
October 1, 2020
Better, Cheaper, Faster: Why Companies that Reduce Friction Win | Modest Proposal on Invest Like the Best with Patrick O’Shaughnessy
Check out the Invest Like the Best Podcast Page & Episode Notes
Key Takeaways
- Today’s most successful investors need to be more comfortable with uncertainty
- While some investors saw uncertainty in new business models, others had a qualitative insight that allowed them to take the risk
- It’s important to be willing to look at investments that look silly
- Early on, few people understood what Airbnb could have become
- It’s about having the ability to put all your preconceptions aside and ask “why are all these users here?”
- Step 1 to Building a Big Business
- Remove friction from a process many consumers deal with every day
- The Scarce Asset in the Digital World is Distribution
- “Acquiring and maintaining an audience is extraordinarily difficult and expensive” Modest Proposal
- Second-order effects of COVID-19 on E-Commerce
- Offline retailers who were not investing heavily in online are forced to do so
- Cost of acquiring customers will increase dramatically
- If you want to understand heterogeneous marketplaces you have to start with eBay
- Modest is interested in businesses that have high demand, but that are still viewed as silly
Books Mentioned
- Modest mentioned 7 Powers: The Foundations of Business Strategy by Hamilton Helmer, as a foundational book of business strategy
- To learn about Heterogenous marketplaces, Modest recommended:
- The Perfect Store: Inside eBay by Adam Cohen
- eBoys: The First Inside Account of Venture Capitalists at Work by Randall E. Stross
Intro
- Modest Proposal (@modestproposal1) is the pseudonym of one of the most respected accounts in financial Twitter
- Host: Patrick O’Shaughnessy (@patrick_oshag)
- In this chat, Modest discusses some of the biggest themes in the stock market, his favorite companies, and more advice for investors
Investing is About Underwriting the Future
- The classic stereotype of the value investor is quantitatively focused on the past
- This approach worked for a very long time, but not so much in recent times
- Buffet’s biggest wins came from qualitative insights, while most of his capital was spent on quantitative analysis
- Today, underwriting the future has shown to be more successful and it’s a skill that any investor should have
- Even within a “value” sector, a company can outperform its competition wildly
- Quantitative methods are still but qualitative insights make a big difference in these situations
- Business knowledge is essential to underwriting the future
- Being able to analyze a company’s position within its competitive landscape becomes much more important
- Modest mentions important “tools” such as
- Michael Porter‘s work
- 7 Powers: The Foundations of Business Strategy by Hamilton Helmer
- Today’s most successful investors need to be more comfortable with uncertainty
- They do a lot of work and learn about the latest, most innovative business models
- While some investors saw uncertainty in new business models, others had a qualitative insight that allowed them to take the risk
Increasing Returns to Scale
- The idea that big companies can continue to grow without running into diminishing returns
- Example of Facebook, approaching 3 billion users
- If 20 years ago you internalized this idea you would have wildly outperformed most investors
- Today every manager has probably read about that idea
- Still, being able to apply it in novel ways can provide a strong advantage
- Today every manager has probably read about that idea
- It’s important to be willing to look at investments that look silly
- Early on, few people understood what Airbnb could have become
- It’s about having the ability to put all your preconceptions aside and ask “why are all these users here?”
Step 1 to Building a Big Business
- Provide a meaningfully better consumer experience
- Remove friction from a process many consumers deal with every day
- You’ll see consumer change their behavior to adopt your solution
- Behavior change is a clear consumer signal that your product adds value
- Uber reduced friction from the process of getting a cab
- Now Uber and Lyft are worth twice as much as the Taxi industry
- By removing the friction of finding or calling a cab, they enabled a non-linear change in consumer behavior
- Now Uber and Lyft are worth twice as much as the Taxi industry
iBuyer
- The three biggest disruptions that Modest noted in recent times were Uber, Airpods, and iBuyer
- iBuyer’s removes friction from buying and selling homes
- Many people tend to scoff when they first hear about iBuyer
- They see it as just a house flipping service
- You should ask yourself: Are they solving a consumer problem?
- Buying or selling a home is the largest transaction that most people ever do
- If you can provide a better way to buy or sell homes, don’t you think that many consumers will be happy to use it?
The Scarce Asset in the Digital World is Distribution
- “Acquiring and maintaining an audience is extraordinarily difficult and expensive” Modest Proposal
- CAC (Customer Acquisition Cost) is the new rent
- Instacart’s unit economics were not great (losing money on every transaction)
- As Instacart’s customer base grew to tens of millions, CPG companies had a strong interest to advertise their products
- More and more companies are now leveraging their audience to sell ads
E-Commerce Penetration (during and after COVID)
- Modest’s stance is that E-commerce is a very difficult business
- Due to COVID, many competing channels to E-commerce were shut down, causing huge demand to spill to online channels
- Some behaviors will probably continue in the long term
- Online grocery is likely to continue to benefit
- Getting a taste of the convenience of online shopping, many consumers will likely continue to use it
- Digital fitness will also see a permanent benefit
- Online grocery is likely to continue to benefit
- Second-order effects
- Offline retailers who were not investing heavily in online are forced to do so
- The competitive intensity once the situation normalizes will be very different
- Gavin Baker mentioned that changes in competitive intensity in tech will create non-linear effects
- Cost of acquiring customers will increase dramatically
- Offline retailers who were not investing heavily in online are forced to do so
Predicting the Consequences of COVID By Looking at the Supply Side
- Modest likes to use the Capital Cycle Framework
- This framework focuses on the supply side than the demand side
- Many people today are mainly concerned with changes in demand
- The restaurant industry
- Sysco is a huge food distributor, but only owns around 16% of the market
- There’s a long tail of small food distributors
- As the industry continues to decline, many small distributors will die leaving a larger share for Sysco
- Demand will eventually normalize but the supply side will be very different
- Sysco is a huge food distributor, but only owns around 16% of the market
- In the Retail industry, also the supply side will look very different once the demand normalizes
Homogenous vs. Heterogeneous Products and Services
- Heterogenous Products
- If you want to understand heterogeneous marketplaces you have to start with eBay
- Modest recommends reading:
- The Perfect Store: Inside eBay by Adam Cohen
- eBoys: The First Inside Account of Venture Capitalists at Work by Randall E. Stross
- eBay reduced friction dramatically
- They brought buyers and sellers of heterogenous goods together, globally
- Plus, they take advantage of network effects
- Modest recommends reading:
- If you want to understand heterogeneous marketplaces you have to start with eBay
- Homogenous Goods
- Direct to Consumers sellers of homogenous goods are not generally good businesses
- They ultimately compete on their brand
- Homogenous goods are fungible
- Once you start selling it, the competition will come
- Direct to Consumers sellers of homogenous goods are not generally good businesses
- Homogenous Services (e.g. ridesharing)
- Supply becomes a commodity (you don’t usually care if a Prius or another car picks you up)
- Take advantage of network effects up to a point
- Ridesharing’s network matters insofar as it allows users to get a car within less than 5 minutes
- The network still works for a second player (Lyft, but it becomes difficult for a third one to assert itself
- Heterogenous Services
- Providing a digital service on a local level across multiple categories
- Hasn’t really been done successfully
- “You need frequency to build a marketplace” Modest Proposal
- Average transactions tend to be small, so without high frequency, you are not able to pay for the costs
- Cleaning services (i.e. Homejoy and Handy) were not able to scale before running out of money
- This model hasn’t worked because you have the cold start problem
- You have to build both sides of the marketplace
- The solution would be to start with an existing asset that allows you to access the demand side and avoid the cold start problem
- ANGI Home Services is doing this
- They have a business called Home Advisor where consumers request the services they are looking for
- The question is, can they build a product that is so much better than the alternatives and own demand over time?
- ANGI Home Services is doing this
Businesses that Fascinate Modest
- If Modest had to choose a sector to focus on, it would be communications, marketplaces, and network-effect driven business
- Even better to invest in unregulated monopoly networks
- Modest is most fascinated by ridesharing companies
- There used to be many questions about the unit economics of this model
- Modest’s calculations found that Lyft was earning a margin of about $1 per ride
- When Lyft went public they were losing $0.20 per ride
- To this day there is still prejudice against this business model
- Maybe because the network effect is not as dominant as other marketplaces
- There used to be many questions about the unit economics of this model
- Food delivery is interesting because it’s less proven that ridesharing
- Modest is interested in businesses that have high demand and strong consumer signal but that are still viewed as silly
Case study: IAC/InterActiveCorp
- Modest spent a lot of time analyzing InterActiveCorp
- IAC is Barry Diller’s vehicle to make investments in the digital landscape
- Since the late 90s, they were very early into online dating, online travel, and online home services
- In travel, they acquired Expedia, TripAdvisor, Hotels.com,
- In dating, they bought OkCupid, Match and incubated Tinder
- Since the late 90s, they were very early into online dating, online travel, and online home services
- “They are maniacally talented at taking a product and figuring out ways to bring users to it, in an economically efficient manner and making a lot of money doing it” Modest Proposal
- They have done it across so many market and so many times, that there seems to be repeatability to it
- They just bought Care.com, a public company that was struggling
- Modest is extremely optimistic about that
- With COVID demand for both B2C and B2B health care is going to surge
- Modest is extremely optimistic about that
- “IAC’s has been very good at identifying large, growing end markets, finding assets that are already there and turbo-charging them into leadership positions” Modest Proposal
- Related companies to explore
- Liberty Media
- Similar situation to IAC
- Facebook and Google have aspects of it
- Liberty Media