Is business all about luck?

  • Is business all about luck?

    Is business all about luck?

    What you will learn:

     

    “Peter believes that “Business, like many of life’s challenges, is all about luck. Successful business people seek out the right business model, work hard and smart in implementing their ideas and consequently are well prepared for when they get lucky”.

     

    You might be interested to know that there is quite a deal of science as well as cognitive psychology embedded in this statement….

     

    New Sam Wilko Advisory Blog by Peter Wilkinson

     

    Some of you may have read the quote I lead with on my Linked-In profile:

     

    “Peter believes that “Business, like many of life’s challenges, is all about luck. Successful business people seek out the right business model, work hard and smart in implementing their ideas and consequently are well prepared for when they get lucky”.

     

    You might be interested to know that there is quite a deal of science as well as cognitive psychology embedded in this statement.

     

    To illustrate I will borrow an excerpt from “Thinking Fast and Slow” by Nobel Prize Winner Daniel Kahnemann. This fascinating book explores how we exercise judgement and make decisions, with our apparently fully rational brain blissfully unaware of the effects of unconscious biases that shape the choices we make. In the book Daniel reveals two favourite equations:

     

    Success = talent + luck

    Great Success = a little more talent + a lot of luck

     

    Kahnemann illuminates these equations using the example of a golf tournament, for which and for simplicity’s sake the average score of the competitors is assumed to be at par 72. A player who did very well on Day 1 scored a 66. One could infer from this score that the golfer is more talented than the average participant in the tournament. The formula for success above suggests that another inference is equally justified: this golfer probably enjoyed better than average luck on that day. The equation above proposes that either conclusion is equally warranted.

     

    By the same token, a player who scored 5 over par on that day may be less talented and had a bad day. Of course, it is entirely possible that a player who scored 77 on the same day is actually very talented but had a very bad day. As Kahnemann points out and uncertain though they are, the following inferences from the score on day 1 are plausible and will be correct more often than they are wrong:

     

    Above-average score on day 1 = above-average talent + lucky on day 1

    Below-average score on day 1 = below average talent + unlucky on day 1

     

    So what can be predicted for the score on day 2? Given the golfers retain the same level of talent on the second day, the question becomes one of luck and there is no way of predicting the golfers’ luck on the second (or any) day. Accordingly, your best guess must be that it will be average, neither good nor bad. This means that in the absence of any other information, your best guess about the players’ score on day 2 should not be a repeat of their performance on day 1. This is the most you can say:

     

    • The golfer who did well on day 1 is likely to be successful on day 2 as well, but less than on the first, because the unusual luck he probably enjoyed on day 1 is unlikely to hold.
    • The golfer who did poorly on day 1 will probably be below average on day 2, but will improve, because his probable streak of bad luck is not likely to continue.

    We also expect the difference between the two golfers to shrink on the second day, although the best guess is that the first player will still do better than the second.

     

    This is regression to the mean in action. The more extreme the original score, the more regression we expect, because an extremely good score suggests a very lucky day.

     

    For further sporting related evidence of this effect which is all around us, look no further than Test Cricketers’ career batting averages, the very best of which are clustered around 50 runs per innings (for an explanation of Don Bradman’s career average of 99.94 you may wish to refer to “Outliers” by Malcolm Gladwell).

     

    Just recently, David Warner scored 244 Not Out at the WACA on Day One of the Second Cricket Test between Australia and New Zealand (surviving what was reported as three clear chances to be dismissed). The day after and despite his stated intention to bat on, he advanced his score by nine runs before getting out. Was this (as the commentators suggested at the time) that he was just tired from the previous day’s efforts or that the pitch had suddenly come to life or that the bowler had found renewed energy? Or in a sport where luck has a very significant influence on overall result, was this just regression to the mean?

     

    In short, we invent stories, or causal links, for performance – our brains are actually wired to be very good at it – when in reality all we are observing is regression to the mean.

     

    So back to the business challenge: Assuming we have chosen the right business model in an appropriate industry sector, if we fully show up and engage our talent as business people whilst being aware that great success is largely driven by a lot of luck, how are we to improve our chances of success?

     

    HARD WORK in the right areas, focused on maximising talent, and being ready for the luck when our share inevitably comes our way.

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