I came across a great blog post by Brian Balfour, “What Blackjack Strategy Teaches us About Growth,” target=”_blank” that does a great job of illustrating the power of focusing your growth efforts rather than chasing diversification. Balfour, a co-founder of Viximo and former Entrepreneur in Residence at Trinity Ventures, draws parallels between the crux of good strategy in Blackjack, doubling down (double down on an 11, and sometimes on a 9 or 10 depending on what the dealer shows), and how it should be applied to your growth strategy.
In blackjack, you follow this rule rather than saving your resources for another hand and diversifying your risk. He explains the logic behind this strategy: With a 9, 10 or 11 you have data for that hand that it is “working.” Thus, you have a higher probability of optimizing your winnings by focusing more of your money on a hand that is working than diversifying on other hands that you do not have data on yet.
Application of Blackjack to growth
Balfour points out that many companies work hard to get a growth strategy or tactic to work. Once they get one working, the first instinct is to then find another channel to add to the mix. He argues to fight this instinct and learn from Blackjack: Double down before you diversify.
First, it is important to understand the driver for growth. Growth is a function of (probability of success, impact and resources required). This formula means growth occurs by balancing the probability of success for an AB test, the impact it has if successful and the resources required to implement. You then focus on opportunities that have high probability of success, high impact and low resources required.
Blackjack theory, as I will call it, recommends doubling down on a single channel/strategy to increase the probability of success component in the above formula. You optimize your winnings, or growth, by doubling down on something that already has signs it is working rather than spreading across channels and opportunities where you have no data.
There are two other reasons a focus strategy works over diversification, according to Balfour. First, the better you understand a channel and how your customer acts in that channel, the greater the probability of running successful experiments. Doubling down accelerates how quickly you develop deep knowledge of a channel. Second, we all have limited resources (I am assuming nobody from WhatsApp is reading my blog), which forces us to focus. Every channel you add increases the effort, be it creating landing pages, viral, open graph posts, creative, etc. The overhead of attacking different channels quickly adds up.
Diversification does not lower risk
Balfour points out that in the case of growth, diversification actually increases your risk because you are less likely to find a single channel that works. Balfour quotes Peter Thiel, co-founder of eBay, venture capitalist and serial entrepreneur, who in a course he teaches at Stanford states,
Just as it’s a mistake to think that you’ll have multiple equal revenue streams, you probably won’t have a bunch of equally good distribution strategies. Engineers frequently fall victim to this because they do not understand distribution. Since they don’t know what works, and haven’t thought about it, they try some sales, BD, advertising, and viral marketing—everything but the kitchen sink. That is a really bad idea. It is very likely that one channel is optimal. Most businesses actually get zero distribution channels to work. Poor distribution—not product—is the number one cause of failure. If you can get even a single distribution channel to work, you have great business. If you try for several but don’t nail one, you’re finished. So it’s worth thinking really hard about finding the single best distribution channel.
If you get one channel to work great, you are then more likely to replicate your success in other channels rather than diversifying early. Even as you grow, you will find one channel is the key to that growth and there is nothing wrong with that;heavy tails are as natural as bell-shaped distributions.
An illustration
Let’s use one of my favorite companies, Uber, to illustrate the double-down philosophy. When Uber first experienced traction arranging rides through an app it could have diversified so it would not be too dependent on people with access to a smart phone (which was not ubiquitous at the time). It could have diversified into having operators and storefronts, arranging rides (and it could have diversified its offerings to include arranging flights or connecting people with handymen or probably a thousand other enterprises). Instead, they doubled down on the app-distribution channel. In its latest investment raise, investors gave Uber a $3.4 billion valuation. It would be trite for me to say that represents 3.4 billion reasons to focus, but what the heck; I will.
Key takeaways
If you are focused on growth and building the next $3.4 billion company, there are three key takeaways to help achieve this goal:
- When you see traction in one channel or growth mechanic, focus your efforts on that traction rather than diversifying;
- Diversification actually increases your risk, as it keeps you from finding one channel that works very well;
- Your biggest challenge is to get one distribution channel to work well. Not getting the appropriate distribution is the biggest cause of failure.
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