We Lost...And We Wouldn't Change a Thing

Resulting - (verb) the tendency to judge a decision based on its outcome, rather than the quality of the decision itself. (made popular by Annie Duke, professional poker player, psychologist, author of "Thinking in Bets: Making Smarter Decisions When You Don't Have All the Facts"

Here is a betting quiz for you.

You and a friend are betting on the outcome of a coin flip. Heads you win, tails you lose.

Most people know the odds are 50/50 and over a long series of bets, no one will really win.

But let's add some drama, instead of a coin flip, its an investment with the same 50/50 odds and the minimum investment is $10,000. If it comes up heads, you win $25,000, if it comes up tails you lose $10,000. Do yo take the bet (again, assuming you can easily afford the $10,000 loss).

These thought games occur all the time to try and illustrate the mathematical optimal strategy. This one is easy to judge - you take the bet...you keep taking the bet. And the reason is that, like in a coin flip, you success and failure of getting heads or tails IS STILL THE SAME, but the asymmetrical dollar outcome greatly tilts your financial success in your favor!

Here are a series of coin flips I will not perform while I type this:

Flip 1 - Tails: Loss of $10,000 (ouch)

Flip 2 - Tails: Loss of $10,000

Flip 3 - Heads: Win $25,000

Flip 4 - Tails: Loss of $10,000

Flip 5 - Heads: Win $25,000

Flip 6 - Tails: Loss of $10,000

Flip 7 - Tails: Loss of $10,000

Flip 8 - Tails: Loss of $10,000

Flip 9 - Heads: Win $25,000

Flip 10 - Tails: Loss of $10,000

Tallying this up, we landed heads 3 times and tails 7 times for a 30% win rate. But when we add the dollar amounts, my 3 successes made me $75,000 and my 7 losses, lost me $70,000, so even though good fortune was not on my side this round of flips, I still came out ahead.

Because of the odds, and the asymmetry of the payout, the longer I play this game, the further ahead I will get. Thus, I should keep playing this game until the other party quits playing.

But this is not how many of us execute strategy. As I was flipping the coin I imagined being in a board room and being lectured on the poor win rate. Being reprimanded that my strategy was "too risky". And this happens way too often in corporate setting, especially in our discipline of insurance.

Imagine in my example, after the unlucky first flip how something similar to that would have played out in your company?

"Bad Strategy Nick"!

Why? Because I lost...this one time. But to keep playing is actually good strategy even in the unlikely, but still possible event that I lost every one of the 10 tosses of that coin!!

And much of our inability to make and execute strategy is our inability to define the outcomes we desire. Strategy is about winning or success, but what are we winning at? In my coin flip game winning was NOT whether the coin came up heads or tails but whether the financial outcome justified playing the game in the first place. Winning for me were not just the odds of the coin flip, but the odds of the flip and the dollar amounts associated with the outcome of the flip. It was the second part of the game that drives the decision to play.

In some businesses, the odds of winning are very low, but the payouts are so astronomically high, that it's still good strategy to execute. Two examples come to mind.

Venture investing is one area where investors put up millions of dollars betting on startups. Venture investors also know that most of the startups will either fail or be a dud. A very small percentage of their investments become unicorns, which fully justifies the strategy. Think of the guts you have to have to invest $1 million dollars in a startup knowing it is very, very likely to fail! No risk, no reward!

Another great example is from investor and author Nassim Taleb. Mr. Taleb has become a bit of a celebrity around his take on the concepts of randomness, black swans, anti-fragility and skin in the game. Taleb created his wealth in the stock market crash of 1987. Yes...the crash. Taleb's strategy is to buy far out-of-the-money options. This strategy has a very, very high likelihood of losses. The vats majority of your far out-of-the-money option purchases will expire and you lose all of your investment. But stock options are financial instruments that dont operate linearly but exponentially. As Taleb puts it, he was fine to have his options expire worthless month after month after month after month, and take small losses along the way. What he was looking for was market move where the underlying stock might move 10-20% in a single day, but because of the exponential nature of the option, that option might go up thousands of percent! And that is what happened in October 1987. The stock market went down >20% in a single day, and Taleb's put options on the S&P500 made him tens of millions of dollars. Most people don't have the stomach to bear the losses for the one chance to make a killing. It still is a great strategy simply because there is little competition to work it.

Look around and you will see resulting everywhere! Its in the news all the time and used for political purposes to make a point (the government did this thing, and egg prices went up, so clearly that thing is not working). If you look close enough you will see it your businesses and companies. You will see it in your managerial judgements. You will see it in the board room, you will see it mail room.

Resulting kills strategy. It derails it, creating s premature ending, perhaps like the coin flipping game, before you have a chance for the asymmetrical payout to accumulate.