Because I am all about the base rate

bayesPictureTis the season for predictions. If one has an audience one seem compelled to make predictions.  You are better off reading the book Superforecasting than this article. The book explains in depth the simplest elements you need in making predictions and forecast.

It starts with – Base Rate – which is how frequent does the said event happen in general relative to all other events. For example

  1. What percentage of tweets are retweeted?
  2. What percentage of people are named Bill?
  3. What percentage of startups achieve $1B valuation?
  4. What are the chances of you winning Survivor when you start the season with 19 others?

The next step is an iterative process that refined this prior knowledge by seeking new information and refining your estimate. That is the posterior probability.

Most likely you won’t read the book, so I present here these two concepts set to the tune of Megan Trainor’s song.

 

Because you know I’m all about that base-rate

‘Bout that base-rate, no tails

I’m all about that base-rate

‘Bout that base-rate, no tails

I’m all about that base-rate

‘Bout that base-rate, no tails

I’m all about that base-rate

‘Bout that base-rate… base-rate… base-rate… base-rate

Yeah, it’s pretty clear, I ain’t no sigma two

But I can predict it, predict it, like I’m supposed to do

‘Cause I got that Bayesian that all the gurus chase

And all the right tunables in all the right places

I see the magazine workin’ that Crystalball

We know that shit ain’t real, come on now, make it stop

If you got logic, logic, just raise ’em up

‘Cause every inch of you is curious from the bottom to the top

Yeah, my mama she told me “don’t worry about your data size”

(Shoo wop wop, sha-ooh wop wop)

She says, “Bayesians like a little more posterior to hold at night”

(That booty, uh, that booty booty)

You know I am wont to be stick figure xkcd comic doll

So if that what you’re into, then go ‘head and move along

How entrepreneurs estimate the probability of picking a red ball from a urn?

Stay with me on this till the end of this article.

Suppose you asked me the probability of picking a red ball from a urn that has 10 red balls and 10 green balls, I would say the answer is 1/2. I cannot say with certainty what the next pick will be but if you picked a ball enough times I can say 50% of those instances will be red balls (yes you return the ball after each pick).

But what if you brought a mystery urn (of unknown size) and didn’t reveal how many red and green balls are in the urn? Heck, what if there were lot more colors than just red and green? I would have no idea. My best approach would be to guess a number (using my gut feel or intuition) and say something like  1/1000.

But as someone too analytically bent I would find it hard to play this game. You didn’t tell me how many total balls, the different colors and whether the urn had a red ball or not. I cannot even apply Bayesian reasoning to refine my answer.

Entrepreneurial outcomes,  says Saras Sarasvathy, is like estimating chances of picking red balls from such a mystery urn. According to Sarasvathy entrepreneurial thinking is

Whatever the initial distribution of balls in the urn, I will continue to acquire red balls and put them in the urn. I will look for other people who own red balls and induce them to become partners and add to the red balls in the urn. As time goes by, there will be so many red balls in the urn that almost every draw will obtain one. On the other hand, if I and my acquaintances have only green balls, we will put them in the urn, and when there are enough, will create a new game where green balls win

It is hard not to imagine someone you know doing exactly this – hustling to find those with red balls to add to their urn (discover a few early adopters and build on them) or pivoting to redefine the game as picking green balls not red balls.

That is the clear distinction between the mind of an entrepreneur with irrational optimism and that of rational person. And I do not use rational and irrational to say one is better than other rather  use irrationality as equally positive trait as rationality (or rationality as equally negative trait as irrationality), like the way Dan Ariely did.

Rational people, there are many of us, refuse to play the guessing game of picking red balls from unknown mystery urns. But if picking red balls is important to significantly improve our lives, someone has to do it. However no single person can keep on trying with a single urn. And most run out of cash and time before they can add enough red balls to their urn.

That is why we need many many entrepreneurs with irrational optimism to keep picking balls from their own mystery urns. Most end up picking all kinds of different balls but a few will find urns and change it in such a way to always draw red balls.

Where do you fall?