From explaining the past to looking into the future

Great piece in the FT (below) on the mis-use of mathematics in finance. The target of criticism are those who over-fit past data to profess a successful trading strategy for the future.

It is not a long shot to extend this to explanations of entrepreneurial performance. To a large degree, we tend to look for patterns in past performance data, but are these really useful as guides for the future?

Because we know what actually happened, we can always find an explanation for it. But since what happened cannot be assessed probabilistically among its many alternative paths (which did not happen and which cannot be really enumerated) there is no weight to our explanation in guiding us towards an open ended future.

Financial Times, When use of pseudo-maths adds up to fraud

Opportunity as friendship

Entrepreneurship is typically defined as the pursuit of opportunities. But what is an opportunity?

Let’s answer this question by trying to construct one. As a basic minimum we need three things: (1) a product or service, (2) one or more agents who consume it, and (3) one or more agents who produce it. But just the simple collection of such agents and artifacts is not enough; the essence of the opportunity lies in the relationships among them. Behind each relationship lies a distinct pattern of interaction, for example exchanging money for the product or exchanging labor for money. In other words, an opportunity is a set of interactions, a social structure.

Friendship is also a social structure. It requires at least two people. But the simple collection of them does not produce friendship; it is their distinct pattern of interaction that does so.

As social structures, opportunities and friendship are emergent phenomena, i.e. they amount to more than the sum of their parts. It is the interaction of these parts that give rise to the structure in question.

Given this, what does it mean to identify, recognize, discover, research, or even create an opportunity? Well, these terms make no sense when applied to friendship, so why should they make sense for opportunities? In a forward looking sense, the relationships that constitute an opportunity or a friendship do not exist; they can be imagined and aspired to. An opportunity or a friendship arises – if at all, that is – only when those relationships are fired up and sustained.

We do not plan our friendships. We take small steps to interact and, if there is a mutual spark, keep the interactions going. Over time, these sustained interactions become friendship.

Let’s revisit the opening definition of entrepreneurship. Entrepreneurship is the taking of many first steps, some of which may give rise to opportunities.

The illusion of understanding entrepreneurial success

Whenever successful entrepreneurs are asked for the secrets of their success, it strikes me that their answers inevitably involve one or all of the following: (1) persist, i.e. do not give up; (2) learn from your mistakes; and (3) give the customers what they want.

I have always found it troublesome that such advice sounds too simple, that there must be someting else, the secret that makes such entrepreneurs special. But perhaps there isn’t. Perhaps entrepreneurial success is indeed built from the iteration of these simple rules.

Why – I hear you ask – isn’t everyone successful then? I see the answer in the fact that entrepreneurial outcomes – huge success, failure and everything in between – are chaotic. The key to understanding the term chaotic is not to confuse it with random. Both chaos and randomness imply unpredictability but in different ways.

Randomness is what creates lottery winners and it is clear to us that there is no secret to becoming a lottery winner. Hence we never invite lottery winners to speak about their success. This is because random outcomes are non-deterministic, i.e. there is no particular reason why they happen; they just do.

Chaotic outcomes, on the other hand, are deterministic but unpredictable. In other words, the rules that generate the outcomes are clear. They can be very simple but iterative, that is applying the rule over and over. Just like persisting, learning and responding to customers. In entrepreneurial settings, such iteration traces non-linear paths, which means that there is no telling where you might end up. Miniscule differences at the outset can end up widely apart. I love the analogy of kneading dough. If you put two chocolate chips next to one another and continue by pressing, stretching and folding – simple, iterative rules – there is no telling where the two chips will end up in the final form.

Many successful entrepreneurs say that entrepreneurship is simple. It indeed is – the action rules are simple. There is just no telling where you will end up.

The Anna Karenina principle in entrepreneurship

The opening sentence of Tolstoy’s Anna Karenina

“Happy families are all alike; every unhappy family is unhappy in its own way”

– has inspired the term “The Anna Karenina” principle. It readily applies to entrepreneurship:

Successful entrepreneurs are all alike; every non-successful entrepreneur fails in his or her own way. Success, then, is not about ensuring positive factors, but avoiding all the negative ones.

Succeeding by avoiding failure may sound like an oxymoron, but if you replace “avoid” with “learning from and adapting to”, then success is all about finding and ironing out the kinks.