When two or more psychological biases combine together, the effect get compounded on a tremendous scale. Charlie Munger calls this combination as Lollapalooza Effect. Let us understand this with several examples.
1. Create systems that are hard to cheat
People will steal
- If it is very easy.
- If they will not get caught.
Once they start stealing then things get out of hand. Why? Several psychological factors combine together.
- Consistency – Once they get used to stealing, it forms a habit.
- Social Proof – If someone else does it, we will also do the same.
- Incentive caused bias – Stealing creates incentives. This in turn causes biases which results in rationalizing bad behavior.
Charlie Munger tells that you also get Serpico Effects. Excerpt from Seeking Wisdom
If enough people are profiting in a general social climate of doing wrong, then they’ll turn on you and become dangerous enemies if you try and blow the whistle.
In the movie Serpico, Al Pacino played the role of Frank Serpico. Frank was the first police officer in the history of the New York City Police Department to step forward to report and subsequently testify openly about widespread, systemic corruption payoffs amounting to millions of dollars. In 1971 he testified before the Knapp Commission
Through my appearance here today…I hope that police officers in the future will not experience…the same frustration and anxiety that I was subjected to…for the past five years at the hands of my superiors…because of my attempt to report corruption. I was made to feel that I had burdened them with an unwanted task. The problem is that the atmosphere does not yet exist…in which an honest police officer can act…without fear of ridicule or reprisal from fellow officers. Police corruption cannot exist unless it is at least tolerated…at higher levels in the department. Therefore, the most important result that can come from these hearings…is a conviction by police officers that the department will change. In order to ensure this…an independent, permanent investigative body…dealing with police corruption, like this commission, is essential..
Remember it is very, very important to
Create Human systems that are hard to cheat. Otherwise you’re ruining your civilization.
Tupperware manufactures and sells products related to food storage. In 2012 it had an annual sales of around 2.6 billion dollars. You can signup with tupperware to host a party. You invite your friends to attend the party. Why? In the party, several tupperware products will be available for sale, which your friends will buy. Depending on the sales you get a sales commission. Several psychological factors combine together, which helps to sell the products.
- Reciprocation – Games are played when the party starts. Prizes are given to the winners. Those who did not win also gets to reach a grab bag. Everyone has received a gift before the buying begins.
- Commitment – Each participant describes publicly about the uses and the benefits of tupperware products they already own.
- Social Proof – Everyone is buying the product. So the product has to be good.
- Liking – Your friend purchases the product because of you.
Excerpt from Influence
It’s gotten to the point now where I hate to be invited to Tupperware parties. I’ve got all the containers I need; and if I wanted any more, I could buy another brand cheaper in the store. But when a friend calls up, I feel like I have to go. And when I get there, I feel like I have to buy something. What can I do? It’s for my friends.
Tupperware party starts somewhere every 2.7 seconds.
3. Life Insurance Corporation
Life Insurance Corporation of India sells insurance products through its agents. The company services around 350 million policies. The agent sells the insurance to the people in their network. In this case also several psychological factors are at play.
- Liking – The agent is someone who you know already. In my case it was a family friend. It is very hard to say no.
- Reciprocation – He will start by selling a policy with a higher premium. If you reject it, he will back off with the one that has lower premium.
- Social Proof – He will tell that some your friends who purchased the policy.
In 1995, I took a life insurance policy for 25 years. Every month I pay Rs 111/-. Till date I am regularly paying my premium. Why? It is because of my consistency.
4. Coca Cola
Coca Cola went public in the year 1919 at $40 a share. If you had bought a single share and held on to it and reinvested its dividends, it would have become $5 million in the year 1998.
In 1996, Munger gave an informal speech – Practical thought about Practical thought. He discusses about the lollapalooza effects of coke.
- Association – Coke associates its brand with all things which the consumers like and admire.
- Social Proof – Mere sight of someone consuming coke will make us consume.
- Availability – Coke is available everywhere. It has ensured that if a competing product, if never tried, can’t act as a reward creating a conflicting habit.
5. Board of Directors
The Board of Directors is a group of people elected by the stockholders to represent their interest. The board is responsible for hiring the CEO, setting compensation policies, determining dividends, and evaluating performance. Are they doing their job? Munger talks about this in Psychology of Human Misjudgment
- Authority – CEO is the authority figure and it is very hard for the members to question him.
- Social Proof – Nobody else is objecting the CEO. Every one keeps quiet.
- Reciprocation – CEO raises the directors fees every year. He is flying you around in the corporate airplane.
Excerpt from the speech
Finally the institution of the board of directors of the major American company. Well, the top guy is sitting there, he’s an authority figure. He’s doing asinine things, you look around the board, nobody else is objecting, social proof, it’s okay? Reciprocation tendency, he’s raising the directors fees every year, he’s flying you around in the corporate airplane to look at interesting plants, or whatever in hell they do, and you go and you really get extreme dysfunction as a corrective decision-making body in the typical American board of directors. They only act, again the power of incentives, they only act when it gets so bad it starts making them look foolish, or threatening legal liability to them. That’s Munger’s rule. I mean there are occasional things that don’t follow Munger’s rule, but by and large the board of directors is a very ineffective corrector if the top guy is a little nuts, which, of course, frequently happens.
6. Kudankulam – Nuclear Power Plant
Kudankulam, A Nuclear Power Plant in Tamil Nadu, India. In 2012 people residing near the power plant protested against operating the plant. In spite of power shortages in Tamil Nadu why did they protest? Professor Sanjay Bakshi explains several biases here. This is one of the best articles and every time I read it I am learning something new.
- Availability – People overreact to the recent event. The recent event they are referring to is the Fukushima disaster.
- Base Rate Fallacy – The number of deaths caused by nuclear radiation accidents is very low. People ignore this fact and instead focus on the influential stories.
- Loss Aversion – Loss aversion refers to the tendency for people to strongly prefer avoiding losses than acquiring gains. They overweight the possibilities of diaster much more than the benefits of abundant electricity.
7. Warren Buffett and his creation, Berkshire Hathaway
In 2007 Wesco Annual Meeting Munger, asked and answered the following question.
Why were Warren Buffett and his creation, Berkshire Hathaway, so unusually successful?
His answer –
If that success in investment isn’t the best in the history of the investment world, it’s certainly in the top five. It’s a lollapalooza.
- Mental Aptitude – Warren is seriously smart. On the other hand, he can’t beat all comers in chess blindfolded. He’s out-achieved his mental aptitude.
- Strong Interest – Then there’s the good effect caused by his doing this since he was 10 years old. It’s very hard to succeed until you take the first step in what you’re strongly interested in. There’s no substitute for strong interest and he got a very early start.
- Learning Machine – This is really crucial: Warren is one of the best learning machines on this earth. The turtles who outrun the hares are learning machines. If you stop learning in this world, the world rushes right by you. Warren was lucky that he could still learn effectively and build his skills, even after he reached retirement age. Warren’s investing skills have markedly increased since he turned 65. Having watched the whole process with Warren, I can report that if he had stopped with what he knew at earlier points, the record would be a pale shadow of what it is.
Only Munger can explain this in an amazing way. It is worth the time to read his entire explanation.