Forget Average, Think Power Laws

Forget Average, Think Power Laws

Average is intuitive. Almost every news summary, scientific paper and business report looks at an average. Average is a short-form summary of the normal distribution. In more depth, the normal distribution is described by deviations from the average, with larger deviations being less frequent.

Even the words average and normal provide an aura of comfort and safety. But that aura is false because the most important opportunities and risks in the world do not operate according to average, they follow power laws.

When we think of extreme outcomes, the initial ideas that spring to mind are negative: things like health problems, financial crashes and natural disasters. Although any single extreme negative event is unlikely, the probability of extreme negative events in general is actually very high because there are so many. Some, like financial crashes, are more cyclical in nature and happen with regular but unpredictable timing. Others, like health problems, are tied to a combination of complex genetic and environmental factors in a structural way: they typically get worse over time if left alone.

Although we struggle to predict individual negative outliers, we must build resilience into our lives in order to withstand them in general because something negative is inevitable. This means sacrificing efficiency and creating a drag on short-term performance. It does not matter how efficient you are currently if you cannot survive the next negative shock.

Power laws are not only negative. We can also find opportunities that follow extreme positive power laws. In healthcare, new discoveries are able to change millions of lives. In education, we are starting to make progress at scalable impact. In business, network effects are becoming more common. While individual positive extreme outcomes are difficult to predict in advance, they occur with enough frequency to believe that they can continue regularly under the right circumstances.

When evaluating opportunities, it is therefore extremely important to understand the upside potential of power laws. Any individual attempt at an extreme positive breakthrough seems unlikely, but having several different attempts increases the probability of success significantly. Importantly, the potential positive impact of that success is exponentially larger due to the inherent nature of power laws. This means that society and organizations should be aggressive in encouraging extreme breakthroughs even though the probability of a single breakthrough succeeding may be small.

So is there a paradox of power laws? People who focus on resilience tend to be conservative by nature. They are less excited by breakthroughs with a low probability of success. People who focus on breakthroughs tend to be aggressive by nature. They tend to worry less about resilience.

Although difficult, the ideal strategy is to combine resilience with breakthroughs. Focusing on resilience helps to protect against the inevitable downsides of power laws while focusing on breakthroughs helps to capture the upside potential of power laws.

Forget average because power laws are the real driver of risks and opportunities in the world.