The business laws of nature: ignore them at your peril.

This post talks about the first business law of nature: noise. What it is and what you can do about it. Even Bill Gates can’t stop noise. He did something else instead.

Not the kind of noise that you hear. Unless perhaps you are listening to a radio station that isn’t tuned in properly, that might count.

Noise as in interference. Let’s say you flip a coin 1,000 times. You know that it will come very close to landing on heads 50% of the time and tails 50% of the time. But you also know it won’t be a case of heads then tails, then heads and then tails. It will vary a lot. For 1,000 flips of the coin don’t be surprised if at least once you get 10 heads in a row and 10 tails in a row. Random numbers are actually a lot more random than we expect. With lots of clusters that look like patterns in the short term.

But noise doesn’t just happened to coin tosses or dice roles. It happens to you every day. And it happens in business.

On average you may sign up 1 in 3 prospects that you visit. Noise could mean you sign up the next 5 in a row and then you fail to sign up the 15 after that. Any number that you can put an average on could potentially be subject to noise. Including the number of prospects you get from your marketing efforts, the number you close, the number of sick days you have this year, your performance for clients, how much you get paid for each job, the chances your office gets burnt down to the ground in some freak occurrence.

What Problems Does Noise Cause?

A new business with a million pound investment and a great business plan may be all set to make 20% profit each year. But that may come in the form of +40% in year one, +30% in year two, -10% loss in year 3 and +20% in year 4. This averages out to +20% per year. There are two big problems that can happen because of this noise.

(1) The first is that almost everyone would look at this and believe they can see a pattern. Concluding that what they are doing isn’t working and that it is getting worse each year. They may erroneously changing the business plan to one that may be inferior.

(2) The second depends on the order of the noise. If year one is the -10% year and the business doesn’t have access to credit or some other form of extra cash then the perfectly sound business could be written off to debtors before its first birthday. With everyone left scratching their heads and probably pointing the finger at each other or everyone else.

Small Businesses 

A smaller businesses represents a much smaller number of coin tosses, so the effect of the noise is many times greater. If a large business is the equivalent to a thousand coin tosses then your fledgling enterprise could be the equivalent 10 coin tosses.

Someone out there has to be the 10 heads in a row. Possibly doing everything wrong the first year and still having a stellar year thanks to a couple of lucky big contracts or sources of work.

Someone also had to be the ten tails. Investing huge time, effort and person risk and through sheer luck having an abysmal year.

Most of us are somewhere in between but still heavily subject to the effects of noise. It can lead you astray in other ways too when you think you see patterns that aren’t there and try to capatilise on them. You may end up specialising in a certain area just because that is who came through the door first thanks to noise. This could have a permanent impact on the course of your business.

Noise in the early days can make or break your business. It is the difference between roaring success and bankruptcy.

People rarely like to acknowledge the role of luck in their lives. We like to feel in control. But unless you have the power to make the coin alternate perfectly between heads and tails on every flip then you are in the same boat as the rest of us.

Working hard increases your chances of success. But it doesn’t mean you won’t be subject to noise.

Big Egos

The scariest effect of noise is when it is compounded by our giant egos. Big businesses are subject to less noise because of their size. More customers means you come closer to your actual average. Also they can usually withstand a bad year or two. The problem is when they have a really good year. Everyone in the business discovers to their pleasure that they must be some sort of business genius that can’t see to do anything wrong. Dismissing any possible notion that it could have been luck.

The large business, after a great year, decides to invest very heavily in growth. If this first year is especially lucky then that second year just has to be what will actually turn out to be an average year. The company ends up over extended and in trouble.

Likewise a small business owner might loosen his belt and start to splash some cash after a good year. Possibly moving to a nicer office and taking on some extra staff to deal with the influx of work. Small businesses are less able to withstand the effects of noise. After a good year like this the following year could be the end for the over excited and over spent business owner.

What Should You Do About It? 

In the book Great By Choice by James Collins and Morten Hansen studied what successful companies did in comparison to much less successful direct competitors. The research that the book is based on highlighted two things that Microsoft did and it’s competitors didn’t.

All the other businesses that were successful did these things too and their less successful counterparts didn’t. Intel did, but AMD didn’t. The companies that followed these rules where 10x more successful during the period being researched.

(1) First of all they had a paranoia about good years that stopped them over extending themselves. Deliberately aiming for the same amount of growth each year instead of assuming they had it made after a good year. Typically they aimed for 10% – 20% growth each year. Companies that failed to do this and got over excited by good years ended up with unfavourable and expensive cash flow problems. Especially during periods of recession which is the noise of the economy.

(2) The second important thing they did which was also could have been the result of paranoia as opposed to understanding noise was to stock pile cash reserves whilst competitors enjoyed their spoils. Bill Gates wanted enough back up cash to pay all his staff for an entire year in case of the unexpected. This money became important during tougher years.

You can’t stop noise but might just be more successful in business if you acknowledge and prepare for it. 

Let me know if you would like me to write more articles about the business forces of nature?

No Comments

Post a Comment