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We’re in the midst of putting some stuff together which you should hear about in the next coming months.  We’ll be back shortly.

We’ve written previously about Predictably Irrational, and the larger phenomenon of behavioral finance.  Generally, I think the field has added a great deal to our understanding of human behavior and the limits of intuition.  However, on bad days I think the field can step over the line and into the realm of “Gotcha” research - stuff that deliberately confuses its respondents into irrational behavior that they are unable to display in more realistic situations.

A recent example of such “Gotcha” research comes from Rick Larrick and Jack Sole on The MPG Illusion.  I’ll let Rick and Jack explain the research:

Many people consider fuel efficiency when purchasing a car, hoping to reduce gas consumption and carbon emissions. However, an accurate understanding of fuel efficiency is critical to making an informed decision. We will show that there is a systematic misperception in judging fuel efficiency when it is expressed as miles per gallon (MPG), which is the measure used in the U.S.A. People falsely believe that the amount of gas consumed by an automobile decreases as a linear function of a car’s MPG. The actual relationship is curvilinear. Consequently, people underestimate the value of removing the most fuel-inefficient vehicles.

The paper was published in Science Mag, and dutifully reported on by none other than our favorite blogger, Dan Ariely of Predictably Irrational.  Ariely sums up the research so well, that I’ll let him tell it:

You need both types of cars and for now you can replace only one of them.  What should you replace?
Option 1: Replace the 5 MPG van with a 10 MPG van
Option 2 Replace the 20 MPG sedan with a 50 MPG sedan

What would you select?

As a new paper by Rick Larrick and Jack Soll shows many people select option 2, where in fact option 1 would be better for them (also see this story about the research).

Does this sound odd?  Lets look at it more carefully:  Lets assume that people drive 100 miles a month.  This means that the 5 MPG van uses 20 gallons a month while the 20 MPG sedan uses 5 gallons a month. Now what if we change them?  If we change the van we would change from using 20 gallons a month to using 10 gallons a month (saving 10 gallons a month). If we change the sedan we would change from using 5 gallons a month to using 2 gallons a month (saving 3 gallons a month).  Now it is clear that changing the van is a much better move.

The payoff is this: consumers, when presented with mpg information, make the incorrect decision about which car to replace.  But the obvious question is: is this how consumers actually think about their own cars?  I would argue not.  Most of us think about fuel efficiency when standing at the pump, watching those little numbers scroll forward.  We therefore are likely to mentally account for our fuel efficiency as a weekly fuel cost.  And weekly fuel cost is exactly the sort of metric that will lead us to make the correct decision - i.e. to replace the inefficient van, not the relatively more efficient sedan.

I would argue that this paper succeeds only in fooling its respondents because they pose the question in a framework that is unfamiliar to the vast majority of drivers.  Are consumers actually choosing to replace their sedans, while keeping their bulky SUVs?  If we are to believe the latest industry trends, SUV (and Hummer!) sales are way down, while sales of the more fuel-efficient crossover vehicles are way up (16% in 2007).  In other words, people are choosing rational option 1, not irrational option 2.

Irrational human behavior is so prevalent - is there really a need to invent it where none exists?

Yikes.  It’s been > 10 days since a last 26.2 post.  Heading to a friend’s destination wedding will clearly do that to you.  That and preparing grants for Federal funding.

Which leads me to this Harvard Business Blog Post.  Since we are fond of both working and marathons, this discussion is apt.  Not much really to say here except make sure to treat yourself to some well deserved time off.  Anyone who has run a marathon knows that rest days during training and the taper prior to your race are CRUCIAL to peak performance during race day.  Fellow marathoner and venture capitalist Brad Feld, takes an off-grid vacation seemingly every other day (which in reality is once quarterly) where he doesn’t answer email, check stock quotes, etc.  It seems to have gotten him to a good place in his life.

Take your break.  Spend some time with family, read a book, or head out for a walk.  And do it while clearing your head from some work.

Today is earth day.  Go out and plant a tree or walk to work instead of driving.  Better yet, come up with new innovative solutions and technologies that will help out towards addressing our energy, water, trash, recycling needs.  We’ve still got a long way to go and implementing new technologies is the way to achieve scale.

Whatever you do, don’t give your credit card information to the ‘volunteers’ on the street who ask you ‘if you have a few minutes for the environment.’  I can’t think of anything more value erosive than to give a donation to an organization who pays ‘volunteers’ to collect donations.  At best you are getting a 1x return on your contribution and in reality you are probably giving 10 cents per dollar towards end usage.

Instead I would spend that money educating kids on environmental stewardship.

Erik passed along a link to an HBR podcast interviewing HBS professor Rakesh Khurana’s take on whether professional business schools should implement a “Green Hippocratic Oath.”  The basic idea is to establish a codified set of principles whereby professional business managers seek to maximize corporate and social well being, as opposed to money or profits, through its practices and processes.  Professor Khurana’s view is that business school teachings have settled on the notion that students go to business school to develop an elite contact list, obtain a job that pays handsomely and maintains a reasonable moral balance, and then retire and give back after accumulating a large treasure.  He continues to argue that concepts pervasive in business school education such as “maximizing shareholder wealth” or “competitive advantage” need to expanded to include “social welfare” and “consideration for environmental impact.”  One manner this can be accomplished is through a green oath.  There are eloquent arguments for and against such an idea listed in the comments section of the post.

Two points.

1.  I personally really like this idea.  Dan Ariely, in Predictably Irrational, empirically demonstrated that the effect of an ‘honor code’, a set of rules that fall in line with societal expectations, is a strong reinforcer of behavior.  The obtainment of a business management  ‘profess’ional degree, as Ariely writes in the book, should require the practitioner to publicly profess their responsibilities as stewards of business and society.

2. I like the concept of integrating ’social good’ and other values into the utility function.  Let’s call ‘well-being’ a proxy for money, social welfare, positive environmental impact.  Economists have long known that every additional dollar made has monotonically, decreasing added value.  If you take the mathematical extrapolation of “maximizing profits” to its limit, there is zero added value created.  Clearly the outmoded concept of making a ton of money at the expense of all else is the equivalent of being stuck in a local maxima.  Global value [both in a geographical and parameter sense] can be created without being realized only in US dollars [which aren’t that valuable these days anyway].  The practical implementation is obviously completely unclear but the debate and attempts at determining this is worthwhile.

A few months ago, I was up at Stanford University, sitting in on a few of the E-Week events.  It included an interesting forum regarding ’social entrepreneurship.’ The forum consisted of the three founders of B Labs, whose goal appears to be the branding and advancing of a new type of corporate structure (B Corp vs. S Corp or C Corp).  It is a thoughtful and earnest attempt at creating a ‘badge’ or ‘honor code’ whereby corporations can act in a manner to increase well-being.   Check it out.  Oh and these guys are responsible for the And1 shoe company, so at least they were responsible for creating highlight reel dunks over the years.

The guys over at Venture Hacks included this little screen shot of John Doerr’s [of Kleiner Perkins fame] recent talk at Stanford University.

We obviously love point 4 under Missionaries.  But in truth, as Umair Haque points out often at bubblegeneration, there really does need to be a radical re-thinking of the way we do business.  The dollars you hold no longer represent the scorecard at the end of the day.  Economists have taken the first step with the concept of monotonically decreasing utility (i.e. not every dollar is worth the same).

In engineering classes like thermodynamics, you are almost always asked to draw a dotted line around what you perceived the system to be.  I think it is obvious that for several decades, the US viewed the dotted line as its own borders where flows into the system resulted in a rapid increase in wealth.  Now due to reduced friction brought on by inexpensive communication and transportation we see monetary, labor, and political flows out of the US system boundaries.  If the US wants to remain relevant, we’re going to have to redraw our dotted line around the whole world.

But this is just a metaphor.  If we really want to see this happen, we are going to have to embrace what John Doerr lists as Missionary attributes.

Two of my favorite books are James Surowiecki’s The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations and Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds (fun fact: MacKay’s book, when originally published in 1841, was Extraordinary Popular Delusions and the Madness of Krauts. Apparently, this title fell out of favor at some point). Surowiecki’s work argues that the collective wisdom of groups is superior to the knowledge of any individual in that group. Mackay tome instead chronicles the frequent instances in history in which the crowd has practiced a sort of collective insanity (frequently in the form of some sort of bubble). So, which is it: are crowds wise or crazy?

There are many people smarter than I that are thinking about this apparent paradox (including Surowiecki himself), so I won’t claim to add anything substantive to the debate. However, I think there are some really interesting analogies to be made to Ben and my own chosen field of chemical engineering. According to Surowiecki, four elements are required to form a wise crowd: diversity of opinion, independence of opinion, decentralization (people can draw on local knowledge), and aggregation (some mechanism to collect this knowledge). From an engineering perspective, those four qualities are the same four qualities of an ideal gas - basically, a dilute mixture of gas molecules moving about via random Brownian motion. Although the molecules of an ideal gas move about randomly (independence and diversity of opinion), collectively, they move so as to maximize the entropy of the system (aggregation). And, from information theory, entropy=information, so that in maximizing entropy, the gas molecules (or, in our case, investors), are maximizing the information content of the system. Although no individual gas molecule knows anything about the entropy, collectively they maximize it. Sounds like the efficient market hypothesis, no?

So, if the wise crowd is a container of ideal gas particles, when does the crowd go mad? In keeping with our analogy, the crowd goes mad when someone turns on a fan. Now, all our gas molecules are moving in one direction, and brownian motion is overwhelmed by convection. Maybe the fan is the media, a new investment product, a new technology, or something. But when we turn on the fan, all bets are off.

End nerd talk.

Many spin-off companies that arise out of academia raise funds through government/public grants such as small business innovation grants (SBIRs).  These SBIRs serve to provide funding for entrepreneurs to help get their technology out of the lab and into the proverbial garage.  However, the bureaucratic hoops that one must jump through, followed by diversion from developing the core product, can wind up taking a company on the fast track to a meandering eternity of ‘SBIR house purgatory’.

The alternative is to get VCs on board right away, raise a few million, and focus on developing the core product.  Sure you might wind up with only 20% of the company left to split among four founders but hey, you’ve got an accelerated product build out and a 3yr exit strategy right.

The right mix of funding, as well as the total amount of time-resolved funding, is critical to novice entrepreneurs.  Few startups share this in common and is probably harder to get right during startup cocktail hour.

This site is now home to 26.2 Ventures LLC’s discussions regarding politics, economics, technology, and business building. It will occasionally include some chat about music, literature, long distance running, and our personal adventures. We will be sharing some thoughts on the ventures that we are pursuing and actively working on. We hope that any resulting discourse will prove useful to all parties.

This forum arose from Erik and I sharing offices during our years in grad school blathering away while procrastinating from our theses. Some of the topics we considered then: numerical optimization of suicide-no pass spades, computer driven wedding seating methods, determining the amount of force required to disturb the AFM (atomic-force microscope) next door generated during a full contact Nerf basketball game.

Erik’s posts will be much more entertaining because he’s just that kind of guy. We hope you enjoy it!