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.