Part 2: Understanding Antifragile Systems
Contents
Antifragile systems, in contrast to fragile systems, don’t try to predict outcomes. Instead, they make use of options.
Options are a key component of antifragile systems. These can be literal options, as in traded derivatives. In fact, Taleb’s first insights into antifragility came from positioning options trades in order to turn volatility into arbitrage.
But more often they will be options the way you and I use the word, referring to tinkering and testing.
All Hail the Almighty Option
As the COVID-19 pandemic was dying down, rental car companies had trouble keeping pace with increasing travel demand. You ran a real risk of showing up to a counter with a proper reservation and the company having no car for you.
My wife discovered an interesting kind of hedge option for this. Some of these rental car agencies offered no-fee, same-day cancellations. So, when we went on vacation, my wife simply reserved multiple cars from separate rental companies.
The effectively doubled the chances of having a car waiting for us, costing us only the time it took to make the extra reservation. We canceled the other reservation without penalty.
In this way, we don’t have to predict which rental car company will have a car securely waiting for us, we just give ourselves multiple free options and then exercise the best one.
Each option you give yourself requires time and investment—that’s the downside. However, the more feasible or even bold options you give yourself, the more likely one will generate outsized returns—that’s the upside.
In the previous section, we noted that you can recognize a fragile proposition when you hear things, “I know exactly what’s going to happen, and that bad thing will never happen.”
By contrast, the biggest clue as to whether someone is talking about an antifragile system if you hear her say something like, “I’m going to keep testing stuff out there and watch what does happen.”
Because such systems don’t require you to predict individual successes ahead of time, they love volatility. No matter how events end up, you have a pre-set option that can exploit the circumstances.
Antifragile systems evoke dynamics that can seem evolutionary, or Darwinian. You can set up testing pools, testing multiple variables at once in order to see which options give you the most traction.
Antifragility: Turning a Fragile Proposition Upside Down
An antifragile proposition is the exact inversion of a fragile proposition. It looks like this:
Antifragile propositions have a frequent but very limited downside, usually in the form of time and energy spent setting up tests (options).
In an exact inversion from fragility, antifragile propositions have an occasional but potentially extreme upside. It is a situation deliberately engineered to cost a little more in most cases but will also occasionally present a disproportional payoff that overcompensates for such cost.
Antifragile Startup Investment
Entrepreneurs are familiar with one major example of antifragility: venture capital investment. A VC portfolio is an antifragile proposition.
What does a VC company do? It buys a certain ownership percentage of a range of companies and mixes them together into a portfolio. These investments have a limited downside: the up-front cost of ownership. Therefore a VC company always knows what its maximum financial loss would be.
But every once in a while, they get a unicorn in their portfolio, a company that takes off to a far greater degree than the other members of the cohort.
Do VC’s need all those companies to become unicorns in order for the economics to work? No. A tiny handful of unicorns can cover all the downside they incurred by sinking money into companies that didn’t gain traction.
That’s an example of an antifragile proposition.
Notice also that the VC didn’t have to predict which companies in the portfolio would be the ones to take off. This is key. Antifragile propositions don’t require specific predictions about the future.
VCs are not fragile to a deviation from expectation because they don’t care which company in their portfolio takes off. They just have to be correct on average. Every startup investment is simply an option that they can choose to exercise.
Venture capital portfolios are just one example of this type of volatility-loving system. More examples are everywhere. They are easy to recognize because they do not rely on a correct prediction. Instead, they invest their energy in testing and simply discard the tests that don’t work.
Nature Is Antifragile
As you might have guessed from the comparison to evolution, nature itself shows us examples of antifragility wherever one looks.
Consider the Treefrog
Consider the humble treefrog. At the species level, we have a category called “treefrog”—well, technically it’s called Dryophytes cinereus—but whatever you call it, you have a grouping to which all individual treefrogs belong.
Within that species, you have the individual treefrogs that make up that species. Bob, Frank, Sheila, Ralph—I’m assuming they all have names. These are the individual treefrogs, and they roll up to a species called “treefrog.”
Let me pose this to you: Evolution makes it such that the species treefrog is antifragile because the individual members are fragile.
Let me say that again.
The species treefrog is antifragile because the individual members are fragile.
Within evolutionary principles, some members survive towards reproduction. Some of them don’t. A mechanism called death discards the versions that don’t survive to replication.
The genetics of the survivors—which have demonstrated more adaptability than the ones that did not—replicate. And in so doing, the genetic strength and adaptability of the entire species raises one level on average.
This allows me now to introduce the concept of scale as it relates to antifragility. Wherever you have a higher and a lower level of scale in a system, the higher level can enjoy antifragility if the lower level relies on survival and replication.
Let’s go up one level from the treefrog species: Nature itself is antifragile because individual species are fragile. You might not be aware of this, but something like 98 or 99% of all species that have ever populated the face of the earth have gone extinct.
Nature itself has the same relationship to the various species that comprise it as a single species have to its individual members: the former becomes stronger because of the trial-and-error mechanisms exerted on the latter.
Scaling Up and Down
Does this same effect also hold at the micro level?
Why do we get stronger through weight training? That’s because some of the muscle proteins in our bodies break down when they meet resistance. Specifically, the weaker proteins are the first to break down. Our body discards the broken-down proteins through a process called autophagy. At the same time, our body synthesizes new musculature out of nutritional proteins.
This is, of course, not identical to the evolutionary process, but the trial-and-error mechanisms have the same effect. We have a breakdown of relatively weaker muscle proteins due to the application of resistance, then a discarding, and finally a resupply. Because the weakest proteins are the first ones to break down and be discarded, the strength of the entire system increases on average.
A higher level of scale is antifragile if it has some kind of evolutionary mechanism—some kind of test, discard, and replicate process—going on at a lower level of scale.
Looking For Antifragility Beyond Nature
Antifragility is not just limited to living things. Let’s have a look at some concepts.
Information itself can be antifragile. Have you ever noticed that the banned books in a given country are also some of the most popular books?
Reputations can be antifragile for the same reason. Have you ever known somebody who got really famous because all the critics savaged her?
Certain traits of the human condition, like confidence and curiosity, are antifragile. Have you ever noticed that your curiosity about something grows exponentially the moment information is withheld? That your confidence in a particular discipline only increases after having overcome obstacles within those domains?
And competence: Notice that your fluency in a given subject strengthens the most when you are allowed to trial-and-error your way through it, exploring concepts and solutions randomly as questions come up.
The most antifragile thing I’ve ever heard of is unrequited love. You ever get interested in someone that wasn’t that interested in return? How nuts did it drive you? Did you ever become interested in someone precisely because they were off-limits?
I’m a startup mentor at the Chicago business incubator 1871. This organization is named after Chicago’s own antifragility after the great fire of that year. 1871 seeks to produce brilliant, imaginative, ever-improving startups, in the model of Chicago’s own vibrancy and architectural brilliance in the aftermath of that event.
What Does This All Mean for My Startup?
Now, let me shift this to you and your business.
The hard truth about the startup world is that the U.S. economy is antifragile because individual entrepreneurs are fragile.
You’ll recall that in an earlier chapter I asked why startups are so fragile. The real answer is that the economy needs them to be.
The sad fact of the matter the economy gets its strength from the companies that didn’t work out. The trial-and-error mechanism of American small business is the nuclear reaction that powers the national economy. That’s the sad truth of it.
So how do we take advantage of this for ourselves? How do we incorporate these principles to create a truly antifragile startup?
We need to put together a lower level of scale within our startups that replicates the kind of trial-and-error tinkering that we see in other evolutionary processes.
If our companies are going to resemble organisms and start building their own muscle, they need to create analogous processes that systematically clear away the failures and replicate the successes.
The Key to Creating Antifragile Systems
In the following section, we’re going to look at the process of building antifragile startups. However, I want to summarize this section on systems by giving you the formula for creating antifragility anywhere.
These principles apply not just to startups but in any domain. If you want to figure out how to best position your exposure to anything, then you’ll want to keep returning to this list.
The Universal Rules of Antifragility
In the next section, we’ll be applying the following principles to startups:
- Make errors small
- Make them disconnected from one another
- Use the mechanisms of optionality & tinkering
- Cap your downside exposure
- Constantly build in new redundancies
- Grow from the information that comes from consistent, uninsulated exposure to stressors
First, it’s perfectly all right to make errors—errors are information, provided they don’t harm you too much. In fact, when all goes well you will be leveraging information you get back from many, many tests that don’t work out. But you don’t want any individual errors to sink you. You want many manageable, pebble-sized errors rather than a few boulder-sized errors.
In addition to wanting small errors, you want your errors to be insulated from one another. In fragile systems, errors are connected, and can cascade into more errors. Think about something like a product defect spreading into legal impacts, then into economic impacts, then into reputational impacts.
Antifragile systems by contrast take information from errors and use it to make fewer errors in the future. Think about a service business doing a lost-client review so as to make future client losses less likely.
Crucially, you want to use the mechanisms of optionality and tinkering to evoke a quasi-evolutionary process that strengthens with every round of discarding. Remember also that it’s the discard and replication process that makes the whole entity stronger, so experimentation must have discrete time limits and clear criteria for success.
You want to cap your downside exposure so that it becomes virtually impossible to go bust. Applied to startups, this involves a mix of brutally honest due diligence, savvy assessment of the possible events to which your company might be most fragile, and a particular mix of very safe tactics with very bold ones (i.e., the “barbell” strategy, discussed later).
Capping your downside also means building certain redundancies (deliberate inefficiencies) that provide cushioning. Nature evolved humans to have two lungs and two kidneys for a reason, and it’s important to use stressor information to learn when such redundancies may be important in other domains as well.
Finally, we must expose ourselves to the firehose of consistent, uninsulated exposure to stressors so that we can learn from the information they provide. Some startups think about hiding in quiet niches because they secretly want to preserve the insulation normally provided by institutions. They look for ways to occupy semi-protected spaces. They tell themselves that it’s only a short-term strategy to protect themselves while they are nascent.
But this misses the whole point of antifragility: we must learn to welcome and domesticate the stressors of the market because this is our goldmine of information and improvement.