Jay Barney describes a coin flip exercise to make the point that innovation might be modeled as an outcome of pure luck.  If so, how can firms manage such processes? The exercise is simple:

• Distribute coins to the class and have them flip.
• Those who flip “heads” remain standing, “tails” sit down (unless everyone gets a tail – then they remain standing)
• Repeat until one person is standing & pass all coins to him/her

Discussion focuses on several key points (Russ Coff’s slides emphasize real options):

• What capabilities/skills did the winner have? Make a big show of trying to find out how the winner did it (it’s all in the wrist, etc.). Often the winner will have flipped 5 in a row or more (a 3% probability?). People will laugh since they know it’s luck.
• Is it possible that innovative companies are just lucky? We don’t see a lot of repeat innovators and, if it is luck, even these might be explained.
• Selection bias is a problem if we try and draw conclusions by only looking at winners. In a population (like the class), the probability that someone will flip 5 in a row is rather high. We can only identify causality if we study the whole population.
• If it is luck, how should one manage investment? This is a nice lead in for portfolios of strategic investments/real options or superior expectations/forecasting.

Contributed by Jay Barney