More data does not always lead to more insights. Often less is better. If you put a frog in a pot of boiling water, he will immediately jump out. But if you place him in room temperature water, and don’t scare him, he’ll continue to stay put. If the pot sits on a heat source, and if you gradually increase the temperature, the frog will do nothing. As the heat gradually increases, he will continue to swim in the pot. Eventually, he will boil to his death.
Why would the frog refuse to jump out and escape? Because his internal apparatus for sensing threats to survival is geared to sudden changes in his environment, not to slow, gradual ones.
Is this story true? Well, no it isn’t. It is a myth.
In my last column, I wrote about the role of metaphors, analogies, fables and myths in understanding the world. The boiling frog syndrome is one of those myths with vast practical implications. That’s because the human equivalent of the boiling frog is there in all of us. Like that mythical frog, we are not wired to recognise slow, gradual changes.
Every day from tomorrow, if you start taking in 50 calories more than you expend, then you won’t look different the next day, or the day after. But if you keep doing this for a while, then, over time, your body shape will change. And if some friend of yours sees you after a gap of a few years, she will freak out.
Slow changes — both improvements and deteriorations — get magnified over time. But over short periods of time, they are barely noticeable for most people. Cognition, says Charlie Munger, misled by tiny changes involving low contrast, will often miss a trend that is destiny.
Take the case of threats from disruption and how industry insiders usually react to it. They don’t see what’s coming. Here are some clues.
“This ‘telephone’ has too many shortcomings to be seriously considered as a means of communication.” — William Orton, Western Union, 1876
“Television won’t be able to hold on to any market it captures after the first six months.” — Darryl Zanuck, 20th Century Fox, 1946
“The Americans have need of the telephone, but we do not. We have plenty of messenger boys.” — William Preece, British Post Office, 1876
In 2000, the video rental company Blockbuster’s CEO passed up a chance to buy Netflix for only $50 million thinking that it was a “very small niche business.” During that year, Blockbuster took in almost $800 million in late penalties from customers but its long-term stockholders were the ones who paid the ultimate late penalty as the company got “netflixed”over the next few years. At its peak in 2002, Blockbuster had a market cap of $5 billion. That’s also the year Netflix went public. Eight years later — in 2010 — Blockbuster went bust. And the company which destroyed Blockbuster — Netflix — has a current market cap of $78 billion.
It’s not just the insiders who miss seeing the oncoming train that will wreck their businesses. Analysts who track businesses closely tend to miss it too. An analyst report on Blockbuster in 1999 said that “investor concern over the threat of new technologies is overstated.”
Why does this happen? Well, part of the reason is commitment bias. Part of the reason is pain-reducing psychological denial. And part of the reason is the boiling frog syndrome — failure to notice, slow gradual erosion of one’s competitive advantage, because one is focused on daily, weekly, quarterly or even annual changes, not long-term ones.
The digital camera industry didn’t kill Kodak in day, or a year. And the smartphone industry won’t kill the digital camera industry in a day, or a year either. Nor will the electric vehicle destroy the economics of multiple industries dependent on the internal combustion engine in the short term. The decay will happen gradually, much in the manner described by this dialogue from Ernest Hemingway’s 1926 novel, The Sun Also Rises.á
“How did you go bankrupt?” Bill asked.
“Two ways,” Mike said. “Gradually and then suddenly.”
Peter Senge writes in his book, The Fifth Discipline
The decline happens so slowly that it’s difficult to detect, and it is often masked by “shifting the burden” palliatives such as increased advertising, discounting, “restructuring,” or tariff protection. Two things make this pattern hard to see. First it is gradual. If all this happened in a month, the whole organization or industry would be mobilized to prevent it. But gradually eroding goals and declining growth are insidious.
As Charlie Munger warns, some people — in my view, managements and industry analysts — will tend to be misled by tiny changes involving low contrast, and will often miss a trend that is destiny.
Some trends are destiny. Some trends are just noise. And some are mean reverting. For investors, knowing which is which is critical.
One big lesson that I have learnt over the years is that I should never talk to, or rely upon, the management of a company when worrying about risks of disruption. Apart from the fact that they have too much financial and emotional investment in the game, the management of a company is just too close to data which will turn out to be noise in the long run.
They have too much data. They have daily data. Indeed, they have realtime data about hundreds of variables about their businesses. And when one is inundated with so much data over such a short time, one is prone to missing the big picture.
More data does not always lead to more insights. Often less is better. In fact, when one is thinking about disruption (or gradual improvements in the competitive advantage of a business), investors who are somewhat detached as compared to insiders and industry analysts, and who have learnt much after reading evolutionary biology and history of not just businesses but civilisations, are likely to be in a much better position to identify important changes that are hidden in daily, weekly, quarterly, or even annual financial statements.
If you want better insights about tiny changes in businesses that can have big implications on their long-term profits and market valuations, you’d do better by reading up on the subjects of evolution and history instead of talking to managements. Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.