We all have theories. A theory is just a belief about what causes something to happen and why.
Anytime we take a series of actions to achieve some goal, whether large or small, we’re behaving according to some theory. We believe that those actions, as opposed to some other actions, have a better chance of resulting in the outcome we want.
There’s a theory for hitting a baseball and a different theory for hitting a golf ball (and it changes for different situations).
There are theories for curing illnesses and other theories for dealing with recessions.
There are theories for convincing consumers to buy products, and there are theories for persuading people in an argument.
The point is, whether you’re explicit about it or not, you run your life on theories. We all form and refine theories as we go along. For most people, this is all they do. They see what has worked and form an implicit theory of cause and effect. Once formed, it’s difficult or impossible for that theory to change. Others, however, think explicitly about the theories and how to improve them. The impact can be staggering.
I somewhat coincidentally stumbled upon four different people writing independently about the same thing: thinking explicitly about theories. The two that were in finance had met with astounding success and had attributed that success to that mode of thinking. This seemed significant to me, and the rationale for doing so made sense as well.
In other words, it would have been a mistake to think that thinking about theories leads to success because a few successful people did so. That would be correlation, not causation—a mistake that good theory, in fact, helps you avoid. Rather, there emerged clear, logical reasons that living life this way made sense and would lead to more success.
Ray Dalio runs Bridgewater Associates, which with $122 billion under management today and having returned 18 percent annually on average for the last 20 years, is the biggest, most successful hedge fund in the world. Not only that, it’s returns are uncorrelated with other hedge funds, which is incredible.
It’s hard to grasp the scale of that achievement. Doing all four of the following together is completely unprecedented: good returns, constant returns, uncorrelated returns, and a very large pool of capital (few hedge funds are larger even than $10 billion).
Dalio is unique in that he writes openly about his thought process. It’s clear when you read his writings that he thinks about the world in fundamental, timeless ways. (The Fed at times turns to him for advice, and he was regularly involved in discussions during the financial crisis.)
His broad ideas are captured in a document titled Principles on Bridgewater’s website. It’s worthwhile reading, even though some have called the ideas “weird” or “cultish.” There’s no doubt that he promotes a strong, unique culture. The strength of the culture and how openly he discusses it can be disconcerting to many.
The most powerful part of the document, however, is in his approach to life, which he explicitly summarizes as:
Truth—more precisely, an accurate understanding of reality—is the essential foundation for producing good outcomes.
He extends that idea into many forms, from a philosophy of self-improvement to mastery of a craft to running an organization.
But the heart of his philosophy is the same: there is an objective way the world works, a fundamental reality, which you can either accept and seek to understand or not. It doesn’t matter whether you do or not, the reality remains. And those who seek to understand it will meet with more success than those that don’t.
Charlie Munger is Vice Chairman of Berkshire Hathaway, which he runs with CEO and Chairman Warren Buffett. Berkshire Hathaway’s groundbreaking successful I probably don’t need to make explicit, but I will anyway: Berkshire Hathaway in 2011 had $143 billion in revenue and total assets of $392 billion. It has grown book value 20 percent per year for the last 44 years. And, of course, Warren Buffett is at varying times the richest man in the world or in the top five.
Munger, in addition to his role at Berkshire Hathaway, has become famous for his view of the world, which came to light in a series of speeches in which he advocates addressing life by building up a store of elementary, worldly wisdom.
In his speech to USC Business School in 1994, he begins:
What is elementary, worldly wisdom? Well, the first rule is that you can’t really know anything if you just remember isolated facts and try and bang ‘em back. If the facts don’t hang together on a latticework of theory, you don’t have them in a usable form.
You’ve got to have models in your head. And you’ve got to array your experience—both vicarious and direct—on this latticework of models. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and in life. You’ve got to hang experience on a latticework of models in your head.
What are the models? Well, the first rule is that you’ve got to have multiple models—because if you just have one or two that you’re using, the nature of human psychology is such that you’ll torture reality so that it fits your models, or at least you’ll think it does. You become the equivalent of a chiropractor who, of course, is the great boob in medicine.
It’s like the old saying, “To the man with only a hammer, every problem looks like a nail.” And of course, that’s the way the chiropractor goes about practicing medicine. But that’s a perfectly disastrous way to think and a perfectly disastrous way to operate in the world. So you’ve got to have multiple models.
And the models have to come from multiple disciplines—because all the wisdom of the world is not to be found in one little academic department. That’s why poetry professors, by and large, are so unwise in a worldly sense. They don’t have enough models in their heads. So you’ve got to have models across a fair array of disciplines.
You may say, “My God, this is already getting way too tough.” But, fortunately, it isn’t that tough—because 80 or 90 important models will carry about 90% of the freight in making you a worldly-wise person. And, of those, only a mere handful really carry very heavy freight.
Munger goes on to describe those models. He starts off with things like permutations and combinations, which are powerful but that human minds, as a consequence of our evolution, are not naturally equipped to handle.
And because it’s powerful yet not natural…
…you have to learn in a very usable way this very elementary math and use it routinely in life—just the way if you want to become a golfer, you can’t use the natural swing that broad evolution gave you. You have to learn—to have a certain grip and swing in a different way to realize your full potential as a golfer.
He moves on to psychology:
And then when you get into psychology, of course, it gets very much more complicated. But it’s an ungodly important subject if you’re going to have any worldly wisdom.
And you can demonstrate that point quite simply: There’s not a person in this room viewing the work of a very ordinary professional magician who doesn’t see a lot of things happening that aren’t happening and not see a lot of things happening that are happening.
And the reason why is that the perceptual apparatus of man has shortcuts in it. The brain cannot have unlimited circuitry. So someone who knows how to take advantage of those shortcuts and cause the brain to miscalculate in certain ways can cause you to see things that aren’t there.
Now you get into the cognitive function as distinguished from the perceptual function. And there, you are equally—more than equally in fact—likely to be misled. Again, your brain has a shortage of circuitry and so forth—and it’s taking all kinds of little automatic shortcuts.
So when circumstances combine in certain ways—or more commonly, your fellow man starts acting like the magician and manipulates you on purpose by causing your cognitive dysfunction—you’re a patsy.
And so just as a man working with a tool has to know its limitations, a man working with his cognitive apparatus has to know its limitations. And this knowledge, by the way, can be used to control and motivate other people….
So the most useful and practical part of psychology—which I personally think can be taught to any intelligent person in a week—is ungodly important. And nobody taught it to me by the way. I had to learn it later in life, one piece at a time. And it was fairly laborious. It’s so elementary though that, when it was all over, I felt like a fool.
There’s incredible insight through the speech, and in fact, I think he downplays the power of his view. There are many more mental models that are important than he discusses, and of course, the models vary by field.
Yet, the heart of his message is simple and elegant:
…you can’t really know anything if you just remember isolated facts and try and bang ‘em back. If the facts don’t hang together on a latticework of theory, you don’t have them in a usable form.
Business books have gotten a bad reputation, and in most cases, rightly so.
In his book The Halo Effect Phil Rosenzweig reviews the problem with most business books and the studies they rely upon. In the vast majority of cases, they draw a correlation between characteristics common to successful cases to generalize suggestions for other companies without rigorously articulating a theory.
Christensen doesn’t fall prey to this tendency, which is actually a much broader problem with how our minds view the world. In fact, he explicitly combats this tendency in discussing the foundation of good theory.
I knew when I read The Innovator’s Dilemma that it was powerful, but I couldn’t then tell you exactly why. Partly, it was the depth of the research. His research began by studying eighty-three firms that entered the disk drive industry over the course of seventeen years. Partly, it was the logic. Christensen didn’t stop with obvious answers. He persisted until he articulated theories that rested on timeless human behavior. He also extended the idea into a diverse array of industries and time frames. He welcomed exceptions, realizing they were the key to sharpening the theory.
I understood more, however, when I read The Innovator’s Solution, where in Chapter One, he talks about the characteristics of good theory. (Since most people reading this blog are focused on startups, I’m going to replace “manager” in the following with “entrepreneur” to emphasize the relevance.)
Even though most entrepreneurs don’t think of themselves as being theory driven, they are in reality voracious consumers of theory. Every time entrepreneurs make plans or take action, it is based on a mental model in the back of their heads that leads them to believe that the action being taken will lead to the desired result. The problem is that entrepreneurs are rarely aware of the theories they are using—and they often use the wrong theories for the situation they are in. It is the absence of conscious, trustworthy theories of cause and effect that makes success in building new businesses seem random.
Christensen goes on to articulate a process of building solid theory, one that has been adopted across disciplines.
1. Describe the phenomenon you wish to understand.
2. Classify the phenomenon into categories.
3. Articulate a theory that asserts what causes the phenomenon to occur, and why. (The theory must also show whether and why the same causal mechanism might result in different outcomes, depending on the category or the situation.)
The process is iterative.
As mentioned, a key problem with the way many people build theory is that they generalize from a few observations. In other words, they mistake correlation for causation. Like Dalio, Christensen uses the theory of flight as an example to illustrate how good theory works.
The phenomenon researchers wanted to understand was flight: What allows creatures to fly, and how can we create flight for humans?
Researchers began categorizing their observations into things that could fly and things that could not. They saw that most of the creatures that could fly had feathers and wings that flapped so an early theory articulated was that creating feathered wings and flapping them would lead to flight.
They were wrong. It wasn’t until Bernoulli’s study of fluid mechanics that they understood how pressure differentials created by wings caused flight.
The Innovator’s Solution is filled with great theory about what leads to success in innovation.
K. Anders Ericsson
There’s a final angle here that may not appear to fit in the same mold at first and that’s the idea of deliberate practice, first articulated by psychologist K. Anders Ericsson. Ericsson wrote an article in Harvard Business Review, and other authors built on his ideas in the books The Talent Code and Talent is Overrated.
Ericsson began by studying memory and found that with training anyone could be made to remember long strings of numbers. Previously, it had been believed that the human mind could only hold seven numbers at a time, that this was a “hardware” problem. Ericsson proved that this was wrong, reliably increasing the capacity to ten times that (and feeling that he had not found the upper limit).
From there, Ericsson went on to become the leading researcher in the acquisition of extreme skill. He basically wanted to understand how experts, the leading performers in any field, acquired their skill. Were they born with the skill (i.e., were they naturally talented), or did they acquire it?
What he found:
Consistently and overwhelmingly, the evidence showed that experts are always made, not born. (Emphasis Ericsson’s.)
Ericsson goes on to articulate a theory he calls “deliberate practice” of explicitly and consciously improving one’s skills. He goes on to discuss how much of an expert’s skill comes from literally knowing more than others by having seen many more situations from which to draw lessons.
But that’s not all. These experts also saw the world differently. Having seen so many situations, they were able to fit situations into certain frameworks to draw the relevant key pieces of information and implied actions quicker and more reliably than others.
As with the other approaches, explicitly thinking about performance is key. Whereas Dalio, Christensen, and Munger all focus on thinking, Ericsson expands that skill to other arenas as well, including sports. But the core remains the same: explicitly focus on improving performance. Believing that you’ll improve passively is a pipe dream.
Realize there are timeless, fundamental rules for everything. Going forward, I’m going to write more about using theories as well as specific theories.