch, a sales plan, a production forecast, you need to show a chart where, from a standing start, forecasts go confidently upwards – the “Hockey stick” graph.

In reality, the forecasts are not achieved. Year after year, as actual performance stays flat or even drops, the forecasts create a series of lines that go up – and the hockey stick turns into a “hairy back” – like the ones cows have…

Why does this happen? Why do smart people get it wrong year after year?

There are a number of reasons, and they all come down to the psychology of business.

Targets are set that are not connected to the underlying business

A target is easy to set. 50% growth. 20% increase in production. 80% reduction in staff turnover.

If someone important in a business sets a target, then everyone else starts to work to try and meet that target.

Proposals are worked on to make sure the numbers reach the target rate, especially if everyone is competing for resources and the only way to get your budget for the year is to make sure you reach the target.

This is called “gaming” and a big part of good strategic planning is minimising the opportunities for gaming behaviour in pursuit of a target.

As Warren Buffet writes, if your business is based on “making the numbers”, you can well end up with a situation where you “make up” the numbers.

Targets should be based on a realistic assessment of the capacity of the business and the resources it has in place and how they create value.

Human biases get in the way

Once someone decides that a particular approach is a good idea, confirmation bias kicks in.

That person now looks for information and data that confirms their point of view, and discounts or ignores information that disagrees with it.

People believe that all you need is a goal and optimism and you will do anything with whatever you have.

In reality, what you achieve is often determined by mundane things like whether you have the resources and time to do fairly basic tasks well day after day.

If it eventually turns out that the idea doesn’t work, attribution bias helps the person explain it away by blaming whatever seems convenient.

Ultimately, although forecast setting seems very scientific, there is an emotional dimension to almost everything we do, and that causes us to use shortcuts, see patterns where none exist, tend to believe what we would like to be true, explain everything and feel like we operate more logically than we really do.

How to create better forecasts

There are two ways to improve forecasting.

First, put better decision making processes in place. Use techniques to generate ideas, encourage dissenting views and create real discussion, debate and challenge about options and what they mean for you.

Second, listen to the voice of the business. Targets need to be connected to the business, and there will be lots of data that shows you what is happening.

The trick is to convert this data into insight, separate out what is signal from the noise and connect decisions to data.

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A roundup of BREXIT risks: What does it mean for you?

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Theresa May invoked Article 50 of the Lisbon Treaty on 29th March, giving the UK two years to leave the EU – on Friday 29th March 2019.

The government’s focus over the period is on laws, transferring EU law into UK law and deciding what to keep and what to scrap.

What are the really big issues from the UK’s point of view?

There are 3 things that come out of the withdrawal letter sent to the EU.

  1. If the UK leaves the EU without an agreement, trade will continue on default World Trade Organisation (WTO) terms but it would be good to have a free trade agreement.
  2. We have to work out what happens to citizens currently living and working in different countries.
  3. It would help to have an implementation period to avoid a cliff edge.

The negotiations between the UK and the EU need to unpick over 40 years of processes and go through thousands of points, but these are probably the most crucial overall.

What about individuals – what could happen to us?

Things will cost more

The fall in the value of the pound has made imported goods more expensive. People expect the currency to stay low for the long term now, so prices could increase rather than decrease.

Travelling could involve more checks

At the moment, there is visa free travel across the EU. In some countries, UK citizens can stay for up to 90 days without needing a visa, and that sort of arrangement would help with tourism.

If you are planning to stay for longer, that may require visas in the future.

Common services could change

There will be an impact on areas like health cards, insurance, car number plates and so on where the outcome of the negotiations will determine where you buy them and what it means for you.

What will happen to businesses?

The risks for businesses fall into three broad categories:

  1. Labour
  2. Trade
  3. Finance

A number of industries depend on international labour

Sectors such as Accomodation and Food Services, Manufacturing and Transport have between 20 and 30% of their workforce made up of non-UK nationals.

These businesses will have to prepare for the cost of replacing or recruiting workers.

A trade deal is crucial for exporters and importers

Many products involve supply chains that criss cross the EU.

The Airbus supply chain, for example, has parts built in several different countries. Could the parts built in the UK have to pay additional tariffs? Or, could those manufacturing tasks be moved to Europe.

Four-fifths of cars made in the UK are exported and more than half of these go to the EU.

The financial sector is exposed to similar risks. Activities carried out in London may move to Hamburg or Paris.

The costs of doing business don’t look like they will go down

If the exchange rate remains low, companies that import will have problems while those that export could see increases in sales.

Wages, however, will probably rise if there are fewer workers available and the value of the remaining pool goes up.

Agriculture, in particular, could suffer both from a shortage of workers and from the loss of EU subsidies.

Summary – a model for assessing risks

As a starting point, it makes sense to fall back on Michael Porter’s value chain.

What are the things you do to deliver a product or service to your market?

How will you BREXIT affect you in each of these areas:

  1. Your infrastructure – office locations, equipment, materials.
  2. Your workforce.
  3. The technology you use.
  4. Procurement – how you buy everything you need.
  5. Inbound logistics.
  6. Operations.
  7. Outbound logistics.
  8. Marketing and sales.
  9. Service.

Will BREXIT increase costs or decrease costs for you in these areas?

Will it create opportunities or result in lost business?

With less than two years to go, it is time to get busy planning for the future.

Note

Drawing – inspired by the work of Chaz Hutton

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Why is UK productivity flatlining?

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The ONS released its quarterly bulletin on labour productivity covering the first quarter of 2017 on 5th July 2017.

The index of productivity, measured by gross value added (GVA) per hour normalised fell from 102.4 to 101.8, a drop of 0.59%.

The BBC’s headline for this was “Today’s productivity figures are bad to the point of shocking.”

Really?

It’s worth going over a couple of points from Understanding Variation: The key to managing chaos.

Comparing one number with another for a previous period is often used when reporting figures in the press. If the number is up, great. If it down, the sky is falling.

While this is easy to do, such comparisons are weak and lead to sensationalist headlines with little insight. They are limited because they use less data than there is available and because they don’t take variation that is in real world data into account.

If we look at the underlying data over a slightly longer period a few things jump out at us.

First, gross value added (GVA) seems to increase over time fairly linearly. Apart from a brief hiccup around the time of the financial crisis in 2008 the line pretty much trends upwards.

That takes care of the numerator in the productivity equation.

The denominator seems more complicated. Looking at the ONS data, its hard to find something that is a simple measure of hours worked.

For example, this page has some material, but its hard to work out which particular set or trend should be used.

Looking at a website called trading economics, it looks like average hours worked came down from 1995 to 2010 and then started rising agan.

So, we have two charts. One with steadily rising numbers and another with numbers that first fall, and then start to rise again.

When you put the two together, the impact is a chart that first increases and then flatlines as the rate of change of GVA matches the rate of change of hours worked.

The reasons for this in the press point towards the number and type of jobs in the economy as the problem.

There are more jobs than before, so there are more people working than before. This means that total hours worked is increasing faster than the rate at which output from those hours is increasing because the jobs being worked are not as high value as they were previously.

To change the trend, you need to either increase GVA – do more valuable work, or reduce hours – do the same work with less people.

Simple to say, but not easy to do.

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The significance of 46

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What we believe is significant is heavily conditioned by the media and what it chooses to focus on.

The BBC website, for example, now changes little from day to day. A few new stories come on that are shocking or terrifying, while other stories that are popular because they were shocking or terrifying show up day after day.

It gets harder to think independently when everyone is shown (roughly) the same collection of material from news sources as everyone else.

Search tools cause you to focus on what you know – because it is a little difficult to search for what you don’t know, or what you aren’t aware of yet.

One approach to deal with this is Edward De Bono’s random-word technique, described in Think! Before it’s too late.

Find a random word, for example by opening a book at random and pointing at a page with your eyes shut, and then see where that word takes you.

This may seem a little absurd at first. Its main benefit, however, is that it opens up a new line of thinking, something you may not have considered before.

The book closest to me is “The Weekenders: Adventures in Calcutta”. The word that came up, or number rather, is 46. Where will that take us?

Some interesting places it turns out.

Code 46 is a movie that came out in 2003, a futuristic romance story where the characters are genetically incompatible.

The 46 degree halo is a rare ice crystal halo that forms when sunlight enters ice crystals.

Expedition 46 to the International Space Station ran from December 11, 2015 and ended March 1, 2016 and is significant because Tim Peake was on board, the first British European Space Agency (ESA) astronaut to fly in space. The mission patch shows the Union flag prominently because of this.

The Mark 46 (Mark XLVI) is the forty-sixth Iron Man Armour and appears in Captain America: Civil War.

Directive 95/46/EC of the European Parliament talks about personal data and the movement of such data.

The Model 46AS food waste disposer is an entry level disposer for smaller households.

The only slightly sinister sounding Division 46 of the American Psychological Association looks at how to use psychology in media communications and technology. That’s not scary at all…

The KC-46A Pegasus is a widebody air to air refuelling tanker.

In 2015, Americans checked their phones 46 times a day.

And finally, and rather delightfully, Organism 46-B is a 14-legged giant killer squid discovered in the Arctic that is now being weaponised by the Russian military.

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What will you do when it starts to rain gold?

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UK markets are at a high right now. The FTSE is in the region of over 7,300.

At its peak in 2007, the FTSE was at 6,700. So it’s around 10% higher than that.

At the end of 1999, it was at nearly 6,800.

So that means one of two things:

  1. We are significantly overvalued and due for a crash. In 1999 you had the tech crash, and in 2008 the financial markets crash OR,
  2. History is not a reliable indicator of the future and something else is going on.

What are the reasons behind the current highs in markets?

Cheap money has flooded the economy for several years. Low interest rates mean that money doesn’t earn a return sitting in banks and so the price of everything goes up.

In the UK, the fall in sterling has meant that companies that make a lot of money in foreign currency see higher earnings, and that has given a boost to the FTSE in particular, where about 70% of income is from outside the country.

If you look at fundamentals, you might think that the underlying economy remains weak. There is a problem with productivity. Increases in earnings are starting to lag the increase in valuations.

Are we due a crash?

Some people don’t think so. Not yet anyway.

Although the UK market is at a high, with the price/earnings ratio of the FTSE 100 at around 30, the Cyclically Adjusted Price Earnings (CAPE) was around 14 at the start of the year.

The high PE is partly because many partipants had poor earnings last year.

The CAPE is supposed to be a better indicator of what is happening over a cycle and at 14 (20 in Q4 2016).

Robert Schiller, the Nobel prize winning inventor of CAPE argues that from this level, stock prices could still perform strongly for a few years.

If markets have been distorted over the last 10 years because of QE, then perhaps we can’t take current highs as a signal of overvaluation and there is still plenty of room for markets to rise.

So what could happen now?

It’s been 10 years since the last crash. This time 10 years ago, we didn’t know that markets were going to blow up the way they did.

We knew that certain markets looked like they were good value and made particular decisions about them.

Some decisions were never made. Investments on autopilot simply carried on regardless of market conditions or opinion.

We don’t really know much more this time around. Markets could go up higher. They could crash.

And some markets look like they could be good value.

In his 2016 shareholder letter, Warren Buffet set out what he hoped to do.

He had no plans, he said, other than to “dream big and be prepared mentally and financially to act fast when opportunities present themselves”.

And here is the important bit, given where we are right now as an economy and with BREXIT around the corner.

“Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons.”

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Putting inflation in context – what does 2.9% mean for us?

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The Consumer Prices Index (CPI) reached 2.9% in May 2017. This brings inflation back to levels last seen in 2012.

Goods and services have become more expensive in the UK following the BREXIT vote and the start of exit talks.

The pound has weakened and prices have risen.

The ONS points to a rise of 7.7% in electricity prices during the year. Food and alcohol, clothing and footwear, furniture and household goods and recreation and culture are all showing their highest rate of increase for 12 months.

What can inflation tell us about what is ahead for the economy?

Not very much it turns out. Inflation is a lagging indicator of economic activity, and it is only after a trend is underway that it starts to move significantly.

Where it does have value is in telling us where there might be potential hotspots.

For example, imported goods are clearly going to be more expensive because of the weak pound – and the four categories with the highest inflation rate are all dependent on imports or global prices.

That tells us to watch the exchange rate carefully if our business depends on global markets.

Inflation is expected to continue rising for the rest of the year, peaking at over 3%.

As the increase appears to be mostly due to exchange rates it is unlikely that interest rates will be increased in the short term.

What it also means is that households will have less money after they have paid for more expensive goods and services, and this is already showing up in lower levels of household saving.

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When is it a good idea to think differently?

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Two roads diverged in a yellow wood, wrote Robert Frost, and taking the one less travelled by made all the difference.

When is it wise to follow the crowd and when is it not a good idea?

Crowds are good at particular kinds of thinking. In his book The Wisdom of Crowds, New Yorker staff writer James Surowiecki talks about three kinds of problems that crowds are particularly good at solving:

  1. Problems of cognition: These are problems which will have a solution at some point. How many cars will sell next quarter? How likely is it that a new drug will get approved?
  2. Problems of coordination: How should a group of people behave? for example, how do buyers and sellers trade fairly? How should people drive safely in cities?
  3. Problems of cooperation: How is it possible to get people who are focused on their own interests to work together? How can we tackle problems like pollution, climate change or tax policy?

Crowds can also be extremely unwise. This usually happens when the rules they should follow break down, communication fails to moderate behaviour and you get things like a riot or stock market bubble.

Interestingly, a crowd seems to fail when its members start to think the same way. This is the essential cause of stock market bubbles and has been seen over time, from tulips to houses.

When everyone starts to believe that the price of something will always go up, you get irrational exuberance, and a bubble that eventually bursts.

The paradox is that wise crowds integrate individual judgements to produce a group judgement – but in order to reach a good judgement, each member of the group needs to think and act independently.

Organisations that want people to reach better decisions should encourage diverse and independent thought and action.

Individuals who want to make better choices should not be afraid to disagree and contest ideas and options. We think better when we think independently.

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What kind of organisation do you work in?

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An organisation’s success depends on the nature of its relationship with its customers.

How customers view your company is key to how they choose to interact with you.

Thinking of an organisation only in terms of its staff, its products or its processes can hide important strategic aspects from you.

The model in the picture is adapted from this TED talk by Guy Kawasaki and this paper by Lepak and Snell and shows how customers treat organisations based on how they perceive them.

1. Efficient organisations: High Value but not Unique

Organisations that produce something of value are going to have a market for their products.

Their customers, however, have a choice between many suppliers. For example, car insurance is much the same between providers.

Your supermarket shop is going to have more or less the same things between major supermarkets.

In this quadrant, the winners are the ones with the lowest delivered price, which means they are the most efficient and with the lowest costs to deliver their service.

Customers are likely to go through tendering to work with organisations in Quadrant 1 and pick the cheapest one that does all the things they need.

One more thing about this quadrant – if you reduce your costs by becoming more efficient, the customer benefits in the form of lower prices but you don’t keep the savings in the form of higher margins.

This is why textile mills in the developed world went out of business. All the investment they put into reducing costs resulted in lower prices for consumers, but the companies themselves remained low margin and unattractive businesses and eventually closed down.

2. Contract based organisations: Low Value and not unique

If customers think that what you do has little value and is not unique then they have no incentive to work with you on anything other than a contract basis.

For example, many companies think of cleaning services just as something that needs to be done, but there are many companies that can do it.

The chances are that they will agree a contract with a cleaning company. That contract will continue as long as the facilities stay clean and the terms of the contract are fulfilled.

Over-delivering against the contract may not result in anyone noticing, but under-delivering – having facilities that are dirty – will probably result in complaints and having the contract terminated.

3. Stuck organisations: Unique but of low Value

Your organisation may produce something unique, but unless there is a market and customers perceive value in it, you are likely to be stuck with early adopters and find it hard to get more customers.

Many products fall into this category – there are now museums of failure to products such as Harley-Davidson Perfume.

In the city of Ann Arbor, Michigan, GfK Custom Research North America has a storehouse of failed products ranging from microwaveable scrambled eggs and TV dinners sold by Colgate to Clairol’s Yoghurt shampoo.

Many of these products were unique but perceived as having low or poor value and were withdrawn from sale within weeks or months because no one would buy them.

4. Growing organisations: Unique and with high value

Organisations that do something unique and are thought of by customers as delivering value are likely to be able to maintain higher margins than others, invest more into their businesses and attract more customers than their competition.

Apple is probably the poster child for this category. The company is sitting on $250 billion in cash as it brings in profits every quarter of over $10 billion.

This happens becuase its products are unique and it has customers that love what it does and are prepared to pay a premium to buy its stuff.

Warren Buffett has made a career out of buying businesses that have above average earning power – and credits managers with being able to get extraordinary results from ordinary businesses.

Summary

In summary, how your customers see what you do is crucial to getting the relationship right with them.

If you do something that is currently seen as low value and not unique, the only option, if you want to grow, is to work on changing your customer’s perception of what you do.

On the other hand, if you can deliver the best service, at the lowest price, working in a contract based business or in a business where you are the lowest cost provider can still work for you.

The place you don’t want to be is where your ideas are unique but no one wants to buy from you.

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