Mathematical explanation of entrepreneurial bug

Not all things in life are quantifiable (you know, things like justice, love, or your experience of the color purple), but the proverbial "entrepreneurial bug" is not one of them.

As a corollary to a well-known math problem called the two-envelope paradox, it is perfectly rational for an individual to want to start one company after another and expect a higher reward after each iteration, even if the expected outcome associated with each of these endeavors is completely random (as I would argue is the case every time you start a new company)! To understand that mathematically, this is how the two-envelope paradox works (taken from the latest analysis of this paradox on PhysOrg.com):

In the two-envelope paradox, a player must choose between two envelopes, one of which contains twice as much money as the other. The player can open the envelope they choose, and then they have the option of switching envelopes. The other envelope, of course, has either twice the money or half the money as the first envelope, but the player does not know which.

It may seem that, since a player has a 50-50 chance of choosing either envelope, they have an equal chance of gaining or losing money whether they decide to switch or keep the original envelope. However, probability theory seems to confusingly show that it’s always better to switch.

For example, say the first envelope you pick has $10, so that the other envelope has either $20 or $5. Then you can calculate the expected value (i.e. the probability-weighted sum of the possible values) of the second envelope, assuming that each possibility has a 50% chance: (0.5 x $5) + (0.5 x $20) = $12.50. Since $12.50 is more than $10, it makes sense to switch. No matter which numbers you use, you always get an expected value for envelope two that is 5/4 higher than the value for the original envelope: if c is the value of the original envelope, the expected value of the second envelope is (0.5 x [0.5c]) + (0.5 x [2c]) = 5/4c.

This counter-intuitive mathematics can explain very well why so many first-time entrepreneurs try again, regardless of the success or failure of their first attempt. And why it is perfectly rational for investors to expect a higher payoff from a not-so-successful serial entrepreneur than a first-time entrepreneur.

Do "good guys finish last" in business?

I remember a few years ago the CEO of a then-successful startup told me in confidence he couldn't afford to care about ethics in his business because "you know, good guys finish last"!

That statement was shocking because that individual on a personal level had high integrity and good moral character. But market pressures combined with the demands of the Board had somehow convinced this CEO that doing right by the shareholders demanded that he put personal morality aside and do "whatever it takes" to increase the company's bottom line and competitive positioning.

This was not an individual driven by Enron-style greed or Madoff-style excesses, but someone who was merely trying to survive; someone who was simply afraid of finishing last. Was he being a good CEO or a lazy one?

When all your competitors are getting ahead through less-ethical practices (such as buying positive reviews for their product on the App Store or other social media outlets), what do you do? Do you sit back and concede the market to your competitors or do you also join in the game and start an arms race? How do you competitively price your product when your competition uses various schemes (ahem, scams!) to hide the real price of the same product from their users to give them the appearance of a bargain (as is a common practice in the calling card industry)?

The answer to these questions depends on whether you are trying to build a long-term, sustainable business or whether you plan on making a quick buck and run for the border. Because if you plan to stay in business, in the post-twitter information society, transparency is becoming the name of the game and your reputation as a trust-worthy business one of the single most determinants of survival: Sooner or later, the non-ethical businesses are found-out and abandoned by users/customers/partners/employees (I am not going to even talk about the legal dimension of unethical business practices here, and some argue that there is really no line between illegal and unethical to begin with).

My above statement is not a hypothetical or game-theoretical proposition (although there is plenty of academic literature around the topic of reputation effect in repeat-game vs. end-game scenarios - just google it), but an empirically proven observation: For instance, in ecommerce, many studies and A/B tests have proven that perception of "trust" has a very strong correlation to the conversion rates of your website. And just as an eBay-seller would not make it far without a positive reputation score, your company or service will not make it far without an overall online reputation that is positive.

Being one of the "good guys" will not ensure your success, but without it, you are guaranteed not to succeed.

Revisiting Alchemy, Valley Style

Let's be honest about this, the quintessential Silicon Valley entrepreneur is not that different from your typical alchemist dating back to the Persian Empire of 2500 years ago, as described by Wikipedia:

Alchemy (Arabic:al-kimia) (Hebrew:אלכימיה al-himia) is both a philosophy and a practice with an aim of achieving ultimate wisdom as well as immortality, involving the improvement of the alchemist as well as the making of several substances described as possessing unusual properties.

But wait, what about those less noble pursuits such as greed and let's-make-gold-out-of-cheap-metals bit?

Well, when you look at it closely, any human endeavor that can promise to get you close to "ultimate wisdom" and "immortality" (which apparently some believed to be possible through gold back in the day as the Wikipedia entry goes on to explain), inevitably becomes mixed up with financial gain and material success. And such, seems to be the lot of us Silicon Valley entrepreneurs as well.

So it is not surprising that many entrepreneurs find inspiration and motivation in Paulo Coelho's international bestseller, The Alchemist. As a matter of fact, I started my last company (jaxtr) after reading that book and finding it to be completely appropriate to quit my well-paying corporate attorney job and pursue a dream (thank you @paulocoelho).

This blog will not be about jaxtr, but about what I have learned from that experience, as well as my reflections on encounters with many other entrepreneurs, ideas and practices.