My views on the market, tech, and everything else

A Dozen Things I‘ve Learned About Technology Investing

1. “Payoffs from research are from Extremistan; they follow a power-law type of statistical distribution, with big, near-unlimited upside but, because of optionality, limited downside.” Nassim Taleb.  http://www.amazon.com/Antifragile-Things-That-Gain-Disorder/dp/1400067820/ref=sr_1_1?ie=UTF8&qid=1372633921&sr=8-1&keywords=antifragile    Valuing a technology company is uniquely hard.  The probability of any company encountering a positive or negative Black Swan is impossible to compute since you can’t assign a probability to an unknown “future state.” It is simply not mathematically possible. And even if you know the potential future state sometimes probabilities are unknown. Overall risk of a tech investment can be reduced via diversification by making that purchase one of a number of similar, but unrelated opportunities in the technology sector. 2. “There’s a lot of luck involved.” Bill Gurley. http://gigaom.com/2012/12/11/bill-gurley/  Lots of things in life benefit from compounding and one of them is skill.  For example, if you get lucky early in life you can via feedback become more skilled (i.e., early luck attracts opportunity and people who help the lucky person get more skilled). For a great analysis of the difference between luck and skill read Michael Mauboussin’s book The Success Equation. http://www.amazon.com/The-Success-Equation-Untangling-Investing/dp/1422184234/ref=sr_sp-atf_title_1_1?ie=UTF8&qid=1372715835&sr=8-1&keywords=the+success+equation    Since there is a lot of luck involved in technology investing having a margin of safety when making in investment is a wise idea.

3. “The old industrial economy was driven by economies of scale; the new information economy is driven by economics of networks.” Carl Shapiro and Hal R. Varian.  http://www.capatcolumbia.com/MM%20LMCM%20reports/Exploring%20Network%20Economics.pdf    The potentially good news for a technology investor is that nothing is more powerful than network effects in terms of their ability to create a sustainable competitive advantage/moat. If the technology investor gets the analysis right and makes a significant bet, the financial returns are potentially enormous. But the investor must keep in mind that the number of times a company generates a significant new network effect in any given year in a big markets you can count on your fingers. There are fundamental top-down constraints on how much revenue companies can generate.

4. “It’s all about scale economics and market share.  When you’re shipping a million units of Windows software a month, you can afford to spend $300 million a year improving it and still sell it at a low price.” Bill Gates.  Fortune, June 14, 1993  http://25iq.com/quotations/bill-gates/     There are other ways besides network effects to generate a moat, such as supply side economies of scale, intellectual property and brand.

5. “I’ve always said 25 percent margins are not a forever thing.” Bill Gates.  Forbes, February 28, 1994 http://25iq.com/quotations/bill-gates/  Moats created by existing network effects or others factors are brittle even though they are strong. All moats deteriorate over time the only questions are (1) is how fast the process happens and (2) can the company generate a new moat with the cash flow.

6. “Change is more rapid and unpredictable in technology relative to the broader economy.” Warren Buffett.  http://blog.rcfunds.com/?p=106    Companies can decline as fast as they rise since the phenomena involved are often nonlinear in nature.

7. “There are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that’s still going to be lousy. The money still won’t come to you.  All of the advantages from great improvements are going to flow through to the customers.” Charlie Munger.  http://ycombinator.com/munger.html   Sometimes, all or almost all of the benefits of innovation end up as “consumer surplus”. If the producer of an offering is to generate some producer surplus it must have a moat.  That something is disruptive may not result in any direct profit since only consumer benefit.  That a given company has revenue does not mean that it will generate a profit.

8. “That willing suspension of disbelief for the moment, which constitutes poetic faith.” Samuel Taylor Coleridge. http://en.wikipedia.org/wiki/Suspension_of_disbelief   There are lots of skillful promoters of technology who are wonderful story tellers. The can weave tall takes with promises of EBITDA and such and suspend the disbelief of investors. One weird aspect of these stores is that stories can be more credible the more facts that are left out by the promoter. If there are too many facts, the story becomes less believable.

9. “‘Free’ is kind of an incredibly tempting human hot button. And sometimes it’s great and sometimes it gets us into trouble.”  Dan Ariely.  http://bigthink.com/videos/when-free-is-dangerous   One tricky part of today’s technology world is that companies often decide to give things away as “loss leaders” as part of a freemium business model.  As a result, many companies are a press release away from having what they sell offered “for free” by their competitors.

10. “Strategy is only 5% of the [technology] business” Bill Gurley.  http://gigaom.com/2012/12/11/bill-gurley/   There are a small number of people who are fantastic at “making trains run on time” in a company. And in terms of engineering, a given company with thousands of engineers may only have a handful that are capable of putting all the pieces together. Betting on technology companies who have such managers or engineers is wise. Business execution capability matters!

11. “Many entrepreneurs who build great products simply don’t have a good distribution strategy. Even worse is when they insist that they don’t need one, or call no distribution strategy a ‘viral marketing’ strategy.”  Andreessen Horowitz is a sucker for people who have sales and marketing figured out.” http://techcrunch.com/2012/05/12/marc-andreessen-visits-peter-thiels-stanford-class-to-talk-startups-how-he-invests-the-future/   Selling stuff is really hard and people who do it well deserve to be well compensated. Engineers too often think people will line up with unmarked $100 bills if the product or service is good enough.

12. “The notion that people who have been lucky enough to make a lot of money know something or are worth listening to is a risky proposition.” Bill Gates.  Chicago Tribune, October 24, 1993 http://25iq.com/quotations/bill-gates/  Dave Chappelle arguably puts it best:  “Stop worshipping celebrities so much. Just don’t pay attention. There’s too much googaa over celebrities. People don’t know what’s fake and what’s real anymore.” http://comedy-quotes.com/dave-chappelle/celebrity_worship.html  

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