Using small bets to become a better investor — with Peter Sims (podcast)

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Today’s guest is Peter Sims. Peter is a jack-of-all-trades. He’s an author, speaker, and entrepreneur. His latest book is “Little Bets: How Breakthrough Ideas Emerge from Small Discoveries.” He was also a co-author with Bill George of The Wall Street Journal and Business Week’s bestselling book, “True North.” His articles have appeared in Harvard Business Review, TechCrunch, Financial Times, and he’s an expert blogger for Fast Company. He received an MBA from Stanford, and he collaborates with faculty at Stanford’s d.school, that’s the Institute of Design. He previously worked in venture capital with Summit Partners which, at the time, was one of the top VC firms in the world, and was instrumental in opening up its London Office.

This book is a great book both for investors as well as for general business people, bringing in a lot of disparate research and many different interviews from lots of different types of business people and scientists. “Little Bets” sort of spells a recipe for success in life. Core to its thesis is basically the need to take small bets, where you don’t wager the farm, learning from mistakes to incrementally, to basically iterate your way to success.

A lot of people think that very wealthy investors, very successful entrepreneurs have gotten there by betting the farm on one particular idea, and Peter tells us that that’s not the case. Through his interviews, he’s found that most of these people who have become extremely successful have done so by, exactly by this process that he talks about, taking little bets, making a lot of mistakes, falling down, picking themselves up, and quickly looking for a new solution.

I found this book extremely easy to read. It’s a great overview of all the different sources out there, and I think it’s a good lesson for me in my investing practices, in my business life, and in my personal life. We don’t want the fear of failure to keep us from applying ourselves to trying new things. If we’re investors, we don’t want to go whole-hog into a new industry that we don’t have experience investing in without really learning and taking baby steps first before we get there. That’s obviously an idea that we use in terms of position sizing, and not risking our entire portfolio on a small number of ideas.

On the other hand, it doesn’t mean that you can’t have large, audacious goals, where basically you have to have that vision in the future, but then the process through which you get there is a process of incremental learning and incremental failure, and then hopefully, incremental success.

Let’s just jump right into the podcast.

Where did the genesis of this idea come from?

Peter: For the book itself, or for ‘Little Bets’?

Zack: For “Little Bets.”

Peter: The title came from literally using the approach I write about in the book to develop ideas, so that the thesis is small, affordable, achievable actions to discover and develop ideas. When I was trying to decide whether to write this book, I scribbled some ideas on a few sheets of paper and literally went around and spoke with people I knew. Friends, or family, or people I really respected and trusted, to get their reactions to see if I was on to interesting terrain or not.

One of those people who I spoke with was Ned Barnhold, a former executive from Hewlett-Packard, who looked at one of the sheets of paper. He said, “I really like what you’re on to. This reminds me of some mistakes that we made when I was an executive. We used to make these great big bets on ideas to get into new areas when we were trying to get into new markets. We’d look at billion dollar markets, and we’d try to just drop into those markets, whether it was flat screen TVs or home monitoring equipment. We just put the HP label on the idea and we just assumed that it would do very well because HP had such a powerful brand.”

But what they learned was that all the big bets failed, because at the end of the day, they weren’t solving for what he calls the intangible factors beneath the surface, what they couldn’t know from the outside looking in. They couldn’t know about the certain customer needs, competitive dynamics. They were just trying to use a very conventional approach to drop in to solve a problem that really at the end of the day wasn’t solving the right problem. He said, “That’s where I learned to make a lot of little bets.”

As it turns out, when you look at the community of maybe over 200 creators and innovators for the book, you look at the way they actually work, there’s this myth that people have these big, ingenious ideas, but that is completely at odds with reality.

Take for example comedians like Chris Rock or Jerry Seinfeld. They have no idea what’s going to be a great joke. They go out into these small clubs and try their ideas out in front of 30 to 40 people, and through this process, which is very rigorous and puts an emphasis on testing and iterating, night after night, after night, after night, they discover what’s going to be the great material. They piece together an act, and it takes them six months to a year, but what we see is only the end of a very sophisticated discovery process.

So that’s what the book is about. How to think and act in terms of this little bet, a little, achievable bet at the center of a discovery process.

Zack: But that doesn’t obviate . . . I guess that we have to separate the process for achieving goals with actually the goal itself? So you can still have the big hairy, audacious goal, right?

Peter: Absolutely. I think you need to have one. For example, when Frank Gehry, the architect, who I interviewed for this book, when he starts a new project, he has a very clear idea mission in mind. When he created the Guggenheim in Bilbao, or Disney Hall in Los Angeles, he wanted to create an experience that would be transformative for the people who went there. He had to solve thousands of little problems such as around making the acoustics perfect, but he started with that big vision. With a big, as you say, hairy, audacious goal, which is a good way of thinking about it.

And the same is true for a comedian. They want to produce a great act. Or somebody who starts a company. They have a vision. In the case of the Pixar founders, they wanted to make digitally animated films, but the technology and the means to do that didn’t exist when they started out, so they had to, through small bets on short films, discover how to make and tell digital stories. So that’s critical, to begin with that core of a hairy, audacious goal, or passion for what you want to do.

Zack: I think it was pretty elucidative. You talked about Chris Rock’s process of how he vets out funny material. He gets up there in small crowds and really pays a lot of attention to the feedback he’s getting from the audience, and he iterates it.

A lot of times, I remember being a young professional, reading the Industry Standard, reading about 25 year olds that have made $100 million very easily by making a big bet, we sort of lose sight of the process of how they got there, right? It just seems that they had an idea and they did it, and they bet the farm on it, but that’s not actually what’s happening behind the scenes.

Peter: I used to work in venture capital, both in the U.S. and Europe, and I have yet to find an example of a company that started with one bold, ingenious idea, and just got there.

Google is a favorite example, because it started not as a bold vision to change the way information was prioritized online, but instead as a library search project, where Larry Page and Sergey Brin were graduate students at Stanford who wanted to understand how they could best prioritize and sort library books through a web search. And when they figured out how to have the number of links that pointed to library books prioritized which books should appear first, they used that same basic algorithm for a much, much larger problem when it came to sorting information online.

If you look at the history of Starbucks, or PayPal, you name it, it’s this evolutionary discovery process that leads to the big idea. So I like to say that great entrepreneurs, successful entrepreneurs, don’t begin with brilliant ideas, they discover them. Like I said, I have yet to find a case where that’s not true.

Zack: So can we talk about the discovery process? First of all, what is the discovery process, and how can we accelerate it?

Peter: One of the most fundamental elements of discovery is to be able to do rapid, low-cost prototyping. Chris Rock is doing that. Jerry Seinfeld is doing that. They’re reeling off, literally, hundreds of little bets a night, in clubs, and they’re not sure what’s going to work and what’s not until they literally try these little low-cost experiments. So you can do the same thing, obviously, with a startup or with technology.

Zack: If you’re an investor, you can take a small position in a company. A hedge bet, in some sense.

Peter: Yes. Absolutely. Whenever I speak with my friends who are investors about how they get into new types of investing, they say that they can’t just jump into a new area. If they’re a hedge fund long/short, and they want to get into looking at how the bond market works, they have to tip-toe in, making small bets to really learn as they go about how that market works. And they can make these small bets in order to see how the market moves in order to get the dynamics down, in order to get familiar with how to trade there, so they’re not making big risks as they learn, and instead if they find that they can identify real opportunities, then they start doubling down and tripling down, and making bigger and bigger bets as they go.

So the point of the discovery process is it’s really just a learning process. And the book has various chapters for how you can do this more strategically, or free up your mind from some of the barriers that block us as well from being able to go out and say…a lot of us just don’t like to be imperfect. A lot of people don’t like to fail. Well, there’s research to show how you can become more comfortable with failure and setbacks, and I write about it in the book.

There’s research from neuroscience that shows how you can unlock the creative part of your brain so that when you’re at the early stages of developing ideas you’re not blocking yourself too soon. There’s very compelling neuroscience research that shows when you’re in a more playful, improvisational state, the prefrontal cortex of your mind is literally deactivated, such that your inhibitions are lowered and you’re much more comfortable with coming up with new possibilities. This is critical at the early stages of developing any new idea.

These ideas I think apply to whether you’re trading or investing, whether you’re starting a company, or just in life, trying to get into and discover new opportunities and new ideas.

Zack: What role do, something that I talk a lot about with my audience in my book, I published a book last summer, is the value of experts and expert advice in the investing process. I think too often we get swept up in “group think.” I used to be a hedge fund analyst, and so your best friend is buying a stock, and you think you’re smart because you’re piggy-backing on top of him, but in terms of learning nowadays, and this iterative process, I think experts play a huge role in that. Did you look at that in the book?

Peter: Yeah. Reframe that question, if you could. There is a whole chapter dedicated to that. I just want to make sure that I’ve understood the question correctly.

Zack: Yeah, I sort of danced around it. I guess there’s a balance. I know you talk about, particularly in investing, the idea that there are crowded trades. Everybody thinks that they’re a genius because they spoke to their best friend who is also an analyst at a hedge fund and you bought what he did, right?

Peter: Right. Jim Chanos, who I interviewed for the book, the hedge fund investor Jim Chanos who shorted Enron and Tyco, calls that the “Smart Guy Syndrome,” where you just sit around the table and try to get your leads and your ideas from smart guys sitting around a table in New York.

Zack: But ultimately we learn, like, my son just had a birthday, and he got a Rubik’s Cube, and he went straight to YouTube to learn the algorithm to solve it, right? So he went directly for the expert advice. It clicked something in my mind. We do the same thing in all of our businesses, like part of being in it to win it, and failing quickly. It should also be connected to going out and reaching out to people that have sort of gone through that process, also. Does that kind of accelerate the learning process?

Peter: Well, there’s no doubt about it, Zack. I was at a dinner the other night with a group of Silicon Valley entrepreneurs and investors, and one of those people was Reid Hoffman, the founder of LinkedIn, who has obviously just had a huge offering this past week. He and I were talking about what makes Silicon Valley so [inaudible 14:23] for developing great ideas, and we concluded there were two things. One is that there’s just [inaudible 14:32] structure which allows people to do business, you know, legal structures and all that. But the other thing is just the access to free knowledge, the access to free advice from people who have been there and done that. People like Reid, people who will spend time with aspiring entrepreneurs to help them understand the insights they need to be successful sooner rather than later. So that’s a huge competitive advantage for people who live in that area, Silicon Valley.

And if you look at where great ideas often start, people like Chris Rock or Jerry Seinfeld will pay attention to certain people in the comedy audience. Certain what you might call really early adopters of comedy, people who have seen it all, who can really quickly identify where there’s something new or interesting, and help develop an idea at a very early stage, and in conjunction with Chris Rock or Seinfeld, there’s a lot of research done by Eric Von Hippel out of MIT about how these early adopters can be especially valuable in helping to develop early stage ideas, no matter what the context.

Zack: Is there a parallel in the investing field? I mean, when you’re selling a product, at the other end there’s an adopter, somebody on the other end of that transaction, right? So, do we have that feedback loop in investing?

Peter: I would think so. I would think that no matter what product you’re trying to sell, there’s going to be certain people who are going to be such advanced users of that product or that area of product, that the sooner you bounce the idea off them, the sooner they’re going to be able to say, yeah, that’s an interesting problem, or that’s an interesting idea. So these people, like I said, the early adopters, the most active users of a particular product or service, are the ones who are often tinkering on their own, already trying to figure this product out on their own.

The analogy would be if you looked at “The Big Short” by Michael Lewis, the people who are at the very early edge of that adoption curve of trying to figure out what was going on with the mortgage market were the ones you would want to go to if you were trying to develop a new product if you were a bank or if you were an investor. These were people at very front end who were doing the research, trying to figure out the new opportunities that were emerging, and there were like six or seven people who were the earliest adopters who figured that out first. The people who jumped on those bandwagons were the ones who made the most money.

Zack: A ton of money. It’s almost as if the Internet and the tools for finding expert advice have become better or more transparent, that the advice itself eventually could become commoditized, and therefore there’s no replacement necessarily for the experiential learning, right?

Peter: Right. Absolutely no replacement for that whatsoever.

Zack: So the need to sort of suffer through these continuous failures, they’re the building blocks for what make, ultimately, a big successful decision down the road.

Peter: That’s a really good insight you’ve pulled. I think that’s true. I think if you look at how Twitter came about, or if you look at how Pixar came about, for example. When Jack Dorsey, who founded Twitter, had been working on the short messaging problem for some years, trying to figure out how he could use the existing technology, which at the time when he first started trying to do it, wasn’t sophisticated enough to allow him to exchange short messages between people. He was tinkering, constantly trying to learn how he could share messages. He started out on an early Blackberry platform, and he found out that nobody was interested in using that type of messaging at the start. Then he got into when cell phones came out, and they were starting text messaging, and he saw he had his opportunity to create the short 160 character message that ultimately became the basis for Twitter, but he had a lot of insight and a lot of expertise from lots and lots of small bets in order to be in a position to do that.

The same is true for Pixar. There is no way that Pixar would have been able to make a full length film if they hadn’t been making lots of short films throughout the 1980s. That’s where they learned how to tell stories. That’s where they learned the technology, the software, the backend systems. They learned it all in a very low-risk way. This was 1% of the company’s expenditures for a long period of time. But once they figured out that puzzle, they were in a great position to partner with Disney to make ‘Toy Story’. So that learning accumulated into something they could scale once they were solving really interesting problems.

If you look at how, again, I’m a former venture capital investor, if you look at how the savviest entrepreneurs work, that’s how they think. They use lots of little bets when they’re trying to discover a process [inaudible 19:49] learn, this is a low risk way to learn. And then once they figure something out that’s interesting, then they scale up and bet big. That’s just the way they work.

Zack: As you’re saying that, what comes to my mind, I’m actually calling you from Israel, and we have a lot of entrepreneurs here that don’t necessarily grow up in an industry. They just kind of come as outsiders and they sort of create the solution looking for a problem. So in some ways that breathes a breath of fresh air into the situation, to get people from outside the industry looking at something with not jaded… but in some ways, what you’re describing is really a clarion call for extended periods of experience and time within an industry, really depth, as opposed to breadth.

Peter: Well, I think there’s a really interesting tension between those two things. On the one hand, there’s no doubt that deliberate practice and developing deep expertise in a given area is extremely valuable. We’ve seen a lot of research on the 10,000 Hours Rule. Now that said, that doesn’t necessarily make you more creative. What the research on creativity shows is that the more you’re able to take in experiences from many different areas, the more likely you’re going to be able to connect dots in a new way.

So take Steve Jobs. Jobs develops a deep, deep interest in technology from his 20s, studies lots of patterns in technology, technology trends, he becomes very good at projecting where the personal computer is going to go, where later devices are going to go. That sort of becomes one of his core strengths. But on the other hand, he also makes a point very often that most people just don’t have enough reservoir of experience across different parts of life, enough diverse experiences, to make new connections in a way to come up with new ideas. He tells this example often, when he was at Reed College for a few years, he dropped out, but when he was there, he took a class in calligraphy, and he never expected that class to have any practical benefit, tangible benefits, but ultimately that was the class that allowed him to come up with a new font scheme when Apple was releasing some of its early versions of Mac.

The two things, I think, are both very important. The creativity doesn’t happen just purely in a very narrow vial, if you will. It really requires people to be able to make these connections across different fields to come up with new solutions to problems.

Zack: It’s interesting. One of the things that I talk to investors about in terms of scaling their practices is focusing on what they’re good at and offloading what they’re not. It’s not just in the investment industry. There’s a growing trend to offshoring. I myself even use a team of virtual assistants for specific tasks, but what I try to tell people is first do the task yourself, so you really understand it, and then unload it on somebody. It’s almost as if we get too caught up in unshouldering some of our responsibilities. We lose touch with those processes that in some sense they may be mundane, but from what you’ve said, they’re sort of the birth pains of really creative ideas sometimes.

Peter: I don’t know about that example, but I do know that in order to have…I wrote two chapters later in the book. One is called, “Learn a Little from A Lot,” which is basically the importance of learning a little bit from a lot of people, i.e., the diversity point. There’s a lot of great research to back up why that’s so important. Frank Gehry learned from artists in order to develop his style of architecture. The other chapter is to learn a lot from a little, which goes back to the point we were just describing of this importance of really having that understanding and insight in that narrow area, very well developed. So it’s a combination of both. The example you’re using, that doesn’t relate to the work that I’ve done. I don’t know the answer to that, per se.

Zack: I think what makes your book such a fascinating read is that you’ve pulled in really fact-based research from a variety of different fields, entrepreneurs, artists. It must have been a huge undertaking in terms of just tapping those brains.

One thing I ask of all participants of the show is where do you go for your information, your own personal information consumption? What do you read, and how to you stay on top of your game, to help enable this book, to some extent?

Peter: You know, I act very much like an anthropologist, probably like you do. I spend a lot of time on Twitter. I spend a lot of time, if I find something that I think is really interesting and unique and insightful, it can be a magazine or a book, I will get deep on it and just keep following the breadcrumb trail. That’s really how that book came together was to start with certain insights and patterns that I was seeing, just through observation, i.e. with my experience in venture capital where I worked very closely with entrepreneurs, and then getting to know and understand the emerging field of designed thinking, and saying, “Okay, well this is interesting. This is addressing an interesting problem.” And once I get latched onto a problem, then I just dive deep. That’s how I got into looking at comedians and the counter insurgency examples from the military. We did tons of interviews, over 200 interviews, and then you’ve got to make sure that it’s very tight by looking at the empirical research that’s out there, secondary research that’s out there, because if it’s not extremely tight and fact-based, then what’s the use? I mean, it has to be true, right? So that’s how I work.

Zack: Peter, this was a great phone call. Great interview, and the book was a great read. I really appreciate you taking the time today.

Peter: Thanks. I really appreciate that. Great speaking with you.