The Element of Certainty — A Universal Framework for Wealth Creation Through Entrepreneurship and Investing
Summary: Fundamentally, wealth creation depends on two things: Providing value to customers and capturing part of it. In this article, we will study how to pursue opportunities to create billion-dollar businesses. Essentially, there are two ways to go about: Firstly, you can become an “Aggressive First Mover” in a newly emerging industry. Secondly, you can use a technique called “Element of Certainty” to become the “Contrarian Last Mover” for less obvious, but equally interesting opportunities in a more developed sector.
Quite frequently, people ask me how to find a great business idea. This question is important for both people who want to create a company or investors who want to beat the market. The reality is that there is no shortcut. Finding a billion dollar idea overnight simply won’t work.
However, I tend to believe that there is a repeatable process for identifying great ideas each and everyone can follow: You need to anticipate the future and pursue emergent opportunities. Some investors call this the pursuit of edge. I call it the “Element of Certainty” (EOC).
In this essay, I will shed some light on how I believe some of the world’s most successful entrepreneurs became wealthy through this process. Learning about the underlying methodologies behind their success can then help us to adjust our own approach for increased success.
Problems: Opportunities for Wealth
Fundamentally, wealth is created by (1) creating value for customers, often through solving a problem for them, and (2) capturing a share of the value that has been created. As solving bigger problems creates more value, it is often desirable to find these big problems and then invest to capture them. Typically, investors invest cash while entrepreneurs without cash invest their time. Both are looking for these problems, which brings us to the question of where to find them.
To find a problem worth solving, it’s crucial to understand the concept of market efficiency. While many academics argue incessantly about whether markets are efficient, I personally have a very distinct view on this: Markets are efficient in the long run, but short-term inefficiencies often exist.
This is linked to Adam Smith’s concept of the invisible hand as well as the concept of the window of opportunity. If you pursue an opportunity too early, you will burn too much cash before the opportunity materialises and are likely to fail. If you are too late, competitors will have already capitalised on the opportunity at hand.
A large number of economic actors are constantly looking for opportunities and cumulatively they will solve most of the world’s problems. By and large, markets are efficient and good ideas get executed over time. Those actors who are best at solving these problems at the right time will become wealthy as a result.
Picking the right opportunity ultimately comes down to risk preference. Many entrepreneurs are typically best advised to focus on a concise problem for which their specific experience and skills positions them nicely to win. People who follow this approach become lifestyle entrepreneurs, similar to what’s advocated by thought leaders like Tim Ferriss or Tai Lopez.
However, while this approach maximises the chance of building a profitable lifestyle business, there is a risk of simply not picking the right category to create something truly massive. To do this, a more differentiated approach is necessary that can lead to larger outcomes, but that is also associated with higher risks of failure related to competition or simply picking a wrong opportunity.
Unicorn-Entrepreneurs: AFMs and CLMs
Basically, I see two archetypes of entrepreneurs (and investors backing them) who regularly achieve a bigger share of the wealth in the system. By learning a little more about how each type operates, and which style resonates more with your own personality, you can harness the power of seizing the right opportunities at the right time to maximise your wealth building potential.
Aggressive First Mover (AFM)
I call the first class the “Aggressive First Mover” (AFM). These entrepreneurs see an obvious market opportunity that arises, often through societal or technological changes. Therefore, barriers to finding an AFM opportunity are initially lower. However, success as an AFM requires both to jump on a train early (which requires good judgement) as well as being extremely aggressive in building your business. Additionally, the intense competition with the AFM strategy brings along a specific type of risk around competitive pressure. Thus, typically speed and execution skills determine the winners.
There are countless examples for this throughout history: The Medici’s build a banking empire on the invention of double ledger accounting, the Vanderbilt’s were the most aggressive to build railroads in the US, likewise the Rockefeller’s realised that oil is liquid gold and built one of the largest companies of all time, Standard Oil.
Uber is a good contemporary example: Ride-sharing and cab-hailing companies started popping up all over the place between 2007 and 2009, but Uber was the most aggressive in expanding first all over the US and then using their market position to raise huge funding for global expansion. Still, it’s important to note that for many business models, regional champions can emerge.
I believe today, one of most interesting technologies is distributed ledger technology. Within in this category, many entrepreneurs are using AFM strategies for technologies such as security token platforms and real estate tokenization, as those are very obvious, big opportunities. It remains to be seen who will win these categories.
Contrarian Last Mover (CLM)
I call the second class of entrepreneurs “Contrarian Last Movers” (CLM). Becoming a CLM is initially harder because it requires more efforts in two key regards: timing and unique insight. It also carries a specific risk around being wrong about your assertions on business opportunities. However, when done correctly, there is an opportunity to create a large monopoly business without the fierce competition associated with AFMs.
On the timing side, it’s important to note that you want to enter a market at exactly the point in time when the technology/market has gained reasonable velocity, but before there is a clear winner. In this instance, you can enter the market with a much better suited technology or strategy than early movers. Doing so ideally enables your company to capture most of the market. This dynamic is explained greater detail in an essay by NFX Guild.
Two examples of this are Google and Instagram. Google was the last mover in search engines due to its technologically superior algorithmic approach when the internet was taking off. Instagram became the last mover for picture-based micro-blogging. They realised that while smartphone cameras had become ubiquitous, the quality of most pictures was poor, so they introduced filters to make them more visually appealing.
Aside from the timing piece, CLMs require unique market insights to find these opportunities in the first place. These unique insights are similar to what Peter Thiel calls “secrets.” To find them, he advises people to answer his contrarian question: “What does nobody agree on with you?” If done successfully, the answer to this question can yield unique insights for the potential CLM actor.
While Thiel’s question offers a great starting point for brainstorming ideas that could offer CLM potential, the field of ideas generated by it is too broad. We need a way to narrow the field to the most viable ideas to use with the CLM strategy.
Taking a step back, we can note that both AFMs and CLMs use different techniques to increase the ex-ante likelihood of success of the endeavours they pursue. While CLMs use unique insights on opportunities and timing for this, AFMs use societal consensus to compensate for their lack of thereof. However, I feel that the CLM strategy beats AFMs because competitive pressure can be taken out of the equation if done correctly. To do this, CLM entrepreneurs need to develop a wider perspective on the larger market forces at play and what the future holds in that sector. I call this gaining the “Element of Certainty” (EOC).
The Element of Certainty
In essence, gaining the EOC is aimed at ensuring a start-up’s success prospects ex-ante when making the investment of cash or time. Ideally, you also want to be comfortable that you know something about the opportunity others are missing so that you can predict its success in the market.
There are countless analogies depicting this dynamic throughout popular culture: One is that you are not only supposed to see where the soccer ball is, but also where it is going. Another analogy relates to a chessboard and understanding how the pieces will move. Essentially, you therefore need to understand two things: (1) Present reality (where the soccer ball is / chess pieces are) and (2) future reality (where they will go).
1. Knowing Present Reality: Grounding in the Here and Now
Looking at the first piece, you first need to understand that reality is subjective, and that each and every person has his or her own version of reality. Here, reality is the sum of your experience and knowledge, which shapes your vision of the world. However, knowledge and experience are ambiguous, thus reality is different for each and everyone. Therefore, some people make really questionable decisions about starting new companies or have questionable beliefs like that the earth is flat. Their vision of reality and product market fit is misaligned.
On the flip-side, those individuals whose subjective version of reality is as close to the material version of reality will be able to outperform their competitors by making better decisions relative to actual market conditions. Hence, it’s of the utmost importance to permanently realign your reality through diverse experiences and knowledge with an eye toward acknowledging where you have missed the mark.
2. Knowing Future Reality: An Iterative Process
Now considering the second piece, you need to understand that the future reality is just an iteration from present reality with a large number of steps. Each of these steps represents a subjective reality in the future at a certain point in time. People who successfully extrapolate their reality eventually end up with a likely subjective version of the future.
To give you a data point supporting this hypothesis, consider the following: Ray Kurzweill and Bill Gates have been able to predict many technological developments in the past such as the rise of the internet with great accuracy. I’d attribute this to their stellar grasp of reality through being an expert in their fields, which enabled them to make good calls about future developments.
However, there are two factors generally increasing the difficulty of doing this. Firstly, the rule garbage in, garbage out is truer than ever. If your version of current reality is inaccurate to begin with, it’s impossible to come to an accurate projection of the future. Secondly, it is also important to note that anticipating far-future (20 years+) is exponentially harder than the near-future. This is due to the non-linearity of reality in which small disparities can lead to massively different outcomes down-the-line (a.k.a the butterfly effect).
Hence, there are only few people in the world who can predict with the accuracy of Kurzweil or Gates, but several orders of magnitude more entrepreneurs who can anticipate the near future and build what’s missing. In addition, your own personal knowledge base, experience as well as skill set determine the domain over which you are best suited to make a big move. I will further explore this concept, which I call the “Opportunity Universe Framework” in a future blog post.
3. Gaining the Element of Certainty (EOC)
Based on these considerations, you should do two things to gain the EOC. Firstly, you need to derive a comprehensive and detailed vision of present reality. Secondly, you need to extrapolate this into the version of the future that you expect to become reality.
Having established this vision of future reality, there are now two ways to go about validating opportunities. Firstly, there is a pro-active approach: You look for and find ideas and then check whether they align with this reality. Secondly, you can form hypotheses about business opportunities and wait for evidence to confirm them. I call this the reactive approach. In any case, the alignment of ideas and vision of the future is what I call EOC.
Once you find this alignment, you can pull the trigger and make the investment or create the business. If you don’t find alignment, it means either the company won’t succeed or your vision for the future is incomplete or wrong. Therefore, it’s of utmost importance to constantly improve your version of reality. It should be a fluid image rather than a static picture.
This line of thought is akin to Marc Andreessen’s idea that you should be highly convicted, but be willing to change your opinions rapidly when new information is presented to you. This is important, because the most accurate version of reality is the basis for finding great startup ideas.
Many famous investors have described important aspects of finding the EOC. In the following, I will describe the method Warren Buffet uses to shape his vision of present reality. Then, I will explain Elon Musk’s and Paul Graham’s characteristic methods for executing the second step: Extrapolating present reality into future reality. Finally, I will contrast their approach with how Rocket Internet successfully implemented the AFM strategy to achieve similar success.
Case Study: Warren Buffet
Arguably, world-famous investor Warren Buffet is one of the best people in the world when it comes to knowing where the ball currently is. Buffet spends 80% of his day reading and he recommends reading 500 pages a day. He attributes most of his success to building these knowledge assets and has said that reading operates similar to compound interest.
Let’s analyse this notion in a bit more in detail because it is quite profound. Essentially, it implies that the more you read, the more you benefit from the knowledge you have previously consumed. However, one could argue that reading has diminishing returns once you reach a certain level of knowledge. Then, knowledge would work similar to a bank account, where the first million would give you more utility then the second.
So how can reading have a compound interest effect? What I have experienced is that knowledge works more like a network than a bank account. Imagine that each piece of knowledge is tied to a brain node in a scattered network of nodes. Now, the more pieces of knowledge you have, the more connections you can make between the different pieces of knowledge. This is where the compound effect of knowledge kicks in and additional knowledge does in fact add up. The value of knowledge increases exponentially like any type of network. Each incremental new piece of knowledge allows you to generate lots of new insights by combining them with previously acquired knowledge.
One example for this could be an insight about the rise of millennials in emerging markets: Nigeria is expected to grow to over 1 billion people by 2100. Combining this insight with knowledge about technology trends such as clean energy or co-living allows you to invest in companies capitalising on both trends. To conclude, consuming lots of information helps to create a vision of the present that is detailed and more importantly a vision that gets exponentially better the more time you invest.
Regardless of the metaphor that you use to describe knowledge building, the point remains the same: The more information you have about your world, and in particular your area of interest, the more sound your predictions of trends will become. For CLMs, this is a critical element of gaining the EOC.
Case Study: Elon Musk
One of the most heralded entrepreneurs of the 21st century is Elon Musk. He utilises a technique called “First Principles” to analyse how technology trends will shape the world, i.e. where the ball is going. This methodology is geared towards finding fundamental truths and then deriving business opportunities that exploit these truths, which have been discovered.
According to Musk, finding the fundamental truth can be done by asking a series of questions and solving the problems that pop up. To give you an example, consider the following:
Q: Why does it take 5 hours to go from Los Angeles to San Francisco?
A: Because there is traffic on the roads.
Q: What about a high-speed train?
A: Friction from air determines a maximum velocity because energy required to go faster increases exponentially.
Q: How can we mitigate this friction?
A: By creating a vacuum.
Q: Then you need confined environments.
A: Exactly, what about tubes?
I’m pretty sure that’s more or less how Elon Musk came up with the idea of Hyperloop. As you can see, asking this series of questions helps you to identify the real problems worth solving. If you believe in efficient markets, an entrepreneur will eventually stumble upon these opportunities and build a company to solve this problem. Why not let it be you?
First-principles thinking provides a useful element towards building a vision of the future that is focused on emergent opportunities.
Case Study: Paul Graham
Finally, one of the world’s most successful investors is the founder of Y-Combinator Paul Graham. He gives the following advice to entrepreneurs: “Live on the edge to the future and build what’s missing.” Picking up this thought from an investor’s perspective, you can simply invest in what is missing in your life.
Living on the edge of technology helps you to be very close to future iterations of present reality so that it is easier to anticipate where the ball will go. I feel to best way to achieve this is by becoming an avid user of the technology you want to invest in. Besides, meeting lots of interesting people in the industry will help. They can share with you their personal view on how the future may pan out.
Case Study: Rocket Internet
A large part of Rocket Internet’s success can be attributed to the AFM strategy. For those unfamiliar with Rocket, they became famous for copy-catting so-called proven business models, typically from the US, and bringing them to new geographies in Europe and emerging markets. This has been very successful for Rocket. They have had multiple IPOs and trade sales totalling over USD 20bn in enterprise value. The fact that these are spread reasonably evenly across several ventures strongly implies that there is a well-working method behind their success.
Having worked as the chief scout for identifying business models to be copied by Rocket, I have some insights how this identification and roll-out process works. In summary, we used (1) funding rounds with famous, world-class investors as a proxy for societal consensus required in the AFM strategy and then (2) checked whether there was the potential to build regional champions as a result of local entry barriers and local economies of scale.
However, there are two drawbacks of this method: Firstly, copy-catting business models and replicating them just outside the US and China severely limits the share of value that can be captured in the system. The second drawback revolves around the fact that nowadays lots of serial entrepreneurs have started company building, so there is more competition around this copy-cat approach. Hence, I typically find it more attractive to be a CLM nowadays.
There are two main ways to go about capturing the wealth of new technologies: 1. Be an Aggressive First Mover (AFM) and enter into the intense competition to dominate market share, or 2. Be a Contrarian Last Mover (CLM) who uses intimate knowledge of current conditions to predict and act on a game-changing problem/solution pair.
Personally, I believe pursuing CLM opportunities is most attractive because while both strategies offer big potential payouts, CLM allows you to build a business that has defensible competitive advantages with lower levels of risk of being crushed by the intense competition in the AFM space. Still, there can be merit in opportunistically going after AFM opportunities for those with the right personality, impeccable timing, and vast resources to draw on.
To be successful with a CLM strategy, an entrepreneur or investor must gain the Element of Certainty (EOC) to accurately predict what is next and maximise the potential to bring the right ideas to the marketplace at the right time. In order to explore that concept, we have looked at three successful frameworks to get perspective and insight.
While these three frameworks can be highly useful to gain EOC, I find them by no means comprehensive for doing so. Due to the attractive nature of pursuing big opportunities with EOC, I’ve therefore decided to become a collector of such frameworks. Doing so will enable me and my firm 10x Value Partners to create great success with the help of our teams and investors.
As a collector, I’m always keen to find other methods for gaining the EOC. Do you know any? If so, please message me. I’d be very curious to hear your thoughts.