Thursday, March 6, 2014

Scam Psychology: Charlie Munger on How You Screw Up, Part 1 of 6

You may have heard of Charlie Munger. But if you haven't, you should have heard of his partner: Warren Buffet, one of the 5 richest man in the world.  In 1995, Charlie Munger gave a speech at Harvard... about how people misjudge things. Here's my personal interpretation of his lessons, as applied to network marketing. You can read the full speech.


In the speech given at Harvard in 1995, Charlie Munger identified what he called "24 standard causes of human misjudgment." I call it "24 reasons why you screw up".  Here is 1 through 4.

1) Not understanding power of incentives

Incentives is the standard way if you want to influence someone's behavior. If you are not getting the results you want, you are probably using the wrong incentives. And if you don't understand how incentives work, you won't get the full use out of them (or understand how they're used on you)

One of the most direct ways network marketing company influences its affiliates is the compensation package, also known as the comp plan. And comp plan is the best indication how serious the network marketing company about retail is how it structures its comp plan. If the comp plan rewards self-consumption by tying commission to your downline's self-consumption, you have a pyramid scheme, as little if any product is actually being retailed. By studying how the incentives are actually applied, you can see which way the company wants the affiliates to jump. And if that doesn't match what they say they are, perhaps the business is not what it appears to be.

Another way incentives play into network marketing is not realizing the way incentive actually works, generally by overestimating one type of incentive vs. another kind. One of the most frequently used rebuttals in network marketing "So-and-so is famous and works with MLM X. So-and-so can't POSSIBLY work for a scam as it would ruin his reputation, so MLM X can't be a scam." This argument basically postulates that Incentive A: MLM X paid So-and-So 75K for a special appearance at a convention for a speech is NOT sufficient to overcome Incentive B: Negative reputation due to MLM X may be a scam. However, when you think about it, this makes absolutely no sense at all. Plenty of celebrities have pitched for scam at one time or another. Snooki had shilled for Zantrex the super-caffeinated diet pill that was called out as bunk by doctors. Bob Eubanks was once tricked into making a test show which was then used as "pilot" to scam investors into funding a show that doesn't exist.  Celebrities are people too. They can be tricked, or they simply don't care as you're more focused on his/her celebrity status rather than what s/he endorses. The negative incentive is nowhere as big as the rebuttal claimed to be.

By not understanding the power of incentives (even negative incentives), some people came to the wrong conclusion.

2) Not understanding power of denial

Denial is a powerful emotion. If your reality is just too painful or too shocking to accept, you simply tune out reality or distort it to the point where you can bear with it. You're now living in your private la-la land, or for the modern generation, your own "Matrix", where "reality" bends to your thoughts. The problem is... sooner or later you have to come back out.

You can see this on various news programs where mothers of the most obvious criminals seems to always believe their sons' innocence. You can find mothers of sons in the military that went MIA. Some mothers NEVER believed that the son's dead.

You can find the same in scam world, where the most OBVIOUS Ponzi schemes or pyramid schemes have their victims proclaiming (sometimes, AFTER the government had shut the scam down), that it couldn't POSSIBLY be a scam, the leader couldn't hurt a fly, blah blah blah.

Just because someone's sincere doesn't mean you should believe them. They can be in denial. You can be in denial. Learn to recognize denial in yourself and others, and how it affects your decision making.

3) Not understanding Incentive-caused bias

This is sometimes known as conflict of interest, both in yourself and in others. Basically, you are not judging the item (to be judged) on its own merits, but rather how it can benefit you personally. Or perhaps, you may be relying on someone who has something to gain from you deciding one way.

One possibility is "cost plus percentage of cost contracts". US Department of Defense ran into some contractors with this CPPOC contracts and basically padded the bill (to cost) so the cost simply ballooned to ridiculous amounts. The incentive to the contractor is to push the cost as high as possible, as they have no incentive to save taxpayer any money. Eventually this sort of contract is outlawed... as a felony.

Another possibility is a doctor needing a patient for an experimental procedure to complete his research paper, and he of course, tried his darnest to insult, ridicule, cajole, plead, and beg someone to do it. The doctor has an incentive-caused bias to push his experiment, even on someone who may not be suitable or even want it.

In network marketing terms, you need to understand that recruiters are out there to recruit you, and they will make their case with incentive-caused bias... they have a LOT of incentive to recruit you, not just because they value you as a friend... but as a CUSTOMER... or worse, a DOWNLINE. If you have money problem they will pitch you their MLM instead of helping you with your budget... they have incentive to do so, not because it's the best solution for you.

By the same token, when you give an advice, are you doing it because it benefits you? Or are you giving advice because it really is the best advice you can give?  A lot of network marketing talkes about a "win-win" solution. The problem here is what's 'win win' is not necessary the best solution overall.

Just because they believe a certain way doesn't mean they are giving you their best advice, esp. when they also benefit from it. Learn to spot incentive-caused bias in yourself and others.

4) Not understanding consistency and commitment bias

Human brain generally wants to have only ONE idea at a time, and once the idea got in, it is VERY difficult to get rid of it. The old cliche "You don't get a second chance to make a first impression" is true, same with idea. Once you got the "first impression" of the idea, you will have a hard time believing that the idea is wrong, even when confronted with the facts. This is called "commitment bias". But it can also be "sunk cost fallacy". What's really interesting is this commitment bias leads to a whole slew of other bad thinking.

If you find a conflicting idea, you'll usually deny it (denialism) or simply ignore it (it's not important), not because it's wrong, but because you have a commitment bias against any "new" ideas.

You reinforce the commitment bias, esp. when you let the world know about your position of the idea. The public disclosure will cause you to lose the doubt that you originally have about the idea, as you've made a public commitment and you'll likely perceive shame if you ever do change your mind, even if you are proven wrong. This is exploited by network marketing. If you repeat the sales pitch long enough, you'll actually start believing it, even if you didn't at the beginning.

You will also reinforce the commitment bias, esp. if you had debated with someone about it. You had somehow taken personal ownership of the issue, even when you are supposed to be a neutral observer.

Read part 2 of 6!

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