How a Business Wins

Scott Alexander is way off base

Scott Alexander writes,

I think “Internet retail giant which dominates the market through economies of scale” is a natural niche which Jeff Bezos won the race to fill. When I say “natural niche”, I don’t want to discount Bezos’ accomplishment - I certainly didn’t notice that niche in 1994, and even if I had, I wouldn’t have had the business acumen to fill it effectively. I just mean that, probably sometime between 1994 and today, someone with business acumen would have noticed that niche and filled it successfully. Maybe not quite as successfully as Bezos. But successfully.

On economic issues, Scott comes across as informed as any economics Ph.D. In this case, however, that is not a compliment. I have long thought that an internship in business should be a requirement for getting a Ph.D in economics. Most economists are naive to the point of cluelessness about how business works in practice, and unfortunately Scott suffers from the same lack of insight.

I strongly disagree that all Bezos had to do was notice a niche. That is like saying that all Dwight Eisenhower had to do to make D-Day a success was pick Normandy as the landing spot.

When Bezos was building his business, I noted that in order to compete with Wal-Mart, he would need to match their logistical system. All they had to do to compete with him was build a web site. And yet he won! It took incredible skill to do what he did. I don’t have space here to list all of the management practices and company capabilities he needed to develop. I give zero credence to the suggestion that if Bezos had never existed, someone else would have built Amazon.

Building a business, especially an innovative business in a complex environment, requires many, many decisions. You can be lucky with any one decision, but to get enough decisions right to make the business work takes much more than luck. I tried to explain this many years ago, when I wrote,

Othello is a board game somewhat like Chess or Go, and it has a small fraternity of competitive players, of which I am one.

When I was at my peak, I might have played at 65 percent of optimality. That is, 65 percent the time I played the correct move for the given position. The 65 percent figure is a guess, because it is impossible to prove that a move is correct (except for positions near the end of the game, when one can use a computer to determine the optimal move by brute force.)

At that time, the world champion of Othello might have played at 75 percent of optimality. If this is correct, and the world champion and I had played 100 games, how many would I have been expected to win?

If you think that 75 percent of optimality vs. 65 percent of optimality should lead to a fairly small difference in games won, you are assuming implicitly that the game only lasts one move. In fact, because each player makes 30 moves, the cumulative effect of a seemingly small difference in accuracy is such that I would be fortunate to win 5 games out of 100 against the world champion.

Suppose that a game lasts N moves. I win when I play correctly for more moves than the world champion. As N becomes large, the small per-move advantage of the world champion compounds until my chances of winning nearly vanish.

Software development is a multi-move game. Even the best players make many mistakes. But the game lasts long enough that the chances of victory for an inferior player are not high.

I was trying to explain why Microsoft kept winning, even though so many software engineers thought they were better than Bill Gates.

I also tried to describe my own business experience.

in 1997, we noticed that one of our web partners, Mapquest.com, was undergoing some upheaval. We considered offering to buy the company, but when we learned that they had accumulated a few million dollars in debt, we passed. They have since gone public, and as of this writing Mapquest has a market capitalization of close to half a billion dollars.

The essay describes many of the miscalculations that I made. But I actually made a number of excellent moves, and in those days that was enough.

People tend to describe business success as if it were simple, as if the founder has to has to be right about only one thing. If that were the case, success would be more than 90 percent luck. In practice, I think it is usually less than 10 percent luck. This is a very important point, and too many people do not see it.