Tuesday, February 25, 2014

Type A and Type B Decision Making

Quick Summary:
  • Type A decision making focuses on the few key factors.
  • Type B decision making understands that the fat tail of factors might become crucial someday.
  • Ignoring the fat tails mean failing to understand that these factors could come and bite us someday. Recognizing the fat tail is the key to Type B decision making.
  • In investing, this means looking holistically at the business and asking questions all round.
  • In real-world decision making, it also means constant reviewing of past decisions.
  • One should continuously assess the situation and challenge the assumptions.
In the previous post, we established that there are, by and large, two personality types. 

Type A: Digital, task-oriented, focused on getting things done. Excellent operators and organizers.
Type B: Analogue, multi-dimensional approach, focused on innovating to a better solution. Creative problem solvers and strategic thinkers.

In decision makings, these two Types exhibit different traits and I would like to further point out  as something that is very much related to stock analysis and the final decisions to buy, sell or hold.

As an investor, or to be specific, a stock investor, a big part of our core work involves analysing stocks ie companies and their businesses. There is no escaping that.

Now, businesses are complex and various factors come into play, in different time horizons, in different situations and market conditions. However, there should be just a few key factors that would explain 80-90% of the drivers of businesses and hence stock prices, over the mid to long term. For instance in toothpastes, it boils down to scale and distribution - how big is the manufacturing footprint and how far the products go into hypermarts, rural mom-and-pop stores and e-commerce. Secondly and perhaps more importantly, its brand which translates to pricing power. There will be a thousand other factors that might come into play. But these 2 or 3 would explain most of the business and how the stock should move over time.

A Type A investor would be able to understand up till this point. Yes, these are the two most important factors. P&G has a strong position in each of them so it's a buy. Most of the time, he would be right by just focusing on these key drivers. And most probably, he would also spend a lot of his time focusing on how these key drivers such as the economies of scale and the power of distribution changes vs competitors, neglecting the fat tail which consist of the brand loyalty, the taste, the packaging, all the little, little things.

But a Type B investor, being multi-dimensional would be able to understand that 90% of the time, these drivers explain almost everything, but at the back of his head, he is constantly asking, which of the other thousand factors might become important some day? We already mentioned taste could be one. What about a safety track record? Did the company have a good one? Or the geographical distribution of its manufacturing plants, do they have a concentration risk? What if an earthquake hits? Did they capture well some of the frontier growth markets like Africa? What is their strategy in total oral care? Do they have a mouthwash product or a floss product?

Decisions while 80-90% impacted by the few key factors, are also impacted by the fat tail of other factors.

To understand this, is the essence of Type B Decision Making. 

For every decision we make, ie to buy a stock based on the few top factors, we must know that there are a lot of other things that could come in play someday and debunk the whole thesis.  This is partly why even the best investors are only right 60% of the time.

This applies to real-world decision making as well.

Years ago, I had a debate with someone about whether we should ensure that our kids are fluent in just one language (ie English) or was it better for them to be bilingual in both English and Mandarin while perhaps less proficient than native speakers in either languages. So as a parent, a decision had to be made at some point. Expose our children to both languages or just one?

The other party was adamant that exposure to just the English language was the right answer since it's better to be fluent in one than to be mediocre in both. That was Type A decision making at its best (ie best mediocrity). It failed to take into account the fat tail. What if the kid can actually handle two if not three languages and become proficient in all of them? What if China becomes so interlinked with Singapore that Mandarin becomes a critical must? What about learning the language to understand the Chinese culture. After all, we are Chinese descendants.

A Type B decision maker, while deciding to expose their kids to both languages would again be mindful that this may not be the best for the kids. It is then about constant monitoring and fine-tuning the first decision. Does it still apply 5 years from now? 10 years from now? Decide now but review in time.

Type B thinkers will continuously assess the situation and challenge the assumptions. What if the kid cannot cope? Was the home environment bilingual in the first place? Do both parents speak good Mandarin? What about the emphasis of the school? How about the future career paths and their language requirement?

Type B decision making is about finding truths via the myriad network of logic, critical thinking and constant questioning: forever asking which fat tail risk will hit us in the face?

So strive to be a Type B thinker and decision maker.


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  2. Well say.

    Thanks for the article.
    Informative and with clear instruction for new investor. Only a few people look at the risk or benefit. Few don't know anything about the fundamentals of the company they invest in. Many don't look for dangerous upcoming issues or problem too. So hope it will help them to understand.

  3. Hi,

    I heard of a System 1 and System 2 way of thinking?
    Did you get that idea from the book Thinking, Fast and Slow by Daniel Kahneman?

    Wen Ge