Let’s be honest: Life is pretty random. A lot of things are out of your control. Not being in control is hard for passionate people with a high internal locus of control. Adverse outcomes are physically painful for me. I don't worry, but I hate failing. Since I think most outcomes in my life result from my actions, I take adverse outcomes very personally. If I make a mistake, pain is helpful. It helps me learn fast. But often, the outcome is simply the result of bad luck; in those cases, pain is a waste of time. Reversely, it’s humbling to realize that outlier success also requires a lot of luck.

The more abstract and long-term oriented my work becomes, the more complex it gets to untangle skill and luck. To cope with successes and setbacks, I spend time on trying to separate different factors. Here is an attempt to sort out the following aspects:

  1. What it means to be skilled versus lucky

  2. What it takes to create and capture value

  3. What the primary sources of randomness are

What does it mean to be skilled? I think skill combines IQ, training, experience, communication, determination, network, and judgment. You could probably list ten other things, but these are the big ones. Skill is the ability to improve the odds of successful outcomes.

Unfortunately, we cannot do much about our IQ. We’re born with the brain we get. We can, however, influence most of the rest.

Training yourself to apply a systematic, logical approach to exploring, understanding, and acquiring new knowledge is incredibly valuable. In my experience, the most powerful thing you can do is to learn about “structures and frameworks.” Mathematics is a collection of structures and frameworks. It teaches you ways to write down assumptions and derive conclusions. Initially, math feels like “just learning rules,” but eventually, once those rules are memorized, it’s about learning ways to reason.

Gaining Experience is the process of creating and updating beliefs with new evidence. If training provides frameworks, experience gathers observations to estimate probabilities. The more experience we have, the better we know what to expect. As the world changes, existing experiences become outdated. This is the opportunity young people and companies have to create new value.

Communication is the ability to convey information in an engaging and understandable way. Great leaders are typically also great communicators. They can simplify complex situations and communicate what matters. Noise is the enemy of focused action. The world gets complex fast if we let it. Excellent communication can significantly improve your probability of success.

Determination is the ability to keep going. It requires a deep belief in oneself. The most successful people in the world believe in themselves almost to the point of delusion. Innovation is to do something before it is obvious. There will not be enough data. Others will doubt you. Managing morale in the face of uncertainty is a critical skill. The tricky thing for most people is to balance determination with self-awareness and open-mindedness. Being both stubborn and open-minded is a contradiction. Yet, that is what you need to master. By thinking from the first principle and rejecting outdated social structures, you can channel your determination toward overcoming the most critical obstacles. You cannot fight the laws of nature, but you must believe everything else can be changed. You need to feel like you can bend the world to your will. Most people don’t even try. They accept that things are the way they are. Determination is the opposite of self-doubt. It is the opposite of giving up too early. It means you push hard for an extended time. Determination is a skill.

Network is a person's ability to build and maintain relationships. It’s impossible to change the world on your own. You need a strong network of other skilled people to overcome the critical obstacles you will face. You need great people in your corner. Investing early and patiently in your network provides tremendous, long-term value. The difference between success and failure can come down to making that one call at the right time.

Judgment involves making decisions based on sound principles and values. It means distinguishing between right and wrong and acting accordingly. Integrity is the ability to hold oneself to a consistent set of ethical principles and do the right thing even when it is inconvenient. It requires self-awareness and reflection to avoid bias and inconsistencies.

What does it mean to be lucky? To be lucky is to benefit from favorable circumstances that occur by chance rather than through one's actions. If you place a bet with 10/1 odds and win, you are lucky. The worse the odds, the luckier you are if you win.

Untangling skill and luck requires an understanding of:

Building a business is a big bundle of bets. You bet on a market, a trend, a technology, a founder, a CEO, a team, an obstacle, a solution, a business model, a plan, a brand, and more. All these different factors are rolled up into one giant bet. Entrepreneurs, executives, and investors are paid on the assumption that they can untangle all the bets and improve the odds. Their IQ, training, experience, communication, determination, network, and judgment should give them an edge.

When I examine my performance as a business leader, I’m trying to ask myself: Was this outcome the result of skill or random events? Did I apply my skill to estimate and influence the distribution of possible outcomes? Could I have increased the odds of a more favorable outcome by better analysis or different actions? It’s essential in this context to factor in time and available information. Retroactively evaluating a decision is only fair with the same time constraints and information. Hindsight is, after all, 20/20.

A skilled person should, in most cases, be able to estimate and influence the probability distribution of possible outcomes in a specific situation. Question is, how much? Knowing the distribution of potential outcomes allows you to make an informed decision when taking action. If the problem is familiar and the world is stable, an experienced and well-trained person should be able to ensure a decent outcome or at least help you make a well-informed bet. However, it is harder to make a skill-based decision in novel situations. There aren’t enough prior observations to estimate probability distributions. Outlier outcomes are, by nature, unlikely. They are most often the result of someone placing a big bet on an unlikely event and winning. Data supports this as the correlation between income and intelligence is much stronger than the correlation between net worth and intelligence.

Source

Another way to put this is: Can you “manufacture luck” when building a business? I think you can, to a point. There are definitely powerful frameworks that can improve your odds.

A critical factor necessary to create an outlier outcome is to have a bold vision and overcome huge obstacles. I’m inspired by The Crux, a book by Richard Rumelt, one of the world's leading authorities on strategy. The book suggests how to identify problems that are valuable to solve. His advice is simple: Focus your energy on the most critical obstacle you can overcome to accelerate the world toward your vision. By definition, a critical obstacle is unsolved in a satisfactory way. If it already has a solution, it’s not a critical obstacle.

You need to decide what your vision is. No one can tell you your purpose; that’s up to you. I like to imagine what I want the world to look like in 10 years, 50 years, or 100 years. Then I work my way backward: What are the most critical obstacles to overcome to accelerate the world toward my vision? You can get to work once you find the intersection between our current knowledge, existing technologies, and the most immediate obstacle. My favorite quote from Gibson is: “The future is already here, just unevenly distributed.” My takeaway is that what is ‘table stakes’ in 10 years is probably already available today in ‘pockets of the future.’ The more universal the vision and the more significant the obstacle, the more value you create if you overcome the obstacle. If you solve a meaningful problem, skilled people will want to help you.

Pursuing a bold vision and working to overcome a huge obstacle means you invite randomness into your life. Solutions to overcome critical obstacles do not appear in a structured, predictable way. Skilled, prolific people can come up with more and better ideas, but they cannot just ‘manifest solutions’ out of thin air. It takes persistence and experimentation to expand into the unknown. Inventing new things is extremely hard work that doesn’t necessarily produce the results you want. In my experience, all you can do is ‘trust the process.’ Create the most powerful platform you can for experimentation (team, resources, capital, etc.) and aim to address the most critical obstacles between you and your vision for as long as you can. The more capital you can access to fund your platform for experimentation and the more prolific, skilled people you can hire, the higher the probability of overcoming critical obstacles. For example, Nobel laureates publish 5x more than average scientists during their early careers. It’s not enough to be smart; you must also be prolific.

To make commercial product innovation even more complex, it depends on other people, i.e., your customers. A sufficiently large group of customers must agree that they face the critical obstacle you focus on. And they must agree with you that your solution overcomes their obstacle in a satisfying way. And they must be in a position to pay for your solution. Most companies fail to launch valuable products because they fail to validate with customers that the obstacle is critical.

I think customer feedback is the most confusing aspect of entrepreneurship. During times of major disruption, when new technology emerges that solves problems in an unseen way, social structures become a major adoption factor. Maybe your customer is scared of change and unwilling to risk their current status quo? Or perhaps they want to buy, but management will not approve it? Or maybe the buyer's status is threatened by this new technology? Or does your solution risk replacing existing teams? Or maybe customers are just so invested in their current way of working that they want to avoid disrupting that? This feedback can easily be confused with “you are not overcoming a critical obstacle.” You might have a way to overcome a critical obstacle; your customer may not realize or appreciate it. But they could also be right, and you could be wrong. Or you are both right; the timing just isn’t there. There is a big graveyard of startups with products overcoming obstacles that aren’t critical. This is a significant source of randomness when building a business. Not only are you betting you can overcome a critical obstacle, but you are also betting there will be demand for your solution. There is a saying that "first-time founders focus on products, second-time founders focus on distribution."

This is when determination comes back into play. Outlier outcomes require placing high-conviction bets before it is obvious and being right. I quote from earlier:

Innovation is to do something before it is obvious. There will not be enough data. Others will doubt you. Managing morale in the face of uncertainty is a critical skill. The tricky thing for most people is to balance determination with self-awareness and open-mindedness. Being both stubborn and open-minded is a contradiction. Yet, that is what you need to master.

At this point, we have made two significant bets:

The next random element is capital requirements. Every company needs capital to fund innovation, but the early stage is unpredictable. You need to invest in both the experimentation platform mentioned earlier and the go-to-market activities required to generate customer demand. Neither is a predictable process.

To be a good capital allocator, you invest proportionately to the value you can create and capture. So, you need to make assumptions about the number of customers you can serve and the amount they will be willing to pay. This is the next major bet you are placing. Markets are chaotic. Thousands of companies crash into each other. Countless fundamental factors are aggregated. All of them crash into each other in “the market”.

A system of 3 bodies interacting gravitationally is chaotic.

Chaos is when the present determines the future but the approximate present does not approximately determine the future.

-- Edward Norton Lorenz

Since world market is chaotic, estimating how much value you can create is very hard. Most huge companies today feel obvious in retrospect. “Of course Nvidia is a successful company!” But the reality is that it was usually far from obvious for a very long time.

To make matters worse, creating value is not enough. You also need to capture value. Inspired by the Acquired podcast, I’ve become fond of the "7 Powers" framework to understand a company’s ability to capture value.

"7 Powers" was created by Hamilton Helmer, describing possible sources of persistent competitive advantage. A lot of it is focused on differentials against competitors. You want to establish a flywheel motion that compounds into a growing advantage. Once that flywheel is started, you must ensure you do not run out of money. Sooner or later, you will be unstoppable. That is, until the world changes. When the internet was invented, the power dynamics of markets changed very quickly. The transaction cost of exchanging goods basically disappears, and that rapidly disrupted incumbents. No business is safe. The faster the rate of change in the world, the more important it is to evolve constantly.

Businesses are technical, social, and financial experiments. They bundle a considerable number of sources of randomness.

Skill improves your odds of good outcomes. Outlier outcomes require luck. The outcome is not only the result of your actions as an entrepreneur. Even the most skilled operators can fail when making many bundled bets. I am undaunted. Be busy building.