The Law of Scale (the benefits are “Ungodly Important”)

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 = Lower Costs, Higher Prices & Bets on New Markets

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 …

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The Law of Large Numbers (Another Mental Model)

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 …

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The Mental Model of Incentives

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).

FedEx …

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