Friday, February 20, 2009

Creative Destruction

Richard N Foster's while talking about Creative Destruction provides a wonderful example in an interview in Forbes

Here's an excerpt...

I love your story of creative destruction in sailing ships. Please share it with my readers.

Sure. The first steam ship sailed around 1830. Yet when we look at some of the first photographs of ships from the early 1870s, a full 40 years later, we see an abundance of sails. The vast majority of investments that went into so-called "innovations" in the ship industry had gone into adding more masts to existing ships and more sails to those masts. Why? Because the incremental cost of building a slightly more advanced sailing ship always looked to be less than the full cost of starting up a steam ship from scratch. So there was no incentive for the incumbents to change to the new innovations, there was only incentive for new entrants to come up with steam ships, and that's in fact what they did. This went on for over 50 years, and even as steam ships got better and better, the incumbents continued to just add more sails. How could that be? Well, what was really happening was declining share in a growing market. This can often mean increasing sales--even though market share is falling. Your share is falling in a business that's defined differently than the way you think of it, so you generally don't even notice when in fact your lunch is being taken and eaten right before your very eyes.

So the big shipbuilders of the time didn't even realize that sails were about to be relegated to the realms of leisure boats?

Yes. This is one example of a very broad class of problems called confirmation bias, where we tend to only accept information from the outside that fits into our existing mental models, and we don't actively explore whether our own mental models are actually correct. Certainly, the innovators in the case of the steam ships understood this. The original steam ship builders knew perfectly well that the steam ship could not be competitive initially with the sailing ship. So they did what many innovators do, they came up with a hybrid product, which was a steam ship that had sails on it (or a sailing ship that had a steam engine in it, depending on your perspective).

Over time they improved the efficiency of the steam engine, which allowed the ship to go further and further and sail when there was no wind, and eventually the steam engines became so good that eventually, after 70 or 80 years, they could take the masts and the sails right off and just have a full blown steam ship, and that's in fact how the steam ship evolved. You could find steam ships up until the 1920s and 30s that were built with masts even though there was no capacity to put sails on them! Such was the nostalgia associated with the sailing ships. The basic idea was a confirmation bias, and it's a tremendous threat to companies trying to make a proper economic decision, which is often the decision to move onto a new technology. One doesn't have to look too far north of Detroit to think of current examples of a similar sort of thing…

Tuesday, February 10, 2009

Warren Buffet's Financial Advice for 2009

A snippet of a email that had the subject line " Warren Buffet's advice for 2009"

We begin this New Year with dampened enthusiasm and dented optimism. Our happiness is diluted and our peace is threatened by the financial illness that has infected our families, organizations and nations. Everyone is desperate to
find a remedy that will cure their financial illness and help them recover their financial health.. They expect the  financial experts to provide them with remedies, forgetting the fact that it is these experts who created this financial mess.

Every new year, I adopt a couple of old maxims as my beacons to guide my future. This self-prescribed therapy has ensured that with each passing year, I grow wiser and not older. This year, I invite you to tap into the financial wisdom of our elders along with me, and become financially wiser.

*Ø * *Hard work: All hard work bring a profit, but mere talk leads only to poverty.*

*Ø * *Laziness: A sleeping lobster is carried away by the water current.*

*Ø Earnings: Never depend on a single source of income. [At least make your Investments get you second earning]*

*Ø Spending: If you buy things you don't need, you'll soon sell things you need.*

*Ø Savings: Don't save what is left after spending; Spend what is left after saving.*

*Ø Borrowings: The borrower becomes the lender's slave.*

*Ø Accounting: It's no use carrying an umbrella, if your shoes are leaking.*

*Ø Auditing: Beware of little expenses; A small leak can sink a large ship.*

*Ø Risk-taking: Never test the depth of the river with both feet. [Have an alternate plan ready]*

*Ø Investment: Don't put all your eggs in one basket.*

I'm certain that those who have already been practicing these principles remain financially healthy. I'm equally confident that those who resolve to start practicing these principles will quickly regain their financial health.