Mental Model: Fitness Landscapes

UPDATE (September 2020): I wrote a more in-depth, detailed explanation of fitness landscapes and how they can be applied across disciplines. The original (shorter) version is still below but I’d recommend the latest one for a better understanding of the model.

Fitness Landscapes are used to visualize the relationship between genetic makeup (genotype) and evolutionary fitness (the ability to survive and reproduce). A fitness landscape is a vast landscape divided into a grid of billions of squares. Each square represents a genotype—some squares represent birds; some fish; some humans; with the majority being all the variations of genetic possibility that couldn’t survive in reality. Each square is very similar to its neighbors: two of the same species with a small variation, or two different but related species. The closer the squares, the more similar the genotype, and the further the squares, the more different. The fitness of each genotype is represented by its height on the landscape. Valleys represent low fitness, mountain peaks high fitness.

Fitness Landscape

Over time, species tend to move up the landscape to the nearest peak (A), where all future paths of variation lead downward. The peak that a genotype “settles” on is most likely to be a local optimum, which is not necessarily the highest peak in the landscape (a global optimum). This is because selection pushes fitness towards nearby peaks (what is called a basis of attraction), but lacks the foresight to select the highest peak.

To get to a higher peak, a species may have to reduce its fitness in the near term (C) as it slowly traverses across a valley in order to improve fitness in the long term. In order to make this shift, there has to be sufficient instability or challenge; otherwise, an organism will not opt to leave the intermediate peak and suffer the unknown prospects of the valley. If the valley is too low or the higher peak too far away, it may be unreachable as the low fitness hurdle can’t be overcome. (An example is the lack of wheeled animals, which although beneficial is inaccessible due to the valley of low fitness genotypes around it.)

Evolution usually moves in small steps, but occasionally it takes wild leaps—a single mutation might give a creature an extra pair of legs or another radically different feature. Most of the time these leaps result in much lower fitness (B), and therefore don’t last. But other times it allows the genotype to jump to a higher peak without the slow process of going down before going up.

Every landscape has different terrain that can be on a scale from flat to rugged. A rugged or coarse landscape has many local peaks and deep valleys, while a flat landscape has only very small hills (all genotypes have about the same success rates).

Landscapes don’t remain static—they shift over time due to either environmental changes or adjustments as organisms move across it. The movement can vary from being stable (relatively flat and slow to change) to roiling (likely rugged and changing quickly). Given the likelihood of ever-shifting landscapes, the evolutionary mix of small steps and occasional wild leaps is the best possible way to adapt to the environment.

Generalists vs. Specialists (and the Specialist’s Dilemma)

In December of last year, I gave a presentation to a group of investors on the mental models of robustness and generalist/specialist species. Below are some of my findings, along with how these models can be applied to business and investing.

Animal species reside on a scale with “generalist” on one end and “specialist” on the other. Specialists can live only in a narrow range of conditions: diet, climate, camouflage, etc. Generalists are able to survive a wide variety of conditions and changes in the environment: food, climate, predators, etc.

Specialists thrive when conditions are just right. They fulfill a niche and are very effective at competing with other organisms. They have good mechanisms for coping with “known” risks. But when the specific conditions change, they are much more likely to go extinct. Generalists respond much better to changes/uncertainty. These species usually survive for very long periods because they deal with unanticipated risks better. They have very coarse behavior: eat any food available, survive in many climates, use a simple mechanism to defend a wide range of predators, etc. But unlike specialists they don’t maximize their current environment, because they don’t fill a niche where they could be more successful. It’s tough being a generalist—there’s more competition.

An environment with more competition breeds more specialists. Rainforests have huge diversity and competition, and therefore many specialist species.

Specialist examples: Orchid mantis (colorful mantis with appendages like leaves, thrives only on orchids and in tropics), sword-billed hummingbird (beak longer than body, co-evolved with flowers having very long corollas and difficult getting food elsewhere), koala (lives almost entirely on eucalyptus filling a niche that is toxic to most animals).

Generalist examples: Cockroach (survives in most climates, only needs water/moisture and a food source, only defense is responding to puffs of air), raccoon (wide diet, omnivore, lives in any area with trees, brush, or structures), rat (found everywhere in the world but the Artic, not picky eaters), horseshoe crab (wide diet on floor of sea bed, tolerates wide range of water temperature, can survive in low oxygen waters and out of water for extended periods; species over 360MYO).

Specialists & Generalists in Investing

This model can be applied to many different areas.

Investors themselves can be put on the specialist/generalist scale. The most specialized investors focus only on narrow segments of the market or certain types of securities. They can be very successful during certain time periods but in the long run are usually disrupted by a changing investment landscape or black-swan-like event. The most generalized investors use very coarse, unchanging rules and are truly “go anywhere”, willing to buy or sell any type of security around the world. They may underperform or lag behind their specialized brethren in the short term but will likely do well in the long run when averaged out over many different environments. Most investors (including Warren Buffett) lie somewhere in between these two extremes. Specialists include investors in certain industries like Sam Zell (real estate) and Ron Burkle (retail), or in certain situations like Jim Chanos (shorting) and David Tepper (distressed). True generalists are more rare, but include great investors like Ben Graham and Seth Klarman.

Specialists & Generalists in Business

A more interesting application is to the competitive business world. Like in the animal kingdom, generalists are rare and are usually much bigger than the specialists. They include big multinationals like Johnson & Johnson, Wal-Mart, Coca-Cola, and Proctor & Gamble. Also included are conglomerates that may hold many diversified specialists like General Electric or Berkshire Hathaway. Specialists are businesses that focus on a local niche whether in geography or product space. Because many specialists can dominate their niche, they’re usually protected by moats and thus have high returns.

This is what I call the Specialist’s Dilemma. The stronger your competitive position in a market niche, the more vulnerable you are to eventually being disrupted by changes in the business environment.

Let me explain further. Out of the universe of companies that have strong competitive moats, many of them have advantages originating from the niches they occupy. (Which can lead to barriers like economies of scale, brand attachment driven by habit, and being ahead on the learning curve.) These advantages are durable only as long as the niche itself remains viable. In other words, the more specialized a company’s dominance is, the stronger its advantages are — but the higher the odds of the niche itself eventually disappearing. Not disappearing due to competitors within the industry, but due to the niche being completely destroyed and replaced by something else. The timing of when this happens partially depends on the “clockspeed” of innovation within the industry (more on that in my last post).

Just something to think about if you’re a long term investor or business manager.