We live in a truly special time to be investing in. We live in a time where the rate of technological change is accelerating to a degree that the world may transform itself beyond recognition during our lifetime – perhaps even multiple times. The fact that smartphones have reached the current level of ubiquity in just 10 years is rather astounding in the context of the PC that took nearly 40 years to do the same – but perhaps not surprising when viewed in the context of the broader history of technological innovation which has always exhibited accelerating change.
Why this is happening
There is a fundamental reason for this, perhaps best known as the core thesis of renowned futurist Ray Kurzweil: the laws of accelerating returns. The crux of this is that like evolution, technological innovation benefits from a positive feedback loop: new technologies that are developed are then used to develop further technologies. This fundamentally makes technological change exponential, rather than linear. There appear to be enough examples throughout history to give credence to this – Moore’s Law being the most famous. In 2001, Kurzweil famously wrote that we won’t experience 100 years of progress in the 21st century – and that it’ll be more like 20,000 years of progress (at the then prevailing rate of progress). What sounded like hyperbole back then clearly sounds somewhat more credible today, looking back at everything that has happened since the turn of the century.
Warren Buffett vs. Elon Musk
Warren Buffet and Elon Musk had an interesting exchange on their business philosophies earlier this month – which started by Musk downplaying the importance of “moats” and claiming that “the pace of innovation… is the fundamental determinant of competitiveness.” At Berkshire Hathaway’s annual meeting a few days later, Buffett responded that while more moats appear to have become susceptible to invasion recently, “there are some pretty good moats around.”
As investors, we are students of Buffett and this makes us structurally partial to him. But in today’s day and age of accelerating change, we actually think that Buffett and Musk are both right. A business should never say no to a deep and wide moat. At the same time, the world is changing so fast that the premises on which such moats are based are often getting disrupted by technology and business model innovation at an unprecedented pace. The most potent combination is when a company has both – strong competitive advantages as well as a formidable culture of innovation. Amazon is perhaps the best example. The company’s “always day 1” mentality and relentless pursuit of innovation have led to a virtuous cycle that keeps strengthening not only Amazon’s products and services but also the incredible moats that it has already built. Walmart, on the other hand, has let its negligible pace of innovation render the company’s remarkable moats less relevant over time, ultimately getting overtaken against all odds by a former startup.
What is scary about today’s world is that companies with the largest moats are often in fact those that also have a culture of rapid innovation embedded in their DNA: technology companies. This wasn’t always the case. In fact, a decade ago, only one out of the top 10 companies by market cap was in tech, compared to seven today. This new phenomenon has meaningful implications for long/short equity. It means that the bifurcation of secular winners and secular decliners seen in recent years will likely continue – and perhaps even accelerate over the coming years. Organizational culture and structure are notoriously difficult to change, and it is nearly impossible for the disrupted companies to turn the tide when the winning firms have bigger moats and more rapid innovation. Mean reversion might happen in the equity markets over a month or a quarter, or perhaps even a year if randomness prevails. But structurally, without meaningful regulatory intervention, we believe that there is absolutely no turning back in the foreseeable future.
Furthermore, even outside of the technology sector, we are seeing more and more winning companies that are behaving like the winning technology firms – relentlessly pursuing scale and innovation in their products and services, rather than resting on their laurels. It’s almost as if there is accelerating change even in the art of building successful companies, as firms draw inspiration from some of the most successful companies in the world and iterate on it. And the lines between tech and non-tech are increasingly blurring: we often forget about the humble beginnings of world-class firms of today such as Amazon and Netflix, which originally operated an online bookstore and a DVD-by-mail business, respectively. We are now witnessing the rise of such firms in other traditional sectors, such as Tesla in the global auto/energy sector and Ping An in the Chinese insurance sector.
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