Thoughts on investment (26)- review on ‘Influence’ (1)

This is another book Charlie Munger highly recommended and gave many copies to his friends as gifts. After the reading, I see clearly why.

This is a very insightful book, and the problem this book is trying to solve is the fundamental of nearly all the social and economic models.

Here I would like to share some of the key points and my understandings. To note that: there are so many details and examples in the orignal book, therefore to read the full text of the book is highly recommended.

The Study of the Autopilot Features

Everything should be made as simple as possible, but not simpler. – Albert Einstein

The ethologist have begun to identify regular, blindly mechanical patterns of action in a wide variety of species. Called fixed-action patterns, they can involve intricate sequences of behaviors, such as entire courtship or mating rituals. It is almost as if the patterns were recorded on tapes within the animals. When situation calls for the tape gets played. Clickand the appropriate tape is activated; whirr and out rolls the standard sequence of behaviors.

Apart from the lower animals, we, too, have our preprogrammed tapes (which might be stored in our genes after millions of years of evolution); and although they usually work to our advantage (for example efficiency, risk control, energy saving, etc.), otherwise they will not exist after long time of natural selection, the trigger features that activate them can be used to dupe us into playing them at the wrong times.

For example, some well-known principle of human behavior says that:

1, When we ask someone to do us a favor, we will be more successful if we can provide a reason (even non-logical one, just to show the gesture);

2, The customers, mostly well-to-do vacationers with little knowledge of turquoise, were using a standard principle—a stereotype—to guide their buying: “expensive=good.”

3, Contrast principle: the principle in human perception that affects the way we see the difference between two things that are presented one after another. For example, if sell the costly item first, people will find the second item cheaper even though it might actually be priced richer in its category.

In the long run, over all the past and future situations of our lives, betting shortcut (autopilot features) odds may represent the most rational approach possible, otherwise, as I mentioned, those shortcuts would not live through long time of natural selection.

In fact, automatic, stereotyped behavior is prevalent in much of human action, because in many cases it is the most efficient form of behaving. Especially, the world is now in an extraordinarily complicated and fast-moving environment, and to deal with it, we need shortcuts. We can’t be expected to recognize and analyze all the aspects in each person, event, and situation we encounter in. We haven’t the time, energy, or capacity for it. Instead, we must very often use our stereotypes, our rules of thumb to classify things according to a few features and then to respond mindlessly when one or another these trigger features is present (actually this is the humane way of pattern recognition which AI and future intelligence can learn from).

As renowned British philosopher Alfred North Whitehead recognized this inescapable quality of modern life when he asserted that “civilization advances by extending the number of operations we can perform without thinking about them.”

For value investors, looking for things and businesses which rely on the force of human natures might be able to achieve a longer and more sustainable result.

To note that one of the reasons for shortcuts is efficiency as we are need deal with so many in this complicated and fast-moving world, and this reasoning also coincides with the customer captivity in ‘competition demystified’—complication and search costs.

The most important autopilot features which we have are reciprocation, commitment and consistency, social proof, liking, authority, and scarcity, which are all very interesting and need a much better understanding.

The Rule of Reciprocation

Pay every debt, as if God wrote the bill – Ralph Waldo Emerson

The rule of reciprocation, the rule says that we should try to repay what another person has provide us, might be the most potent weapon of influence around us, without it the human society might not even exist. Actually, the rule of reciprocation commonly exits nearly all the socialized animal species, and it is the very fundamental for forming any kinds of group, not to mention a society.

The indebtedness, caused by the rule of reciprocation, allows for the division of labor, the exchange of diverse forms of goods, the exchange of different services, and the creation of a cluster of interdependencies that bind individuals together into highly efficient units. A widely shared and strongly held feeling of future obligation meant that one person could give something to another with confidence that it was not being lost, otherwise he will never choose to give at the first place.

However, there are many ways try to take advantage of this rule:

1, Providing with a small favor prior to requests. For example: the fund raising used by Krishna.

2, Politics. Lyndon Johnson’s ability to get so many of his programs through Congress during his early administration is due to the large score of favors he had been able to provide to other legislators during his many years of power in the House and Senate, where he stockpiled of obligations. And that’s why some politicians, if cannot find a balance of ideas and reality and aptly trade benefits with others, can almost do nothing even if been elected by the grassroots to the position. The TV series ‘House of cards’ showed vividly about this fact.

3, Merchandising field as well. Most commonly the free sample and gifts. 

Uninvited favor:

Another person can also trigger a feeling of indebtedness by doing us an uninvited favor. It is the obligation to receive that makes the rule so easy to exploit.

Unfair exchanges:

The rule of reciprocal can also trigger unfair exchanges: a small initial favor can produce a sense of obligation to agree to a substantially larger return favor. One important reason concerns the clearly unpleasant character of the feeling of indebtedness as most of us find it highly disagreeable to be in a state of obligation. It weighs heavily on us and demands to be removed. Because reciprocal arrangements are so vital in human social system, we have been conditioned to be uncomfortable when beholden. That’s why we may be willing to agree to perform a larger favor than we received, merely to relieve ourselves of psychological burden of debt. Besides, a person who violates the reciprocity rule by accepting without attempting to return the good acts of others is actively disliked by the social group. In combination, the reality of internal discomfort and the possibility of external shame can produce a heavy psychological cost.

Reciprocal concessions. Another consequence of the rule is an obligation to make a concession to someone who has made a concession to us. The tendency to do so also rests on the interests of any human group to have its members working together toward the achievement of common goals. In many social interactions the participants begin with requirements and demands that are unacceptable to one another, that’s why mutual concession is one important to reach common understandings.

Rejection-then-retreat technique is devastatingly effective way of using reciprocal concessions to achieve a compliance. The technique also makes use of the contrast principle by making the smaller request look even smaller by comparison with the larger one at first. However, the first set of demands need not to be so extreme as to be seen as unreasonable that the tactic backfires.

By-products of the act of concession: feelings of greater responsibility for, and satisfaction with, the arrangement. It is this set of side effects that enables the technique to move its victims to fulfill their agreements to engage in further such agreements.

Commitment and Consistency

It is easier to resist at the beginning than at the end – Leonardo Da Vinci

Just after placing a bet, they are much more confident of their horse’s chances of winning than they are immediately before laying down that bet.

The reason for the dramatic change has to do with a common weapon of social influence: our nearly obsessive desire to be (and to appear) consistent with what we have already done. Once we have made a choice or taken a stand, we will encounter personal and interpersonal pressures to behave consistently with that commitment. Those pressures will cause us to respond in ways that justify our earlier decision. Indeed, we all fool ourselves from time to time in order to keep our thoughts and beliefs consistent with what we have already done or decided, even contrary to our own best interests.

A mindset so common in the investment world. Just made the investment, investors would normally feel more comfortable about this investment. Sometimes this mindset will go too far as investors will look for reasons to justify their earlier investment decisions.

Inconsistency is commonly thought to be an undesirable personality trait. Being consistent is approved -- sometimes more than being right. 

Because it is so typically in our best interests to be consistent, we easily fall into the habit of being automatically so, even in situations where it is not the sensible way to be.

But why is that? 

First, like most of other forms of automatic responding, it offers a shortcut through the density of modern life. Once we have made up our minds about an issue, stubborn consistency allows us a very appealing luxury: We don’t have to sift through the blizzard of information anymore.

The same consistency we should try to use when making investment decisions in those who benefit from the customer consistency decisions, another way to say customers captivity, but to avoid the stubborn consistency in might be wrongful investment decisions, some call anchoring, self-proving effects.

Secondly, and more perverse attraction of mechanical consistency as well. Sometimes it is not the effort of hard, cognitive work that makes us shirk thoughtful activity, but the harsh consequences of that activity. There are certain disturbing things we simply would rather not realize. Because it is a programmed and mind-less method of responding, automatic consistency can supply a safe hiding place from those troubling realizations.

No need to think about the issues any longer. The decision has been made, and from now on the consistency tape can be played whenever necessary.

The third reason might come from the social pressure as the person who is consistent with his promise can be much better expected and thus accounted on for future cooperation. These long-time social responds for consistency would generate social benefits for consistency and pressure for deviates.

Commitment is the key

If I can get you to make a commitment (to take a stand, to go on record), I will have set the stage for your automatic and ill-considered consistency with that earlier commitment. Once a stand is taken, there is a natural tendency to behave in ways that are stubbornly consistent with the stand.

Some examples of commitment and consistency tactics used by prisoner-of-war camps run by the Chinese Communists during the Korean War is quite worth reading. It is very helpful for understanding how propaganda and influence has done using the force of commitment.

For the salesperson, the strategy is to obtain a large purchase by starting with a small one. Almost any small sale will do, because the purpose of that small transaction is not profit. It is commitment. 

Does that mean a company with larger customer base is probably better than the one with smaller base even with a higher price-tag?

The tactic of starting with a little request in order to gain eventual compliance with related larger requests has a name: the foot-in-the-door technique. A trivial commitment at first can become remarkably willing to comply with another request that is massive in the size.

In investment, we sometimes committed too much in the past decisions, sometimes awful ones, however if we take a foot-in-the-door tactic and gradually change our idea might be able to prevent been bogged too much in our old mistakes.

Once you’ve got a man’s self-image where you want it, he should comply naturally with a whole range of your requests that are consistent with this view of himself.

I found that the old saying ‘三岁看老’ seems make sense as the force of consistency is so strong. As for the gangsters, the ‘first blood’ is so important for the new recruitment that this kind of commitment can totally change the mindset of the new members and can make them never go back.

The magic act and public eye

Our best evidence of what people truly feel and believe comes less from their words than from their deeds.

Again, in POW (prisoner-of-war) example listed earlier, the prisoners were always pushed to write pro-communist answers down, and if not at least to copy it. The trick is that once an active commitment is made, then, self-image is squeezed from both sides by consistency pressures. From the inside, there is a pressure to bring self-image into line with action. From the outside, there is a tendency to adjust this image according to the way others perceive us.

The effort extra

Another reason that written commitments are so effective is that they require more work than verbal ones. The evidence is clear that the more effort that goes into a commitment, the greater is its ability to influence the attitudes of the person who made it.

Military groups, college fraternities and organizations are by no means exempt from these same processes. The agonies of “boot camp” initiations to the armed services are legendary.

For the same reason, many lengthy, excruciating recruitment process of universities, companies might not only for talent selection but for commitments from the applicants.

The most important of all: the inner choice

It appears that commitments are most effective in changing a person’s self-image and future behavior when they are active, public, and effortful. But there is another property of effective commitment that is more important than the other three combined: the inner choice. It suggests that we should never heavily bribe or threaten them to do the things we want them truly to believe in. If we want them to believe in the correctness of what they have done, if we want them to continue to perform the desired behavior when we are not present the outside pressures, then we must somehow arrange for them to accept inner responsibility for the actions we want them to take.

Some authoritarian regime relies on pressure and bribe to govern; thus, they need constant effort to reinforce their government legitimacy.

The inner choices grow their own legs: sometimes self-deception

There is no need for the compliance professional to undertake a costly and continuing effort to reinforce the change; the pressure for consistency will take care of all that. Thus, even if the original reason for the behavior was taken away, some newly discovered, even made up, reasons might be enough by themselves to support one’s perception that one had behaved correctly.

The self-deception happens a lot in investment, as investors always voluntarily try to find excuses for their holdings, even though some have already proven to be wrong.

The lowball strategy—give it and take it away later

Because we build new struts to undergird choices we have committed, an exploitative individual can offer us an inducement for making such a choice, and after the decision has been made, can remove that inducement, knowing that our decision will probably stand on its own newly created legs.

But how to find out current satisfaction is real or foolish consistency?

Accumulating psychological evidence indicates that we experience our feelings toward something a split second before we can intellectualize it. We should look for and trust the first lash of feeling we would experience in response. It would likely be the signal from heart of hearts, slipping through undistorted just before our cognitive apparatus engages.

When making difficult decision, believe in your guts, believe in your first impression, and do not let the force of consistency drive us might be key. This is also another way for ‘follow your heart’ or ‘back to the origin’, etc. 

The book ‘Only the paranoid survives’ told a story of how good decision is made by willing to make bold moves based on gut calls instead of been driven by the force of consistency of seemly carefully deliberation.

Social Proof

Where all think alike, no one thinks very much – Walter Lippmann

We view a behavior as more correct in a given situation to the degree that we see others performing it. 

To be clear, the tendency to see an action as more appropriate when others are doing it normally works quite well. As a rule, we will make fewer mistakes by acting in accord with social evidence than contrary to it. Usually, when a lot of people are doing something, it is the right thing to do. Like the other weapons of influence, it provides a convenient shortcut for determining how to behave. However, our tendency to assume that an action is more correct if others are doing it is exploited in a variety of settings. For example, advertisers love to inform us when a product is the “fastest-growing” or “best-selling” because they don’t have to convince us directly that the product is good, they need only say that many others think so, which seems proof enough.

Uncertainty and Pluralistic ignorance

In general, when we are unsure of ourselves, when the situation is unclear or ambiguous, when uncertainty reigns, we are most likely to look to and accept the actions of others as correct.

In the process of examining the reactions of other people to resolve our uncertainty, however, we are likely to overlook a subtle but important fact that those people are probably examining the social evidence, too. Especially in an ambiguous situation, the tendency for everyone to be looking to see what everyone else is doing can lead to a fascinating phenomenon called “pluralistic ignorance”.

Monkey me, monkey do

There is another important working condition: similarity. The principle of social proof operates most powerfully when we are observing the behavior of people just like us. Therefore, we are most inclined to follow the lead of a similar individual than a dissimilar one.

We frequently think of teenagers are rebellious and independent-minded. It is important to recognize, however, that typically that is true only with respect to their parents-- the dissimilar ones. Among similar others, they conform massively to what social proof tells them is proper.

The book also gave some examples about secret religion and cult and showed us how they influenced so many of their members. These examples work well in a more broadly national level, as authoritarian leaders also use this way to manipulate their citizens, for example North Korean.

Clearly, there are limitations of individual leadership. No leader can hope to persuade, regularly and single-handedly, all the members of the group. A forceful leader can reasonably expect to persuade some sizable proportion of group members. Then the fact that a substantial number of group member has been convinced can, by itself, convince the rest. Thus, the most influential leaders are those who know how to arrange group conditions to allow the principle of social proof to work maximally in their favor.

As slaughterhouse operates have long known, the mentality of a herd makes it easy to manage. Simply get some members moving in the desired direction and the others – responding not so much to the lead animal as to those immediately surrounding them – will peacefully and mechanically go along.

There are two features of buffalo that make them especially susceptible to erroneous social evidence. First, their eyes are set in their heads so that it is easier for them to see to the side than to the front. Second, when they run, as in a stampede, it is with their heads down low so they cannot see above the herd. As a result, the Indians realized, it was possible to kill tremendous numbers of buffalo by starting a herd running toward a cliff. The animals, responding to the thundering social proof around them – and never looking up to see what lay ahead – did the rest. One astonished observer to such a hunt described outcome of the buffalo’s obsessive trust in collective knowledge.

Social proof and snowballing effect

Sometimes, an innocent, natural error will produce snowballing social proof that pushes us to the incorrect decision. Thus, an autopilot device, like social proof, should never be trusted fully; even with no sabotage with the input, it can sometimes go haywire by itself. We need to check the machine from time to time to make sure it has not gone out of the way.

In investment, there are so many examples of social proof:

1, Because investment is all about predict the future, when abound to have many uncertainties, thus, as the rule tells, where the uncertainty presents people are eager looking for social proof. In the uncertain world of investment, People are looking for help from experts, authorities, analysts, influential fund managers, other traders, even the market performance itself for social proof, inevitable causing self-reinforces and sometimes madness, due to “pluralistic ignorance” effects. One trading trick of pushing stock price to the daily limit in A share market is another example of exploiting social proof effects to cause others to follow the momentum.

2, People tend to simplify the differences companies have and put the similar companies into the same category, sometimes concept, and trade them as if they are all the same, causing a strong correlation within the category. The logic behind it is that if one company can be success there is no reason others will not, which is absurd. The reality is that even though the companies in the same category may look the same, but in the long run they all apart hugely. Sadly, to understand the many detailed differences is probably too bothersome and unnatural for human beings, thus people still rely heavily on the social proof effects within the category to tell them what’s happened and what will be in the future. 

3, However, we can also benefit from investing in those whose products have already caused social proof effects and would become more mainstream. The book “crossing the chasm” is a wonderful work details how the lack of social proof can leave great product unwanted and how can a product be accepted by majority due to social proof effects.

To be continued…

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