The "Starbucks Principle" - Size Matters

Once while chatting with a very knowledgeable commodities arbitrage trader (J.K.), I asked why he didn't  build up infrastructure to trade a certain type of arbitrage. He simply replied, "I follow the Starbucks principle; if I can make more money per hour working at Starbucks than implementing a trade, then it is probably not worth my time." Eventually, he pointed out that operationally he could not afford to spend 5 hours to book a trade. I thought it was quite an elegant and ironic thought; the lesson has nothing to do with Starbucks employees (who are overwhelming nice and diligent in brewing good coffee), but rather with balancing investment of time vs. the end return for any opportunity.

Let's apply the Starbucks principle to playing poker for a living. Say you are working as an engineer, but happen to be a decent poker player living close to a small-time casino. This casino runs only 1 game of poker, a $0.50 / $1.00 No Limit Hold'em game (small blind = $0.50, big blind = $1.00). You calculate that because you are relatively better than the other players, on average you can earn 20 times the big blind per hour after accounting for the rake (so your expected hourly profit = $20). Do you quit your high-tech job to go play poker full-time? Probably not, because although victory tastes so sweet, you are not earning enough to justify leaving your job. You could try driving to a bigger casino far away, but you might find yourself outplayed in the higher limit games.

Profitable real estate agents in New York City are experts on the Starbucks Principle. Usually an agent cares most about getting the deal done, and secondarily about finding the best price for the client. By convincing sellers to drop their prices or convincing buyers to give an initial bid at the ask price, they are able to complete a transaction faster with less energy. Then once a apartment is close to contract, the agent takes the unit off the market without shopping for a better price in order to focus on the next deal.

As a corollary to the Starbucks principle, you should seek out markets or opportunities which are deep and offer you the choice to scale up. Although sometimes there might be a simple mispriced trade with very high return / little risk, BUT the time required to negotiate, follow, and close out the transaction might not justify the end return or profit. Moreover, some successful managers run concentrated portfolios because they prefer to invest only in their 10 best ideas instead of suffering "diworsification" (Lynch, One Up on Wall Street). When selling short the Sterling in 1992 Black Wednesday, Soros was quoted as saying something along the lines of "if we are confident in our research, then how big can we get?" For Soros and a slew of other great risk takers, size matters.