Podcast Summary
Investing in the future vs. the past: Successful investing now demands focusing on a company's future prospects and qualitative insights, not just quantitative analysis of the past.
Successful investing now requires the ability to underwrite the future, not just the past. While traditional value investing has focused on quantitative analysis and a rearview mirror approach, the market's recent behavior has shown that qualitative insights and an understanding of a company's future prospects are essential for success. This shift in investing requires a new set of tools and a different way of looking at the world. Even for those who don't invest in tech companies like Snowflake, the ability to identify companies with promising futures is crucial. This idea of investing in the future versus the past is a significant shift for many investors, but one that is necessary in today's market.
Understanding Competitive Positions and Business Models: Investors need to supplement quantitative analysis with qualitative insights to identify businesses with competitive advantages and escape base rate returns. Adaptability to new business models and comfort with uncertainty are essential skills.
The investing landscape has shifted, and traditional quantitative methods are no longer sufficient for success. Qualitative insights, particularly in the areas of competitive strategy and business model analysis, have become essential for investors. The ability to understand a company's competitive position within its ecosystem and identify businesses that can escape the base rate of returns has become increasingly valuable. Additionally, investors must become comfortable with uncertainty and be willing to take calculated risks on new business models. While some tools, like Brian Arthur's idea of increasing returns to scale, have been valuable in the past, it's important to remember that markets evolve, and new skills and perspectives will be required to stay competitive.
Identifying and applying novel ideas can lead to massive economic ecosystems: Be open to new ideas, even if they seem trivial or unlikely to succeed at first, as they can lead to significant economic growth and value creation through consumer signals and the removal of friction.
The ability to identify and apply novel ideas, even if they seem silly or insignificant at first, can lead to massive economic ecosystems and significant returns. This concept, known as the increasing returns framework, has played out on a grand scale with the shift from physical networks to virtual networks and the rise of massive platforms like Facebook. It's important to understand this framework and be open to new ideas, even if they seem trivial or unlikely to succeed at the outset. For example, the idea of renting out a room on Airbnb or hailing a ride with Uber may have seemed silly or insignificant at first, but they have both grown into massive businesses serving large and growing markets. Consumer signals, or the clear indication of demand from consumers, can unlock nonlinear behavior and lead to significant growth. By removing friction and making it easier for consumers to access and use a product or service, companies can unlock new and unexpected uses and applications, leading to increased value and economic opportunity.
Revolutionizing consumer experience in transitioning industries: Uber transformed taxi industry with convenience and iBuying simplifies home selling process, both addressing consumer pain points and generating significant economic activity
When transitioning from analog to digital, the key to building a successful business lies in providing a significantly better consumer experience and removing friction from processes. Uber is a prime example of this, as it revolutionized the taxi industry by making hailing a cab more convenient through an app. Similarly, iBuying, or the sale of homes through digital platforms, offers a dramatically better experience for consumers by simplifying the process and addressing the pain points associated with traditional home selling methods. The consumer signal for these innovations is clear, as evidenced by the rapid adoption and significant economic activity they have generated. Traditional industry experts may dismiss these trends, but the potential for growth and the consumer demand for more efficient solutions make them worth considering.
Creating Value through Advertising in Transactional Ecosystems: Businesses facilitating transactions can create valuable ecosystems by attracting large user bases, which in turn become attractive to advertisers, generating revenue through advertising.
Businesses that facilitate transactions between parties, be it social or financial, can create valuable ecosystems that can be monetized through advertising. This idea was discussed in relation to companies like Uber, Ibuying, and Instacart. The latter, despite initial challenges with unit economics, became valuable to brands once it amassed a large user base. Instacart's grocery delivery service attracted CPG companies, who saw the value in reaching consumers through the platform. This concept is not new, as seen with ecommerce giants like Amazon and Etsy, which have successful advertising businesses. With the rapid increase in digital penetration and ecommerce, businesses should focus on building robust, engaged audiences, as the value lies not only in serving consumers but also in providing access to that demand pool for other businesses willing to pay.
The COVID-19 pandemic has accelerated the shift to e-commerce: The pandemic led to increased demand and decreased ad costs, changing consumer behavior permanently. Competitive intensity is uncertain as every business adapts to the digital world, potentially amplifying trends in public markets.
The COVID-19 pandemic has accelerated the shift to e-commerce, creating significant opportunities for some businesses while challenging others. During the lockdowns, high intent consumers flooded the online marketplace, leading to increased demand and decreased advertising costs. This resulted in permanent changes in consumer behavior, particularly in areas like online grocery and digital fitness. However, the long-term impact on competitive intensity is still uncertain. With every physical retailer and seller of goods and services being forced to establish a digital presence, the competitive landscape is poised to change dramatically in the coming years. Gavin Baker's observation that changes in competitive intensity in tech often lead to nonlinear impacts on customer acquisition costs and price cuts is particularly relevant. The pandemic has also impacted traditional tech giants like Cisco, with the rich getting richer trend in public markets potentially being amplified as smaller companies struggle to keep up in the digital world.
Identifying Opportunities in Disrupted Industries using the Capital Cycle Framework: The Capital Cycle Framework helps investors identify opportunities in disrupted industries by analyzing the supply side and considering potential shifts in competition due to temporary demand depressions.
While many small businesses have been negatively impacted by the COVID-19 pandemic and may not recover, there are opportunities to be found in sectors where demand has been temporarily depressed but is expected to normalize. This framework, known as the capital cycle, focuses on the supply side of industries and businesses. For instance, in the case of Cisco, a large player in the restaurant industry with a relatively small market share, the long tail of competition in the food distribution sector may disappear in the coming years, leaving Cisco in a more favorable position. Similarly, in the retail sector, the closure of department stores may lead to a decrease in competition for retailers like Ulta, which sell beauty, skin care, and hair care products. By analyzing industries through the lens of the capital cycle and considering both the demand and supply sides, investors can identify potential opportunities for growth. The 2x2 matrix presented in the exhibit is a tool used to segment online businesses based on their product offerings and degree of differentiation. This analysis can help investors understand the competitive landscape and potential opportunities in various sectors.
Understanding Business Dynamics: Heterogeneous Goods vs Homogeneous Services: Heterogeneous goods leverage massive network effects for global buyer-seller matching, while homogeneous services face commoditization challenges. Physical nexus in services can impact network effects and competitiveness.
The nature of businesses varies greatly depending on whether they deal with heterogeneous goods or homogeneous services, and the presence or absence of a physical nexus. Heterogeneous goods, such as those sold on traditional third-party marketplaces, have massive network effects that allow for the matching of buyers and sellers globally, leading to nonlinear growth. Homogeneous services, like ride sharing, also have network effects but are less defensible due to the commoditized nature of the service. The physical nexus in ride sharing introduces additional complexities, as reducing arrival times for drivers can help kickstart the network effect even in the presence of established competitors. Ultimately, the success of a business depends on the specific market dynamics and the ability to effectively leverage network effects.
Angi Home Services aims to disrupt home services industry with on-demand services: Angi Home Services leverages 26M service requests a year to offer on-demand services, aiming to provide a 10x better solution and align with younger generations' digital preferences
The home services market is an interesting category where traditional cold start businesses have struggled due to the high frequency and small transaction size requirements. However, Angi Home Services, which owns HomeAdvisor, is trying to capitalize on an existing asset of 26 million service requests a year to provide on-demand services and potentially become the go-to platform. By starting with an existing demand base, Angi Home Services aims to avoid the cold start problem and build a product that is 10 times better than existing solutions. This shift from traditional lead generation to on-demand services could disrupt the home services industry, making it more convenient for consumers to book services through an app rather than through traditional methods. The potential for this model to succeed is significant, as it aligns with the preferences of younger generations who prefer digital solutions for scheduling services.
Building a marketplace for heterogeneous services: Marketplaces for heterogeneous services face complexities in supplying consistently, but have potential for high returns due to network effects and monopolies.
Building a marketplace for heterogeneous services, like those offered by HomeAdvisor, is a complex undertaking. Despite the demand for such a product, the challenge lies in supplying it consistently. Marketplaces, communications, and network effect-driven businesses have been popular investment areas due to their potential for monopolies and high returns. However, there are other features of businesses that may fascinate investors, such as asymmetric opportunities in various sectors. Unregulated monopoly networks, specifically, have attracted attention due to their potential for high returns without regulatory oversight. The ride-sharing industry, with its massive consumer signal and improving unit economics, has also been a topic of interest.
Exploring the complex business models of ride-sharing and food delivery companies: Despite skepticism, ride-sharing and food delivery industries offer potential for network effects, high growth, and long-duration cash flows. Understanding competitive strategy and product positioning is crucial for success.
The ride-sharing and food delivery industries, despite having high consumer demand and strong signals, continue to face skepticism regarding their business viability. Companies like Lyft and DoorDash, with their multi-product and multi-country operations, present complex business models. However, the potential for network effects and high growth, coupled with the shift towards businesses with long-duration cash flows and high certainty, make these companies intriguing. Interactive Corp, a company with a core expertise in acquiring and monetizing users in a digital environment, offers an interesting perspective on business strategy. Their history of early entry into various digital markets highlights the importance of understanding competitive strategy and product positioning. As we explore individual businesses in greater depth, we can gain valuable insights for both inspiration and competitive analysis.
Identifying and capitalizing on large, growing digital markets: Interactive Corp's success comes from consistently entering large digital markets and extracting significant economic value through companies like Expedia, Hotels.com, Tripadvisor, Match, OkCupid, Plenty of Fish, Tinder, desktop toolbar business, AskJeeves, Match, and HomeAdvisor.
Interactive Corp, led by Barry Diller, has consistently identified and entered large, growing digital markets that were migrating from offline to online, and successfully extracted significant economic value from them. Over the past 25 years, they have done this repeatedly, starting with online travel through Expedia, Hotels.com, and Tripadvisor, and later with online dating through Match, OkCupid, Plenty of Fish, and Tinder. They also made substantial profits from a desktop toolbar business and AskJeeves search engine. Post-2008, they deconglomerated and refocused on Match and HomeAdvisor, which is now aiming to become the dominant on-demand player in home services. Most recently, they acquired Care.com, a struggling business in the childcare market, which holds immense potential given the current challenges and future demands for backup care for employees. Interactive Corp's strategy of entering large digital markets and making a fortune from them demonstrates a clear persistence to their success.
Identifying growing markets and dominating them: Barry Diller's businesses succeed by identifying opportunities, leveraging past experiences, and executing and scaling in a workmanlike manner. Despite their success, they are often overlooked by investors due to conglomerate discounts.
Barry Diller's success in business comes from his ability to identify growing end markets and acquire or build assets that can dominate those markets. His expertise lies in leveraging his learnings from past experiences, such as his observation of QVC's two-way interactivity, and applying them to new opportunities. Diller's companies, including IAC and Expedia Group, have been successful in part due to their early adoption of making information legible to software and consumers on the Internet. However, it's not just about identifying opportunities; Diller's companies also excel in executing and scaling these businesses in a workmanlike and intelligent manner. Despite their significant cash reserves and market-beating potential, they are often overlooked by investors due to conglomerate discounts.
Understanding a company's core expertise and how it's applied to various assets: Liberty Media and Facebook offer insights into the interactive space by demonstrating how core expertise can be applied to different assets and lead to successful business models.
Instead of focusing solely on individual assets, it's important to understand how a company's core expertise is being applied to each asset. This perspective can provide a more nuanced analysis and help identify related companies worth exploring. Two companies often mentioned in this context are Liberty Media and Facebook. Liberty Media, as an owner operator with a long track record in media and communication, is one example of a company that applies its expertise to various assets. Facebook, on the other hand, is known for its hyper awareness of the next platform shift and aggressive entry into large, growing consumer markets. While these companies are unique in their own ways, they both offer valuable insights into the interactive space and its repeatable process of finding end markets, entering, and spinning out companies as standalone entities. If you're interested in learning more, consider signing up for the Inside the Episode email newsletter at investorfieldguide.com/forward/bookclub. Each week, you'll receive a condensed version of the podcast episode's key ideas, quotations, and more.
