David and Goliath. The colonies and the monarchy. History is rife with examples of underdogs prevailing – a trend that has also traditionally held true in the business world (think: "Innovator's Dilemma"). However, this article from the Harvard Business Review argues that it is harder than ever for small companies to grow as incumbents become increasingly entrenched. Perhaps surprisingly, the facts seem to challenge the idea of a lazy incumbent: "Part of the reason for this growing corporate divide between big and small firms is the growing R&D expenditures of large firms ... On average, a large company spent $330 million on R&D in 2017, while the average small company spent a paltry $6 million – obviously insufficient to keep pace with a large competitor, except through a fortuitous discovery. The decreasing productivity of R&D investments makes matters worse for small companies." I wonder if this is a lasting structural change and, if so, what the economy will look like in the coming decades.
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01. The Big Get Bigger and the Small Get Smaller
While I hope that the wave of SMB bankruptcies caused by the pandemic is followed by a tsunami of new businesses that are better equipped to take on incumbents, this article in The Atlantic is less optimistic. "The pandemic will mean the triumph of franchise chains over mom-and-pop shops, of C-suite executives over entrepreneurs working in their basements. It will mean town centers filled with banks and 24-hour pharmacies rather than bookstores and nail salons and takeout counters. It will also mean fewer start-ups competing with incumbents…Ultimately, this means a less competitive American economy. New companies and small businesses drive net job growth in the U.S. They generate more productivity growth than bigger and established businesses. The great small-business die-off will fuel industry consolidation, which will both depress wages for workers and increase prices for consumers. More inequality, more sclerosis, and a smaller GDP: These are some of the legacies the coronavirus pandemic is leaving."
COVID-19 has forced a change in shopper behavior and even with the slow re-opening of the US economy, things are not going to go back to normal any time soon. Expect distancing orders, one-way lanes in grocery stores, masks, etc, to continue. One obvious beneficiary is e-commerce, which has apparently grown to 25% of US shopping compared to 17% previously, according to ModernRetail. The question is: does this dramatic shift stick? To better understand this, looking at shopping trends reveals an interesting shift as people increasingly opt for unfamiliar private label products: "Less than half of all the respondents said they were sticking with the brands they usually bought, indicating that as the way consumers shopped has shifted over the last month so too have the products they buy." This shift, perhaps a result of limited supplies of branded products, could be longer-lasting. If so, do unknown startup CPG brands help buck the trend of the big getting bigger?
02. Technology: Gaming & Enterprise Sales
Matthew Ball recently published another fascinating article about what cloud video game streaming may look like in the future. In addition to covering existing gaming platforms, different kinds of "streaming," and hardware and software issues, Ball also proposes a type of streaming game that sounds compelling, which he calls "massive interactive live events," or "MILEs." Not true "streaming" in terms of individual game play, MILEs have existed in a couple of recent forms and I wouldn't be surprised to see more of them. MILEs capitalize on a key driving force in gaming: socialization. "[MILEs] reiterate an ongoing truth in gaming: social experiences, not technical capability, drive engagement. Each of these experiences, and dozens more like them, were fun because they were live and shared experiences that involved the audience. Over the past decade, video behaviors have increasingly shifted towards private viewing and on-demand payback. But the human love for communal, real-time events endures." These social links build network effects and have contributed to successes such as Fortnite.
I don't often think about the enterprise sales process. However, I enjoyed this article from a16z that outlines how to sell into large organizations. Perhaps unsurprisingly, the author tells readers that one must think about, understand, and empathize with a customer to sell successfully. "Most product people know you don't build a product by starting with a specific technology just because it is new, cool, or novel. Rather one starts by solving a problem of some sorts where apply [sic] such a technology creates an amazing new experience that addresses a need or solves an articulated problem. Enterprise sales is similar in that you don't start with a solution (your product) and then get to the problem (customer need, articulated or not)." One other inclusion that I enjoyed: the author stressed that you can't understand an organization if you don't understand its culture.
03. Ferrari: Leading Through COVID-19
Different companies have handled disruptions from COVID-19 in different ways. It appears that Ferrari, despite being located in the heart of one of the hardest hit regions in the world, is leading the pack in terms of how to return to business. During the crisis, the company took time when its factory was shut down to develop a comprehensive reopening plan with a singular focus on the health and wellness of employees, their families, and their communities. This approach was recently profiled in an article published by the Harvard Business School: "At a time when businesses are hurting financially, many leaders are focused locally on cost-cutting — including layoffs and furloughs. By contrast, Ferrari has been thinking about its stakeholders more broadly. Ferrari's suppliers can access the same voluntary coronavirus screening offered to employees and their families. In addition, all the protocols Ferrari is using internally are shared with its suppliers so that they can use the same procedures in their own companies, and it is distributing masks not just to employees but also to suppliers and residents of the three towns—Maranello, Fiorano, and Formigine—where most of the company's employees live." The article also details other incredible measures Ferrari has put in place - including onsite testing, sanitation measures, healthcare, quarantine facilities, mental health support, and more. Other companies looking to provide a safe workplace for employees should follow Ferrari's lead, where possible.
This snippet from an interview with a Ferrari former executive compares and juxtaposes the company's capital efficiency and production approach with mass market car producers. Process optimization has been a cornerstone at Ferrari for decades, highlighting how you can use incredibly high engineering and process standards to create a niche business that is tough to replicate. "Since the very beginning of the industrial era of Ferrari, twenty years ago, the efforts have been to optimise all the techniques to reduce capex, to optimise the number of prototypes, to reduce the number of cars you need to test all the elements, to do a very well designed experiments, to make sure that you don't do a test or don't build a tool that is not strictly necessary."
04. Investing Philosophy
Recently, Benchmark Capital partner Sarah Tavel – whose work has been linked in a number of prior Beach Reads – featured on Patrick O'Shaughnessy's podcast, "Invest Like the Best," where she talked about investing (from a VC perspective). Tavel talks about participating versus observing in social media and the social experience of gaming around the 26-minute mark, highlights some issues that may arise if you take product feedback from power users around the 37-minute mark, and describes the role that data can play in guiding business decisions as a company scales around the 53-minute mark.
I'm sure many of us have seen the persistent spread (across a number of metrics) between value and growth over the last decade or so. Cliff Asness of AQR recently examined this phenomenon and confirmed that the divergence between value and growth is as wide as it has ever been: "Value is super cheap today and this is not coming from only the potentially 'broken' price-to-book measure (it isn't even very dependent on it) nor is it due to a group of winner-take-all monopolistic companies. It is not coming exclusively from the tech industries, it is not coming from mega-caps, and it is not coming from the most expensive stocks. Rather it is a pervasive phenomenon." Where will this spread go in the coming years? Who knows - Asness is betting it shrinks.
05. Facing Some Grim Realities
An article that I included in the last edition of Beach Reads questioned the management at Airbnb. This week, Airbnb CEO Brian Chesky demonstrated real leadership aptitude, humanity, and humility in an emotional letter to employees in which he informs the company that 25% of the staff will be let go. Importantly, Airbnb is taking significant measures to help ensure that impacted employees will be taken care of - including a severance package that features extended pay, insurance, mental health counseling, job placement services, etc. Additionally, I found this quote from Chesky powerful: "I am thankful for everyone here at Airbnb. Throughout this harrowing experience, I have been inspired by all of you. Even in the worst of circumstances, I've seen the very best of us. The world needs human connection now more than ever, and I know that Airbnb will rise to the occasion. I believe this because I believe in you." As an Airbnb user myself, I hope that the company will get back on its feet soon, and perhaps even rehire some of its talent.
Disney and dystopia - not words I'm sure I've seen near each other before. Regardless, this FT article makes Disney out to be run by corporate barons, looking out for themselves (and shareholders) instead of employees - effectively a dystopian extension of capitalism. This quote the FT got from Disney doesn't help them counter that case: "When announcing its decision this month, Disney said it was forced to furlough staff. Asked whether there was an alternative, a Disney spokesperson told the FT: 'I suggest you look up the definitions of 'publicly traded company' and 'fiduciary duty'." Ouch. One alternative may have been not to maintain the executive bonus program while furloughing more than 100,000 workers. "Although relatively trivial to the bookkeeping of a $180bn public company, executive perks may be seen in a new light in these straitened times, especially at companies turning to the taxpayer for help." If anything, this crisis has highlighted a number of structural issues - those that may increasingly become a headache as we eventually move through and out of the pandemic.
Breaking bread while sharing apocalyptic predictions. Or, perhaps more accurately, serving souffle and hoarding gold. Whatever the pairing, it is clear 13D founder Kiril Sokoloff sees dark times ahead for America. A long time market strategist, Sokoloff is now concerned with US debt levels, personal savings levels, and potential coming austerity measures in the United States. His negativity (along with a souffle recipe) is laid bare in a recent FT interview. "He had already rejigged his portfolio in anticipation of this, going long on gold as a hedge against what he believed would be an erosion of the dollar's value in a world awash with central-bank money. What struck me more was that he'd stocked up on tradable goods and made sure his truck had enough diesel to travel across the country without stopping." While I'm not sure we should all run out and fill up our cars, the variety of potential outcomes from COVID-19 is striking.
Disclaimer: To the extent that Beach Reads discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. The companies and or securities referenced and discussed do not constitute an offer nor recommendation to buy, sell or hold such security, and the information may not be current. The companies identified and described do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the companies identified was or will be profitable. Beach Reads does not constitute a recommendation or a statement of opinion, or a report of either of those things and does not, and is not intended, to take into account the particular investment objectives, financial conditions, or needs of individual clients.