At the end of 2019 I toyed around with the idea of “time anti-fragility”. Antifragility is a concept created by Nassim Taleb to describe something that benefits from stress. Most things in the world are fragile and break from stress. Some things are robust and can withstand stress. But antifragile things are even better – they benefit from stress.
In that previous discussion, I argued that in the investment world, the concept is often applied with respect to volatility (i.e. companies or assets that can benefit from volatility). But for most businesses, the biggest stressor over the long run is simply time. Time tends to lead to the degradation of all assets, business models, and intellectual property.
As part of that exploration, I suggested that some companies can be “time antifragile”, which are companies that can benefit from time because the passage of time makes them better in one way or another. The example discussed was LVMH since its position as the world’s preeminent heritage luxury house means that time would only make their products more and more valuable as the heritage that it represents becomes more storied and rich.
That example was fairly niche (and LVMH ultimately ended up being a fairly small position in the Paper Portfolio before being sold earlier this year).
However, the Paper Portfolio actually has a large number of time antifragile businesses. Marketplace and network businesses are all likely time antifragile.
At the core of every marketplace and network business is a beautiful flywheel that reinforces itself.
For example, the more consumers there are on Amazon, the more merchants will join. The more merchants there are, the more products there are. The more products there are, the more consumers will come. This is a flywheel that feeds on itself.
Every marketplace and every network business, at scale, has a beautiful flywheel of its own.
And these flywheels are time antifragile.
Normally the passage of time weakens assets. But time is the friend of every self-reinforcing flywheel. Every minute that a competitor allows a flywheel to run undisrupted, accelerates their own demise.
Every minute that retailers dismiss the potential of Amazon and e-commerce effectively leads to the acceleration of their own demise.
Time is also the friend of a flywheel business because it requires almost no effort from the platform itself once it scales.
Amazon gets more customers because of the efforts of merchants. Amazon gets more merchants because of the spending and growth of the consumers. Each side of the marketplace does the hard work!
The passage of time on the value of a flywheel is therefore positive. Incredibly positive.
From the perspective of the disrupted, time antifragile marketplace and network businesses are incredibly hard to compete against. Not only are they fighting against businesses that tends to get better over time (vs their own business that tends to require significant effort to keep up…for example, the effort that department stores need to put in just to keep running in place), flywheels are self-reinforcing. Amazon does not have to do much work to grow either sides of the marketplace. However, a new entrant without a self-reinforcing flywheel tends to need to subsidize the network. And new entrants tend to need to subsidize BOTH sides of the network. Not only are time antifragile incumbents getting stronger without much effort, they can easily fight back by just subsiding ONE side of the network.
For example, a new e-commerce platform may need to discount goods for consumers AND reduce commissions for merchants to attract both sides of the network. But an incumbent like Amazon only needs to do one – either discount products for consumers OR reduce commissions because, at scale, the presence of one side of the network naturally attracts and reinforces the other side.
It is this dynamic that partially tends to lead to serial underestimation of marketplace and network businesses. Investors have a tendency to assume that time leads to negative effects on businesses and that as a business gets larger, it tends to get harder to grow. But marketplace and network businesses are not normal businesses. They are time antifragile. Instead of reducing growth rates aggressively in the out years of a forecast, investors will likely be surprised by how sustainable growth can be because these are businesses that tend to not only be robust against time but are antifragile against time.
If Capital Flywheels is even somewhat close to the truth, the Paper Portfolio should do very well.