Modest Proposal

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

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
  • 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
  • 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

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
  • 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

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
  • In the Retail industry, also the supply side will look very different once the demand normalizes

Homogenous vs. Heterogeneous Products and Services

  • Heterogenous Products
  • 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
  • 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?

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
  • 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
  • “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
  • “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
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Notes By Giorgio Parlato

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