How to Be a Smart Contrarian

There’s a good reason why we’re suspicious of new ideas: Many are unrealistic. But over time managers get conditioned to discounting anything that isn’t familiar. They dismiss ideas that challenge their assumptions about how the world works, make judgments based on stereotyping, and create cultures that limit their choices.

The secret to avoiding these traps is to become a smart contrarian – someone who looks for business practices that don’t make sense, who’s not too reliant on a small group of like-minded people, who can embrace diversity, and who’s happier on the sidelines. Let’s look at what that involves.

The Dominant Logic Trap: Look for Dissonance

Strategic decisions are all rooted in mental models that help decision makers make sense of a complex reality. Managers apply these models in making decisions, refining them over time.  It’s a natural cognitive process that by and large has stood the test of time.

The process should be able to accommodate contrarian ideas – if everyone builds their own model, someone will be coming up with a new and better one all the time.  But inevitably we benchmark successful models or adopt the model of someone with more social power. What eventually happens is that a dominant narrative emerges that attracts increasingly less scrutiny.

It is precisely when wisdom becomes received that the opportunity for smart contrarianism arises. A good example is provided by Richard Fairbank, founder of Capital One, the company that disrupted the credit card industry. Big banks like Citi, Bank of America, and Chase would issue cards to their existing customers and solicit new customers through direct mailing. Profits grew steadily. Creditworthiness was assessed through debt/income ratios, credit scores, and interview scores. Applicants with overall scores above a certain point were offered credit cards on standard terms.

In the early 1980s, Fairbank was studying at Stanford, when he attended a presentation about the industry.  The fact that everyone had the same price (same APR and annual fee) for credit cards in a risk-based business didn’t make sense to him, and he realized that higher-risk customers were being subsidized by lower risk ones.  In this situation a demographically targeted approach, with customized terms, would, in principle, generate a more efficient return.  The business he created on the back of this insight was Capital One, which quickly acquired a large customer base.

The Elitism Trap: Look to the Crowd

Many innovators see their success as a consequence of their superior insight, rather than part of a process of continuous change, in which the industry logic changes to reflect changes in technologies and preferences.

The VC industry provides a good example. The goal of VCs is clear — they want to discover home-run startups that other competitors overlook or do not have access to. This is like searching for a needle in a haystack: Tens of thousands of startups are established every year, and it’s almost impossible to identify who will become the next big thing. Those that are obviously promising may attract multiple biddings from competitors so the VC’s expected profit will be diluted.

VCs respond to this challenge by acting as “knowledge brokers,” recombining information from their own private social and professional cliques who otherwise would not have been in contact. This increases their odds of hitting investment home runs in two ways. First, the ideas they get are typically from their own elite networks, so the average quality is higher than otherwise. Second, competition is reduced because the network connections make the interactions a repeated game.

Because of the first-mover advantage inherent in this approach, latecomers to Silicon Valley were doomed to be the also-rans of the VC industry. But one firm, Draper Fisher Jurvetson (DFJ), spotted an inherent weakness in the model: The ideas of the people in elite networks tended to converge as the networks did not change much, which trapped them in their prior experiences and made them less likely to evaluate new ideas differently from the way they had evaluated prior ideas.

DFJ avoided the trap by focusing on fields that the incumbents wouldn’t touch and by adopting a more inclusive approach to identifying and evaluating projects. When nanotechnology emerged in early 2000, for example, DFJ publicly promised to evaluate every proposal submitted, an approach to prospecting that contrasted sharply with the traditional, secretive approach.

Of course, DFJ recognized that its model presented serious operational challenges; processing the volume of proposals was expensive and took time. But it delivered efficiencies as well, which DFJ could exploit. Having access to many projects created a wisdom-of-crowds effect in that DFJ was able to see which areas in nanotechnology independent researchers were focusing on, which increased its chances of spotting the next big trend in nanotechnology and the eventual winning start-up in that trend.

The Stereotyping Trap: Embrace Diversity and Experimentation

It is one thing to recognize what is wrong with the dominant logic.  You also have to create a strategy founded on your new assumptions and theories. This requires people who can bring other mental models to bear, which is one of the main reasons why firms benefit from working to create a diverse workforce.

The trap here is that organizations believe that they can solve complex problems by recruiting the “best individuals,” according to objective criteria. This belief holds when addressing relatively bounded tasks, but otherwise an individual’s cognitive resource is more useful when it produces additional ideas or perspectives different from those of existing team members. In hiring for Capital One, for example, Fairbank harnessed, as he put it, “the power of an objective ignorant view of the world from someone who really didn’t know anything about credit card[s].”

Capital One’s outsiders certainly provided that. The team ran an experiment in which the company accepted only those applicants with the highest interview scores and those with the lowest scores and tracked the repayment record of the two groups. They found no statistical difference in between them over the three years following their card approvals, confirming their hunch that interviews were neither necessary nor informative.

Fairbank and his team suspected that interviewers were prey to stereotype bias: Female, people of color, and immigrants were often rejected for credit cards due to their low interview scores, even if they scored well on the financial metrics. That pointed towards an opportunity: targeting counter-stereotypical applicants with decent debt/income ratio and credit scores. Not only were these new customers good for the credit, they were also tied to Capital One because they couldn’t get cards from other providers. And when the majors did change their processes, many stayed loyal to the firm that first opened up to them.

If you are to leverage diversity, you should avoid relying on consensus. At DFJ, for example, the firm will back an investment if just one partner feels very strongly about the idea. The assumption here is that if many partners agree on the potential of an idea, then the idea is not radical enough and the firm is likely to face competition for it from other VCs, which reduces the amount of value DFJ can capture from the investment.

Game developer Valve takes a similar approach. It hires developers with idiosyncratic views about what constitutes a good game and allows them to allocate their time as they see fit. Decisions about whether to develop an idea are based on a rule of three: Managers allocate further resources and support to a project if a developer can convince at least two colleagues to give up their own projects and join this project instead.  This ensures that the games the company invests in are of high quality, because Valve has chosen them based on the wisdom of at least three developers who do not easily conform to the opinions of others.

The Culture Trap: Keep Your Distance

Managers often face strong social pressures to conform to the dominant culture, which is rooted in the dominant mental model.  This explains both why established industries present opportunities for disruption and why that disruption seldom originates with an incumbent.  This sounds like an easy trap to avoid, but the power of a strong culture cannot be underestimated.

A study of Sweden’s mutual fund industry provides an illustration. Because consumers care about obtaining high returns and wish to avoid high fees, you would expect banks and financial institutions would at least offer their customers opportunities to invest in index funds. Initial offers by Swedish institutions proved fairly popular and since there were few barriers to introducing index funds, you would imagine that these projects would be swiftly imitated.

That did not happen. Swedish fund managers “disliked” the index funds: “[Firms] would consider it a shame to introduce an index fund and it would directly insult their asset managers.” There was an institutional logic reinforced within an interconnected clique: Most Swedish fund managers were trained and worked in a small number of institutions and the norm was that fund managers are trained to pick the stocks and beat the market. This shared belief and the risk of deviating from it (e.g., being removed from the social circle) meant that the profitable opportunity of introducing index funds was dismissed; people would rather make less money than sacrifice their identity.

In these situation, it pays to be an outsider. When Fairbank first presented his vision for credit cards to the large banks, he was rejected by all of them, which forced him to look for help from other outsiders. He eventually negotiated a deal with Signet, a midsize, regional bank, whereby he would be paid out of the profit generated through new credit card customers. In exchange he gained full control of the credit card business division.

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Biases create opportunities, but they also surround them with behavioral and social traps that prevent strategists recognizing and acting upon them, which means that mainstream managers often lack the insight, capabilities, and self-confidence needed to disrupt the status quo — and all the more so if that status quo was their creation in the first place.  To avoid those traps, be a smart contrarian: Lean into cognitive dissonance, cast a wide net, embrace diversity, and stay on the outside.