I know it when I see it

When I used to be bored as a kid, it was my problem. Nowadays, when my kid is bored, it’s still my problem. So, I really appreciate the rare occasions when my 6-year old is self-occupied in an activity that doesn’t involve self-harm, adult-bother or screen-staring. I have never figured out how he reaches this blissful state, let alone been able to nudge him into one. However, I know it when I see it and have a golden rule for not prematurely ending it: don’t change any variables. If he spots an adult walking out of the room, he follows and ends up leaping onto the fan from a stack of pillows. If someone innocuously offers him juice, he seeks a more comfortable place, taking him right back to TV. If two adults start conversing, we quickly realize why an open office layout is a terrible idea.

This dynamic is generally true of complex social systems. I know a wonderful thing when I see it, without a clue as to how it got that way in the first place. And the surest way to have it stay wonderful is to maintain the same input variables, both within and around it. In technical terms, this philosophy goes by the name holism and is a better way to make sense of our messy world than the more commonly practiced reductionist approach. (I’ll dump on the evils of reductionism in a separate essay).

In investing, I encounter seemingly great businesses that I then need to wrap my head around. My personal soliloquy then runs as follows:

1.      How can I tell if it’s great? I know it when I see it.

2.      Why is it great? Because it’s great.

3.      How did it get that way? I don’t know.

4.      How to keep it great? Don’t change any variables.

As you may now be wondering why I haven’t sought professional help, here’s a longer version.

I know it when I see it

In an oversimplified sense, all great businesses are the same. They stand out, if not dominate, in their chosen niche. Brand is synonymous with category. Consumers demonstrate loyalty, preference and premium for perceived superiority. They command favourable terms from channel partners, as consumer pull minimizes channel risk. Dominance offers scale economics, on both making and selling fronts. They make a ton of money. While I’ve described the picture in disaggregated terms, that’s not what I actually see. I see a blob that seems good all around, with a whole bunch of internally consistent attributes including some that I listed out. I usually recognize a great business when I see one, much like spotting an attractive face without necessarily being able to describe it to a sketch artist. (The surest way to see through a faux great business is when something in the mix just doesn’t seem to fit).

It's #1 because it’s #1

This complex interconnectedness creates a powerful positive feedback loop that makes it nearly impossible for not-so-great peers to catch up or dent its greatness. This provides the real answer to the second question listed above: it’s #1 because it’s #1. This sounds unfair to management, who are typically feted for superior strategy, leadership and execution. I am not calling them incompetent. It’s just that competence by itself isn’t a differentiator. Would competitive positions reverse if #2 poached #1’s haloed management? In fact, #1 position and a self-reinforcing blob of all things good is a better safeguard as #2 would have no place to start. Construct over competence!

No grand narrative or great hero

We buggy humans are biased to weave stories around heroes, even when there are none. Corporate world isn’t immune to a ‘hero’s journey’ narrative, involving quest, adventure, trials, battle and triumph. However, reality is shaped more by context and lucky accidents, although it does help to have a hero who avoids stepping on mines, at least before intermission. Being first mover, fortuitous timing, accidental pivots in the right direction and competitors’ unforced errors have played a central role in shaping most great businesses. Figuring out why a company ended up where it did is both difficult and pointless. It doesn’t matter exactly how they got to #1, so long as they didn’t squander it once they got there.

Don’t change any variables

The most useful question is the fourth one, around what it will take to stay #1 in future. My preferred answer: nothing. To be more specific, nothing new. I deliberately left out something from my earlier list of attributes associated with a wonderful business: a sense of stability. Wonderful businesses tend to feel in equilibrium, or at least have a measured pace of change about them. Industry structure has settled down to a few names, with a set pecking order. Competitive behaviour is rational, not through explicit collusion but through implicit game theoretic considerations. Incumbents make enough money to make it worth their while, but not enough to make it worth a new entrant’s while. No one makes sudden moves and everyone thrives. This doesn’t imply complete stasis. Each company is furiously innovating, adding products, expanding reach and improving efficiencies. However, these generally cancel out, in terms of materially changing competitive position or dynamics.

It’s generally better to view complex systems holistically, rather than try to get too reductionist about constituent parts and precise causality. Stay fuzzy and tread gently. It implies recognizing something good without being able to fully explain how it became so. This is deeply disconcerting to flawed humans, who love stories and heroes. Going down storied-hero path isn’t merely self-delusional but positively dangerous. It can give us false confidence to send off our (already overachieving) hero on new quests with adverse unintended consequences. The alternative approach of embracing path dependence, crediting the construct and valuing stability goes against the grain of human nature. However, it is a safer and surer path to sound judgment. It also leaves more time for naps! 

[This essay is part of the series "Buggy Humans in a Messy World". Views are personal. Ideas are at best unoriginal and at worst plagiarized. For anything sensible, credit goes to people around me. For any nonsense, blame is solely mine.]