…but chances are you can't tell the difference.
Go ahead, flip a coin. No matter how vehemently you wish (or curse), only Lady Luck determines whether it winds up as heads or tails.
Obvious, right? Maybe not. According to a recent study at the Autonomous University of Barcelona, we’re still tempted to chalk a coin flip victory up to skill rather than luck. As economics writer Chris Dillow explains on his blog, Stumbling and Mumbling:
“[A team of academics] got a group of students to predict a sequence of five coin tosses, and then selected the best and the worst predictor. They then asked other subjects to bet on whether the best and worst predictor could predict another five coin tosses. The subjects were told that they would bet on the worst predictor from the first round, unless they paid to switch to the best predictor. Eighty-two percent of subjects paid to make the switch.
“But of course, there is no such thing as an ability to predict the toss of a coin. Most subjects, then, saw skill where there was only luck. And, what’s more, they were willing to spend good money to back this daft opinion. These people weren’t just idiots plucked from the street. They were fourth-year finance undergraduates at one of the best universities in Spain.”
Running a business, of course, requires far more skill than flipping a coin. But sometimes luck can carry you for a stretch — and, regardless of how strong your strategy or how skilled your team, random bad luck can hurt your operation.
Michael Mauboussin, author of The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing, offers many methods for making sure that skill mitigates the effects of luck, if not in the short term then at least in the long term. Here are a couple of our favorites.
1. Play the long odds. “A good process can lead to a bad outcome some percentage of the time,” Mauboussin writes, “and a bad process can lead to a good outcome. Since a good process offers the highest probability of a good outcome over time, the emphasis has to be on process.”
2. Check it off. Checklists are an easy way of making sure proven strategies are being followed. Mauboussin cites the work of Atul Gawande, author of The Checklist Manifesto, in emphasizing the role written instructions play in ensuring things go right. “Where cause and effect can be clearly established, checklists have been widely embraced,” Mauboussin explains. “Examples include aviation and construction. Airplane pilots, for instance, use checklists universally and with great benefit. Checklists ensure that the pilots follow all procedures precisely and unfailingly.”
In a speech to investment research firm Morningstar, Mauboussin said that during periods of prolonged and unexpected success or failure, it’s important to note what happens at the end of the run.
“Whenever you see an outlier, such as a very long winning streak, it’s likely the result of both extreme skill and extreme luck,” Morningstar website editor Jason Stipp wrote in a recap of the speech. “. . . What happens following a streak of outperformance can also offer clues as to just how much luck and how much skill was involved. Reversion to the mean after an extreme outcome is expected to happen anytime there is luck involved, Mauboussin said, but the more skill is involved, the less the expected reversion.”
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