The network effect is defined as an entity getting more valuable the more people who use it. This can equate to a “winner-takes-all” position for businesses and a “moat”, as Warren Buffett and Charlie Munger like to say, to defend your castle (business).
Let’s look at a few examples of The Network Effect:
A key to Amazon’s success is that it: …
Charlie Munger frequently emphasizes that anyone in a position of dominance will inevitably “pass the baton” of leadership.
Below are some examples Charlie has mentioned in talks:
Transcript from the 2003 Wesco Annual Meeting, May 7, 2003 *
“The loss of dominance rate is 100%. Every great civilization that was dominant eventually passed the baton. Similarly, the greatest companies of yore are not the great companies of hence. I like looking back and seeing who would have predicted what happened to [formerly great companies like] Kodak, Sears and General Motors.”
Transcript from Wesco Annual Meeting, May 6, 2009*
“Where is Egypt or Athens or London? It is nature of things that we do baton passing. It is state of nature that baton gets passed, to someone who tries harder and cares more.” …
In his epic commencement speech to the USC law school grads in 1994, Charlie Munger mentions “scale” 24 times.
The advantages of scale are “ungodly important”, he points out.
Benefits of scale include reducing costs, raising prices and testing new markets.
In a beer business, for example, Anheuser-Busch operates at such a higher volume than Anchor Steam beer (based in San Francisco), that …
The law of large numbers indicates that the higher the number of times something is performed, the more likely it will receive something close to the average of the results.
For example, if you rolled a six-sided die, the average results you can expect is the average of the 6 outcomes is a 3.5 ( (1 + 2 + 3 + 4 + 5 + 6)/6. The law of large numbers indicates that your average roll will get closer and closer to 3.5 the more you roll the dice!
That’s why when you’re winning at a casino (or anywhere else where “the house” takes its cut), you should quit early — otherwise, the law of large numbers will eventually kick in: the more bets you make the closer you will get to netting a loss (since a casino is designed to have a greater than 50/50 edge over you).
But don’t fall victim …
Charlie Munger wrote in Poor Charlie’s Almanack:
“Perhaps the most important rule in management is to get the incentives right.” (see 30+ Charlie Munger Quotes).
Charlie argues that people respond most strongly to what they view as their incentive or disincentive.
In business, there is almost always someone else involved in whatever you are trying to do. Munger recommends that you always reflect on:
“What is someone getting out of this.”
Charlie gives a few business examples of incentive bias (source: Poor Charlie’s Almanack).
Confirmation Bias is the tendency of people to favor information that confirms their own beliefs, goals or desired outcomes (and ignore what doesn’t fit).
A definition of confirmation bias from the book Consumer Behavior:
“The tendency of consumers to interpret ambigious evidence as consistent with their current beliefs.”
A business example of confirmation bias is the hugely popular personality-type quizzes (e.g. which ‘Beatle member are you?’ or ‘What type of Ice Cream are you?’). When people take those quizzes they are typically reaffirming the opinion they already have in their mind (“I’m Mick Jagger of course”).
A trick of those quizzes is that most of the successful ones return you results that are positive (you’re unlikely to find one that asks ‘Which mass murderer are you?).
Why do people do this? According to PsyBlog:
“In an uncertain world, people love to be right because it helps us make sense of things. Indeed some psychologists think it’s akin to a basic drive.”
The Principle of Cumulative Advantage, as noted on Thwink.org, states that:
“…once a social agent gains a small advantage over other agents, that advantage will compound over time into an increasingly larger advantage.”
Cumulative Advantage is sometimes known as The Matthew Effect or Accumulated Advantage or “the rich get richer, the poor get poorer”.
A common example of Cumulative Advantage is that a prize will almost always be awarded to the most senior researcher involved in a project, even if all the work was done by a graduate student. The senior researched has accumulated that advantage. …
This article on Compound Interest continues my quest to list out the Top 100 Mental Models Needed to Succeed in Business, inspired by Charlie Munger.
Munger calls compound interest “one of the most important models there is on Earth.”
It arises when interest is added to the principal.
If you don’t know how to use compound interest on a calculator, there are a couple of excellent online compound interest tables/calculators that do all the work for you here:
For example, …