How Not to Fail as You Scale

All I want to know is where I’m going to die so I’ll never go there”??????Charlie Munger?

The genius of Warren Buffet and Charlie Munger is avoiding excess complexity. Over many years, both have emphasised the value of keeping things simple, investing in businesses they can easily understand, and letting managers they trust do the rest.

The polymath statesman and self-improvement pioneer Benjamin Franklin had similar advice: “If you wouldst live long, live well; for folly and Wickedness shorten life.” In his wonderful letter about purchasing a whistle when he was seven , he recounts the embarrassment of learning that he overpaid for the toy but helped him better recognize others’ folly. He concludes with the lesson that a great part of “the miseries of mankind are brought upon them by the false estimates they have made of the value of things, and by their giving too much for their whistles.”

University of Chicago Professor John List mines similar territory in his excellent new book The Voltage Effect . Drawing on research and his experience as chief economist at Uber and Lyft (he also worked on public policy for the George W. Bush Administration), List explains why failing is so common when trying to scale ideas in business or public policy.

For List, to successfully scale an endeavour is to achieve “high voltage.” Those endeavours could be protecting the health and safety of a community, improving the viability of a business, or enhancing the education and opportunities of a future generation. “Translating an idea into widespread impact requires replicating it at scale,” he writes. ?

However, List borrows from Jared Diamond’s Anna Karenina Principle to point out that there are so many unique ways to fail, success is rare. Avoiding a multitude of possible pitfalls requires an extraordinary combination of chance and mastery. He then provides a great summary of these pitfalls, which I have listed below and embellished with my own experience and perspectives.

First, he offers “five vital signs of a scalable idea”:

1.????Dupers and false positives. When an endeavour is difficult, complex, or innovative, the first signs of success should be met with healthy scepticism. This is because early successes are much more likely to be false positives. Naivete, confirmation bias, self-interest, and sometimes even deceit (hence beware of dupers) are all reasons why wasteful investments often follow false-positive findings. High-stakes endeavours must come with higher standards of proof, data, and evidence.?

2.????Overestimating the opportunity – When assessing the merits of a large opportunity only pay attention to people buying into an idea if those people are truly representative of a much larger group. Early adopters often have very different preferences–particularly in the amount they are willing to pay for products and services–than most people. Many marketers rely on focus groups, but it’s remarkably hard to simulate the real market conditions based on hypothetical propositions suggested to consumers who are often more curious and eager to please than the average person.

3.????Unscalable ingredients – If your idea depends on one person or a scare talent pool to achieve success, then it is not scalable. Some ventures have good processes for upskilling people, but if the skill base you require is in short supply, the pace of scaling will be constrained. If you ignore this reality and try and take shortcuts, you will undermine the value of your offer.

4.????Unintended consequences – Many ideas that have achieved scale have also produced negative unintended consequences. A classic example is price promotion. Price promotion attracts new demand from customers, but it’s usually accompanied by a lower willingness on the part of those customers to pay.?You can calculate the additional volume required to make up for the lower profitability, but price promotion can turn off your best customers who previously valued the prestige or exclusivity associated with a brand. ?

5.????Cost traps – Some ideas require a huge amount of cost upfront. The willingness to pay this cost is predicated on the belief that there will be payoffs in the future and the cost structure will improve with economies of scale. But it’s common to overestimate the cost reduction that will result with scale and to underestimate the competitive challenges. The streaming wars illustrate this dynamic in action. There is a scarcity of content creators and as more platforms compete for them, much of the value goes to creators rather than to the platforms.

He then provides the “four secrets to high voltage.”:

6.????Incentives – The most effective way to motivate a large number of people to work towards a common goal is with incentives. But it is very hard to design incentives that work through the various stages of a venture’s life, because what may attract and motivate early employees, may not excite later ones. It’s useful to put extra effort into fully harnessing the power of non-financial incentives. With financial incentives, it’s important to consider how they will affect your people and culture, both positively and negatively.

7.????Marginal returns – When ventures successfully scale, they become increasingly complex. This complexity creates significant challenges, particularly in resource allocation . For example, it’s difficult to know how to invest in activities that provide the best marginal return. How do you decide where to put the next dollar and evaluate the benefit of the average dollar? When making these decisions, it’s important to beware of a cognitive bias known as the sunk cost fallacy –if the next investment isn’t worthwhile, it doesn’t matter how much has already been invested.

8.????Knowing when to quit – Many efforts to scale a venture never take off. Nor do they crash. They simply endure. It’s important to recognize that middling performance is just a slower way to fail. It’s better to fail fast because talent and/or money have opportunity costs. And the real failure of a venture is often hidden because those who know when to quit or kill projects are already pursuing other, often better, opportunities for success.

9.????Scalable culture – Bad start-up culture is now pop culture. And while it’s comforting to believe that bad and toxic cultures will, sooner or later, be cosmically punished, Professor List doesn’t address the question of whether disruptive ideas require, at least in early phases, a band of pirates mentality. Possibly, but besides the fact that these are rare exceptions, if you want to channel Buffet and Munger, it is certainly safer to stay away from any bad ways to get seemingly good things done.

The path from having a good idea to having successfully scaled that idea is unpredictable. To succeed you need an abundance of conviction, the perseverance to overcome many challenges, the humility to reflect on the true state of affairs, and the wisdom to avoid the many pitfalls.

All ventures are difficult, but it’s important to focus on making your venture no more difficult than it has to be. To that end, Scott Belsky’s book The Messy Middle which was published just a few years back, makes the point that all bold ventures have a messy middle journey between vision and success. But here is the critical distinction: All successful ventures may have messy middles, but very few messy middles are indicative of the path to success. It’s all about avoiding the wrong kinds of messy.?

You can hear more directly from John List in this podcast conversation we had.