I just finished reading The Wisdom of Crowds by James Surowiecki, an excellent book that provides insights into consumer behavior as well as the venture capital investment process.
The book’s thesis is a simple one: a crowd of well-informed, independently minded individuals will make better decisions than any one individual, no matter how smart or experienced. The book support this thesis (not in a rigorous academic fashion, but in the breezy, conversational manner that you would expect from a New Yorker columnist) by examining a range of case studies that range from the frivolous (predicting the weight of a pig at a county fair) to the profound (the tragic explosion of the Challenger space shuttle). In example after example, the book nicely weaves a compelling argument that "mob rule" may not be such a bad thing. The author attempts to make connection from this observable human behavior to derive thoughtful insights into decision-making and capital markets.
In my own observations of consumer-based start-ups and their surge in the last few years, it strikes me that "the wisdom of crowds" is one of the more important factors in driving the success of Web 1.0 and Web 2.0 start-ups. The Internet has enabled the efficient congregation of crowds of individuals from around the world and the rapid, low-cost aggregation of their input, allowing this "crowd power" to select the most interesting products to buy (eBay), videos to watch (YouTube), search results to view (Google) and knowledge to absorb (Wikipedia). Arguably, the Web 1.0 and 2.0 phenomenon has largely been built on the theory behind the wisdom of crowds.
And, as usual, the book caused me to reflect on the venture capital process as well. If you believe in the book’s thesis – that no one person can be as smart as a group of informed, indepedent-minded people – then the way to make the best investment decisions is to construct a democratic investment process rather than a hierarchical one. That is, collect aroud the table a group of experienced investment professionals with diverse backgrounds and perspectives and don’t allow any one individual’s power status to sway the discussion. Instead, allow robust group group discussions and debates to ultimately yield better investment decisions; better even than any one smart individual might achieve operating alone.
Interestingly, in my experience, this is the construct of most good venture capital firms. It would be an interesting study of VC firms’ performance over time to determine whether firms that have democratic, open decision-making processes perform better on average than those that have more hierarchical, autocratic decision-making. Understanding this dynamic within a VC firm is critical for entrepreneurs pitching to and working with VCs – an area in which I find surprisingly few entrepreneurs really probe deeply. They should.
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The idea of applying the wisdom of crowds to venture investing is interesting, but surely must be pretty complicated in practice.
Look, the wisdom of crowds, almost by definition, is conventional wisdom. Mostly, of course, conventional wisdom is right. But the real investment opportunities surely arise from deviations from CW which nonetheless are correct. Repetitions of standard ideas are hardly the key to major market disruptions, and major investment opportunities.
The trick would be to find a way to use the wisdom of crowds as useful input into an investment decision without being so overpowered by its results that unconventional ideas don’t see the light of day.
In fact, of course, one of the most biting criticisms of VCs is that they behave instinctively like herds when it comes to new ideas pitched their way. It would not be a positive thing to put into place still another feature that only reinforces this inclination.
It would be interesting to track a VC firm’s investments (and potential investments) using a prediction market as described in the Wisdom of Crowds. Trying to get all of the partners and analysts to forecast key metrics for portfolio companies and potential portfolio companies would be an interesting exercise, and potentially one that makes everyone aware of problems and opportunities even earlier!
Great idea. Just two things are hard for me to digest:
1) How can you avoid Brahmanism not happening among the best of the species? (the VCs ie.)
2. VCs are more than well-informed. The problem is that they are ALL Informed. So, why would they get to -get-her in the first place? Perhaps, if the topic is modified somewhat like ” Top 10 things entrepreneurs STILL get wrong ” , despite the omnipresent stuff on almost ALL VC blogs” – maybe that would work..
PS: As a stupid entrepreneur – can I please make a humble request – please tell your VC bloggers to stop adopting parochial overtones. They talk as if entrepreneurs are these starrry eyed kids – needing the adult supervision of a VC pop ! ( why I wrote here : I dont know you just sound more HUMANE or maybe I am just naivee )
I do have some degrees: so dont discard my rant – just yet .. try this : IIT + MBA (INSEAD) – Age = 38… Mature enough ? ( dislike: VC talk )
A key point in this thesis is that your crowd is “well-informed” and “independently minded”.
You have to work very, very hard to ensure that those who work for you (thinking in an intra-company context) are encouraged and incented to ensure that they are in the know of company and industry trends and are encouraged to be open-minded and won’t receive any retaliation for disagreement.
Diverse groups of individuals, by their nature will not always meet these defintions and as a result, could lead to the opposite of this result: The Dreaded Group-think.
I find it surprising that the space shuttle disaster was singled out. Last time I read anything here, the pundits said that the primary cause was “group-think” rather than autocratic individuals?
As unlikely as it seems from the outset, I think traditional media companies (TMC) will ultimately rule the web 2.0/New Media space. TMCs will surely become the next VCs.
Many entrepreneurs still think VC firm is a hard to approach financial institution. If VC firm is more open, share passion, share vision, success chance is better.
I think your proposed “roundtable” critically misses the thesis of the benefits of “the wisdom of crowds”. In your scenario with only “experienced” investors in the same room together, groupthink will take over, plus all will share the experienced bias.
The amazing results from the book suggest that all opinions, experienced or not can matter, and that those opions should be based on the same information, but polled independently so that groupthink does not effect. case in point the jellybeans, the missing submarine, etc. keeping the decision makers apart from each other is a critical part of the aggregation.
hope that i, as well, am not off the mark in posting about one of my faves.
The wisdom of the crowds is also the basis for a very interesting startup: http://www.predictwallstreet.com
(N.B. I’m not associated).
There seems to be a wealth of research out there on the functioning of top management teams (TMT’s); I believe the University of Maryland is the home of US research in this area. Also of interest is the area of socio-psychology (I think thats the area anyway), where a researcher studies the way in which people speak to each other, and how issues are explored. As you know, framing can be very powerful.