Invest Like the Best with Patrick O'Shaughnessy - Modest Proposal – Better, Cheaper, Faster: Why Companies that Reduce Friction Win - [Invest Like the Best, EP.193]

Episode Date: September 29, 2020

Before getting to this week’s guest, an announcement: starting Thursday we will be introducing a new series of interviews. Be sure to check this same podcast feed in two days to learn more. My guest this week goes by the pseudonym Modest Proposal. He’s both a close friend, and one of the most respected thinkers on financial twitter. I field more inbound questions about him than just about anyone, and you’ll see why in this episode. We discuss many of the biggest themes in today’s stock market, from consumer to technology to marketplace and local home services. As always, Modest brings specific insight and general frameworks to the discussion. I talk to him as often as I can because I learn something new every time, and this discussion was no exception. Please enjoy my conversation with Modest Proposal.   This episode of Invest Like The Best is sponsored by Canalyst. Canalyst is the leading destination for public company data and analysis.  If you’re a professional equity investor and haven’t talked to Canalyst recently, you should give them a shout. Learn more and try Canalyst for yourself at canalyst.com/Patrick.     For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club and new email newsletter called “Inside the Episode” at InvestorFieldGuide.com/bookclub. Follow Patrick on Twitter at @patrick_oshag   Show Notes (2:37) – (First question) – How investing is about underwriting the future (5:42) – Essential tools to underwrite the future             (7:59) – Michael Mauboussin base rate book (9:02) – Increasing returns to scale as the most important tool (11:36) – Example of silly investments (14:00) – Ideas of consumer signal and non-linear beahvior (16:30) – Why he was blown away by ibuyer.com (19:08) – How businesses are targeting facilitating transactions (23:11) – Ecommerce and digital penetration in business             (25:42) – Gavin Baker podcast episode             (26:00) – Modest proposal last podcast appearance (27:56) – His thoughts on the extinction of so many businesses as a result of the pandemic (32:26) – Chart tracking Product to service against homogeneous to heterogenous             (33:41) – The Perfect Store             (33:49) – eBoys (43:51) – Other features of business that fascinate him (46:29) – Ideas that pique his interest right now (51:20) – Case study: IAC/InterActiveCorp (59:36) – Barry Diller’s superpowers (1:01:17) – Why he’s spent so much time exploring IAC/InterActiveCorp (1:02:56) – Related companies to explore Learn More For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club and new email newsletter called “Inside the Episode” at InvestorFieldGuide.com/bookclub. Follow Patrick on Twitter at @patrick_oshag  

This episode of Invest Like the Best is sponsored by Canalyst. Canalyst is the leading destination for public company data and analysis. I'd heard of Canalyst over the past few years and became more interested after meeting the founder and CEO last year to pick his brain about SaaS businesses. Founded by a former byside analyst who encountered friction in sourcing, building, and updating models, Canalyst is now used by over 300 institutions, including the largest money managers in North America and by a number of the guests on this show. With detailed company-specific models, on virtually every investable public equity, Canalist clients are able to react more quickly.

If you've been scrambling to keep up with the deluge of IPOs these days, Canalist has models on Snowflake, Unity, Good RX, and everything in between. Their pre-IPO models are built as soon as the S-1 hits and include all segments, KPIs, and non-gap figures. If you're a professional equity investor and haven't talked to Canalist recently, you should give them a shout. Learn more and try Canales for yourself at canalist.com forward slash Patrick. That's C-A-N-A-L-Y-S-T dot com slash Patrick.

Hello and welcome, everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investorfieldguide.com. Patrick O'Shaughnessy is the CEO of O'Shaunicee Asset Management. All opinions expressed by Patrick and podcast guests. are solely their own opinions and do not reflect the opinion of O'Shaunsi asset management.

This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaughnessy asset management may maintain positions and the securities discussed in this podcast. Before getting to this week's guest and announcement, starting Thursday, we will be introducing a new series of interviews. Be sure to check out this same podcast feed in two days to learn more. My guest this week goes by the pseudonym modest proposal. He's both a close friend and one of the most respected thinkers on financial Twitter. I feel more inbound questions about him than just about anyone, and you'll see why in this episode. We discussed many of the biggest themes in today's stock market, from consumer to technology

to marketplace and local home services businesses. As always, Modis brings specific insight and general frameworks to the discussion. I talk to him as often as I can because I learned something new each and every time, and this discussion was no exception. Please enjoy my conversation with modest proposal. So you sent me a message not long ago saying that you'd been thinking about something for 18 months, which is this idea of investing being about underwriting the past versus the future. And I want to set that as the frame for this conversation. Can you open by explaining the big concept here so that we can dive into all aspects of it?

Sure. I think the stereotype of the classic value investor is very quantitatively focused, very focused on the past, trying to find a margin of safety based on what a company has done and not trying to be too smart and figure out what they're going to do. Obviously having a view to the future, but being far less important. Or even in the case of classic nets, price to book, that kind of thing, that is almost necessarily a rearview mirror approach. And that is what worked for a long, long time. There were folks throughout 100 years of investing. You go all the way back to Phil Fisher. He was always talking about look to the future and look at the qualitative aspects of business.

And there's a Buffett quote from a long, long time ago that biggest outcomes in his life have come from qualitative insights, even though the vast majority of his capital and time at that point was spent on the quantitative. And as we talked about last time, the value sort of quantitative rearview methods have certainly struggled through 2018. And today, they've done far worse. in the interviewing period, I think everybody has come to the realization that underwriting the future now has been what's successful and is probably a skill set that you really need to have. But that comes with an entirely different set of tools and way of looking at the world. And so I just think it's a shift that even if you are a quote unquote value investor

bucketed into that, we're not going to go buy Snowflake, but we might look at, at banks and all the stuff that is bracketed in their wheelhouse, you still need to be able to separate those that have a interesting qualitative future from those that don't. Because one thing that we've seen over the last couple of years is even within sectors, the best companies have wildly outperformed and have gotten far better valuations than sort of the middling company. So even if you're looking at a quote unquote value sector, the quality. qualitative insights have separated wildly the best and the median and certainly the worst. So I think it's forced investors to develop new muscles, left some behind for sure,

whose skill set was right for a different era. And as I always caveat, you never want to say it's totally different and that may never come back. There may be periods where that works again. But I certainly think if you believe like I do that the market is on a relentless march towards increasing efficiency, that some of that rearview underwriting and simply quantitative methodology is becoming less and less valuable and computed away. Can we talk about the toolkit that you referenced, so muscles or however you want to refer to it, what do you think the essential tools are in that toolkit to be able to do a good job underwriting the future versus the past? Well, I don't think it's anything that folks haven't thought

about going back 50, 60 years, but certainly some of the work on Michael Porter and Seven Powers and business strategy, competitive analysis certainly becomes much, much more important and being able to analyze the company's presence within its ecosystem, how other competitors exist against it, who may come in. So your traditional business analysis, but I think it makes that far, far more important to all, forms of investors as opposed to where that may have been a growth investor mindset or a quality investor mindset. I think, as I said, even if you are operating within traditional sectors known for their value-like characteristics, you have to be hyper-focused and much better at this

competitive strategy and analysis. That's certainly one thing. And then the biggest one, I think, is becoming much more comfortable with uncertainty. The entire reason for the margin of safety and for the sort of rear view skills and process was to offset the inherent uncertainty about the future. You were basically throwing your hands up and saying, I don't know what's going to happen and I don't want to pay for it.

I think today it is clear that if you look at the most successful investors, they are willing to take on in many cases a level of uncertainty at the outset by virtue of having done a lot of work and they get a higher conviction in some of these newer business models. And then subsequently and later to that, everybody else is the classic innovator, imitator, idiot cycle. Those who have really prospered over the last 10, 15 years have been early to understanding some of these new business models and where everyone else saw a grave uncertainty about the future, they were able to have some sort of qualitative insight about the business, how it would perform. It's funny, I had this

notion in my mind of sort of escape from base rates. Michael Mobeson wrote the base rate book, and people are now very familiar with the idea that capitalism sort of inherently pulls down and attacks excess returns on invested capital. That's sort of the frame of microeconomics, is that if you earn excess returns on invested capital, capital will pour in and compete it away. Well, one of the qualitative insights and what you're really looking for is those businesses that can escape the base rate. And I think having those skills and tools and muscles to be able to properly identify businesses that can escape the base rate has been very valuable. I assume it will be on a go forward basis as well. And then I think the last thing is still trying to have somewhat of a contrarian streak at some point,

but looking for the qualitative insights and that moment of change and saying, perhaps this business that has been underappreciated is about to go through a moment of change, and you can see that, and maybe you're not paying a whole lot for it. But certainly first principles is being much, much better business and competitive strategy analysts. Do you think that there's a case to be made that the single most important tool is whether or not you internalize Brian Arthur's idea of increasing returns to scale? It seems like if you got that, if you groanked that 20 years ago, you were in a completely unfair or competitive position doing business analysis relative to everybody else. Do you think that that will continue to be true going forward? And do you agree with the idea in general?

I think certainly over the last 20 years, if you did nothing else but invest on that idea, you have wildly outperformed. I would say today, every single manager has probably read that and thought about it. It's obviously not the clear source of alpha that it may once have been, but I still think the ability probably to apply it in novel ways is going to be an advantage. We talked about last time that the scale of mobile has just changed everything. I still just come back to legacy networks, physical networks versus today's virtual networks, a large, in the Western world, so leaving aside sort of China and India, a large physical. network has 30, 50, 60 million subscribers, and if it's a mobile network, maybe 100, 120 million.

And we're talking about a world where Facebook is approaching 3 billion users. So that idea that the big can grow into these massive TAMs and not run into diminishing returns has just played out on a massive, massive way. I'm not sure it will be the same level of advantage it was, but I do think that one, understanding, internalizing it, and then two, being willing to look at things that may look silly a priori and saying, no way, but then using the increasing returns framework to say, wait a minute, what if they do get scale? What happens then? And I think we've been far too quick, the vast majority of people, to scoff at a lot of what has transpired over the last 15, 20 years

because of the scars of the late 90s, and that if you were able to apply an increasing returns framework to some of these novel ideas, you would have been able to look forward and say, I don't really know how they're going to make money, but I know that they're going to have a massive economic ecosystem surrounding them. And if they are serving their customers well enough to get really big, they'll probably be able to pull in ancillary.

economics and prosper. Can you define silly and what you mean by it? I'm assuming one definition is like a hilariously small Tam or something. But what exactly do you mean by silly? And are there any examples that pop the mind of something that might have looked maybe trivial or silly at the start that's now huge just to cement the idea? I always point to Airbnb. I mean, the idea in 2009 of saying, yeah, I'm going to rent out my room to someone. Because remember, at the outset today, it's a very professionalized operation. They're property managers and their entire buildings built special purpose.

But at the outset, a lot of the room nights being booked on Airbnb were sharing. The idea that that was going to be some world-beating threat to shoulder nights at hotel rooms just seemed laughable to someone like me who doesn't particularly like strangers staying in my house.

But the insight clearly was there is a demand for this and consumers are coming. to it. Being able to say, okay, well, if the consumer signal is there on room sharing, what about when you're not in your apartment? Will people take down the whole apartment? Okay, and if they'll do that, what about houses? And I think it's the ability to see a company laddering up, I think is the term. And moving further from their initial point of entry, the initial wedge that they have with the consumer and finding those next steps up and up and

taking the business model bigger and bigger and into larger camps. And so for me, that is the one that when I first heard, and I sort of contrast that to Uber living in New York City, where cabs are sort of central to your existence. And I'm not a big fan of driving. So whenever I would go on business trips, I hated running cars and I would always try to leverage cabs to the extent I could. The first time I saw Uber, I was like, this is the greatest idea in the world. So whereas with Airbnb, I was like, who would let anyone stay in their house? And I think it's that second idea, of silliness that a lot of people have thrown at, even companies that come public, where you still look at it and say, people are just wasting time on this Facebook. Look what happened to MySpace.

It's going to go away. And I think it's the inability to put aside your priors and your preconceived notions and say, why are all these users here? Why are all these consumers using this? What are they doing and what can they be doing there? How could that company further fulfill their needs and wants and economically what does that mean for them. Can you say more about this term you just use? I think it's a Rich Barton term, consumer signal. And you also used a phrase before we hit record that I was fascinated by, which is when you remove friction, you unlock nonlinear behavior.

And I think consumer signal and the nonlinear behavior are related. Can you flesh those two concepts out a bit? Yeah, I think particularly as you move from analog to digital, the holy grail there is two things. One is providing the stereotypical, the term is a 10x better experience. But if you can provide a meaningfully better consumer experience in a digital environment, that is step one towards building a big business. And the second thing is oftentimes that 10x experience is consistent with removing friction from a process. I just mentioned Uber and I always think it's kind of funny when people scoff,

this was no innovation, they just layered an app on top of tax. But if you think about what it actually took and still does take to catch a taxi at 5.30 p.m. in the rain on Fifth Avenue, I would say that Uber has introduced and removed some friction from that process. And one way you can tell that that happened, I was actually looking at these numbers the other day is back in 2014, Azwat de Maradan, sized the market for taxis in the U.S. I think it's like $11 or $12 billion and said this market will grow 6, 7%. So in 2019, that would have it be something like $14, $15 billion, I think. Lift in 2019 did around $11 billion in gross bookings. Uber, as we know from card data and things like that, it is probably roughly twice their size, maybe 1.8, maybe 1.9. So call it 20 billion in booking. So those two did $31 billion in bookings in the United States in 2019. And I think all you can conclude from that is that by removing the friction of finding or calling a cab company, you enabled a nonlinear change in behavior. And the consumer signal clearly was the minute that people got their hands

on a ride sharing app, they started using it dramatically. Rich used it in the context of when they first started offering Zillow homes, they could see that people clearly wanted to sell their home this way. So that was the first time I had heard it. But really what it is indicative of is you've got product market fit, is that the consumer is speaking with their actions that we want this product. And generally it is because you have removed friction from a historically painful experience. I think eye buying, when we're talking about Zillow here, eye buying is a really interesting example here of if you just use the past as your lens for how to analyze something, you might miss a very interesting trend. Can you talk about the experience you had when you first encounter

the idea of I buying and sort of talk to maybe those legacy lens wearers that we're thinking about the same concept? I joke. I'm a pretty late adopter. I'm not downloading apps first and generally not getting devices first. There have been three things in the last 15 years that I sort of said, holy shit at. One was Uber. We just talked about it the day I saw it. I was like, this is the greatest thing I've ever seen. The second one was AirPods. The minute they came out, I put them in, I was like, this is so much better than having wired headphones. And then, The third one was Zybuying. And the minute I heard about it, I was like, this is so obviously better than the existing way of selling your home.

And a lot of people at the time, I remember traditional real estate people and sort of any man on the street that heard the idea said, no, you're just a home flipper. And what happens if prices go down and your balance sheet? Abstract a level above. Ask yourself, are you solving a consumer problem here? Is this the most painful experience of a consumer's life? Yes, it's the largest transaction they do, but it's also probably the most painful transaction they're involved in. So if you can provide a better way to do that,

don't you think you're going to find some consumers want to? And if they do, don't you think over time you can build an ecosystem around there are five and a half million existing home sales a year, plus or minus? And the addressable buy box, you can debate whether it's, a million homes would satisfy the current framework of which they're doing. Is it 2 million? Is it half a million? It doesn't matter.

These are $300,000 transactions. So you could say, well, look, this is going to be a multiple $100 billion economic activity taking place. And we know all the economic activity that goes on around the sale of a home. You can say, well, it's 100x better experience. We now know that there's a tremendous consumer signal for it. but even at the time, it seemed obvious to me people would want to transact it in this way. And I think the companies are starting to figure out.

It's only four or five years since the launch. And they're starting to feel their way towards building that economic ecosystem around it. But that was one of those where Uber and I buy when I saw that, I was like, it's so much better because there is so much friction being taken out of the system. I've seen you joke that if you let a business survive long enough, it'll eventually sell ads. It makes me think of this kind of interesting. idea, which is maybe the best modern way of thinking about business is just facilitating as many either social or financial transactions between parties as possible, because around that ecosystem

will just come attention that can be monetized, whether that's related services in the case of I buying or something else. Can you talk through businesses that have done something interesting there? Like I think Instacart is maybe a good example with ads. What are your thoughts on this? Just make the business goal to facilitate lots more transactions. of some type between two parties. Yeah, I joked last time, maybe the people talking about eyeballs were right. Like, it's the most scoffed at remembrance of the late 90s.

But if you think about the challenge today, the scarce asset in the digital world is distribution and audio. That's the hard thing to build. And it's the reason why people joke that CAC is the new rent, is acquiring and maintaining an audience is extraordinarily difficult and expensive. And so if you have built a product and brought a product to market that consumers love, and you have been able to build a big user base on the back of that, that is going to be really valuable to other people as well.

So I think there's an increasing realization that not only are you trying to build products and services that consumers love because hopefully you can make money bringing those products and services to them, it's that once you do that, if you build a big, robust, engaged audience. That's also really valuable to the people who have not done that. The Instacart story, and I'm not familiar with all the details here. But my understanding is from the beginning, the unit economics there were fairly challenged. And if you think about it, that makes a lot of sense. You have a person going to a store picking groceries and delivering them. And groceries is a

notoriously low margin business. That's a fairly labor intensive process. The take rates that you charge are lower because grocery is a lower margin. in business. The offset there is the basket size can be bigger. But again, my understanding is at the outset, the unit economics were upside down. And so a linear thinker and folks on the outside would probably look at that and say these guys are selling a dollar for cheap and they're losing money on every transaction. And of course, consumers are gravitating towards this. They're getting free money. Well, one day, they got to a certain size and scale and all of a sudden CPG companies said, wait a minute, what milk are they buying? Well, what have we advertised our milk in their basket?

Because one of the things you learn in grocery is that people tend to shop a list. So if you can get on that list, you become a habitual repeat purchase. So obviously it becomes incredibly valuable to the brands to get onto that list. And so if you have tens of millions of customers buying their groceries through your application and you turn around and go to the purveyor of goods and say, how much is it worth to you to get onto these lists? It's worth a lot. I think I jokingly say on a long enough timeline, everyone sells ads. And you can look at any e-commerce site. Amazon has sponsored listings. Their advertising business is now third largest and fastest growing ecosystem. eBay is running promoted listing. Etsy just started running promoted listings. Uber is now running,

they're rolling out ads and their eats product where restaurants, and it turns out again, CPG companies, actually, which they talked about this week. I was a little surprised to hear, but CPG companies are coming to Uber and saying, we'd like to put advertisements for Coca-Cola in front of your eats buyers, irrespective of what restaurant they're ordering from. So again, it's this notion of classic aggregation theory. You've aggregated a large audience by virtue of winning their trust. They want to consume whatever it is you're offering, and others are willing to pay to access that demand pool. What are your thoughts on the drastically changed nature? This is all related to everything you just said of e-commerce. And I'll just say like digital penetration, more generally speaking. What do you think businesses should be thinking about? Obviously, there was a step change function. Everyone's seen that graph now that the steady churn up of a couple percent per year of e-commerce penetration and then it doubled in two months to 30-something percent. What are your thoughts on that? Do you think that that's some portion of that just stays forever? Do you think that it creates pockets of

opportunity for certain types of companies, challenges others. I'd love to hear what you think about e-commerce and digital. The competing channel was shut down for two months. So the fact that it was revelatory that e-commerce took a lot of share struck me as curious. I have consistently and historically said that e-commerce is a very difficult business, perhaps worse than physical retailing and nothing about my views there have changed. I think that this was certainly a unique time period. where competing channels were shut, so you had very high-intent consumers online. And what that meant was an enormous amount of demand spilled into the e-commerce channel at the same time that advertising costs were able to come down

because you had high-intent consumers that you were not having to nudge into demand. I think there are some behaviors that will definitely see noticeable change from that. I think online grocery is one that is likely to benefit on an ongoing basis. that's a product line where historically there was some reluctance to engage in online buying. People would like to touch their fruits and vegetables. And I live in New York City. I've used Fresh Direct for a long, long time. I still do prefer to do shopping in person.

But knowing the convenience of it, the vast majority of our grocery shopping is now done that way. So I think bringing that product to a lot of customers that probably would not historically have tried it is going to see some real impact there. I said one day, I think digital fitness, probably is going to see a permanent change in behavior. I think a lot of other categories, what probably happens is you have a step up in dollar volume, but I don't know that the rate of change there is going to, on a permanent basis going forward,

change to too much. And I think if I abstract a level above this, you and I have talked about this offline, what I actually find most interesting in the competitive analysis of e-commerce and how people are thinking about this is no one's thinking about, the second order effect. You had Gavin Baker on earlier this year and he talked about how to date it had been a first order world, it still has been. But as I think through second order effects, I'm intrigued that people have not started to ask what happens if everyone now has to compete

in e-commerce? Something we talked about last time was when you're a small focus competitor and the only thing you do is x, it's existential to your being and you probably spend all your time, I'm thinking about it and you do it better than everyone else. In the digital world, you probably competed against a lot of offline retailers and sellers of goods who maybe dabbled in digital, but didn't really like it or maybe didn't at all because they looked at the unit economics of it and faced the classic innovator's dilemma of should I get into that? Well, when the offline world shut down, every single company, it became existential to have a digital presence. I don't think, think people are in a number of cases are thinking through the implications of what it means

that it became existential for every physical retailer and every physical seller of goods and services to have a digital presence. Because on the other side of the COVID spike, whenever demand does normalize, the competitive situation is just going to be very different. Whether or not in the long term this is an increasing returns world and the digital disrupts. or will take 80% of the share, that might still be the case. But I have to believe the next three, four, five years in a number of categories, the competitive intensity is going to be dramatically different because these companies, the offline companies, were forced to go all in.

And I remember something Gavin Baker has talked about, which is when there are changes in competitive intensity in tech, the impact is nonlinear, meaning that the cost of acquiring customers and potentially the price cuts. is just dramatically more so. That to me is something I have spent a lot of time thinking about which categories may see that non-linear rise in competitive intensity in an already very difficult business of e-commerce might see it get even worse.

What about non-e-commerce, stepping away from e-commerce, but still staying on long-term impacts of COVID with a business like Cisco where there's this kind of interesting effect where even prior to COVID we had this rich getting richer, higher returns on capital to the biggest, most successful firms in public markets. A lot of that's these digital businesses. But it seems like COVID, again, talking about existential risk, just permanently impaired or destroyed or put out of business, a lot of small businesses that are technically competitors of big public companies in various different markets. So what do you think about that situation, that there was this sort of one-time extinction event, those businesses aren't coming back?

So the flip side of what I just talked about, which was you have a big demand search today. Everyone can see that. Everyone's excited about it. Everyone's paying for it. They love paying up for the certainty of demand today is there are lots of places where demand has been impaired. And let's focus on sectors where it hasn't been destroyed. It's been temporarily depressed. There's a framework going back to marathon partners called sort of the capital cycle and thinking through industries and businesses in a capital cycle framework, which is much more focusing on the supply side than the demand side. And historically, they were talking about heavy-duty industries, and the classic example you can look at here is commodities. The cure for high prices is high prices because high prices incant the addition of supply. And so if you look at the 2000s, China entered into the world economy in a big way, and that demand shock overwhelmed supply and prices surged. But over the intervening four, five, six years, it takes a lot of time to bring on mining supply. The supply responded.

It did what capitalism is supposed to do. Tens of billions of dollars went into that. We got to 2010 and 11, and China had sort of reached the end of their ability to grow at supernormal rates. All of a sudden, there was a lot of supply. And it's not a surprise. Commodity prices have never recovered.

And so that's sort of the traditional classic capital cycle framework. But if we apply that to today, You mentioned Cisco. That's certainly one where you can look at restaurant demand is definitely down. And that end market is pretty interesting in that Cisco is much, much bigger than its competitors, but it only has something like, I think, 16, 17 percent share. There is a very long tale of food distributors servicing independent and chain restaurants. If you can take the view that in three, four years, people will want to go back to restaurants, then what's likely to happen in the intervening period is that a lot of that long tail of supply

or competition is going to go away. Cisco's not going to go away. And so if you just say that, again, a GDP-type grower, a business that probably grows in line with GDP, maybe more, maybe a little less, normalizes post-COVID. The demand situation is not the question. The question of what does a supply situation look like? And it might be much more favorable. I think there are pockets there. where everyone today is hyper-focused on where is demand being impacted. And I have heard less, I know there are people definitely operating under this thesis, but definitely less in the mainstream investment world of people trying to figure out where is there a much more favorable supply situation on the backside of this,

where we believe that demand normalizes. Another one you and I have talked about is Ulta, which is a retailer of beauty, skin care, hair care. I was reading a note from one of the analysts the other day. I think department stores still do $7 or $8 billion in prestige beauty sales. Well, we know not only because of COVID, but even pre-COVID, those businesses were dramatically challenged in shutting down. Now, you have JC Penny shutting a lot of doors.

You can go down the list of department stores. Those are shutting down. And so some portion of that sales, I would assume in two, three, four years, the demand for beauty, hair care and skin care products normalizes. I don't think that there's a trend that's going to permanently change the demand for those goods. You might have a situation where the supply side, the competition is dramatically impact. And so it's thinking through, are there more opportunities to find places where from a capital cycle framework you're going to find on the other side of this normalized demand, but far less supply. I'm staring at a exhibit that you sent me,

which has two axes is the two by two matrix. I want to talk through it. So the vertical axis is a spectrum from product to service. And the horizontal x-axis is a spectrum from homogeneous to heterogeneous. And then you've placed a few, and I can remind you of what's in which corridor on the chart. But walk me through this segmentation. Why did you lay this down? What's interesting about these two variables to you? And then we'll talk specifically about local and home services. I think what I was doing when I was working on that was trying to try to, to think through what are the differences in types of online businesses that have evolved? From sort of classic third-party marketplaces to first-party sellers of goods.

And then why are things that have a nexus to the real world so different than those? And so in that framework, a service was generally something where there had to be a physical nexus, something had to happen in person. And so if you just start with sort of heterogeneous seller of goods, that's a classic market. And I think any time you talk about marketplaces to me, you just always have to start with eBay, because if people haven't read The Perfect Store, I think it's one of the most fantastic business books about the origin story of eBay. And if you read it in concert with EBOIs, which is about benchmark and their investment in eBay, it's a phenomenal one too. But the perfect store in eBay shows you literally it was perfect.

I joked with someone the other day. Product market fit is when your second employee is someone who's opening envelopes of money. eBay was such a good fit. Sellers were voluntarily sending in checks. Pierre had to hire someone, hey, can you help me deal with all these checks that are coming in? And so if you think about what they did was they brought buyers, oddball heterogeneous goods, in contact with sellers of oddball heterogeneous goods. the ability to match them, not on a local basis, like at your antique store, but globally, talk about a friction unlock.

When the difference is walking down Main Street in your town in Pennsylvania or accessing the seller pool of the entire world, you unlock non-linear behavior. So when I think about sort of a heterogeneous goods, what I'm generally thinking of there is a traditional third-party marketplace. Now, homogenous goods, you can have some debate about this, but if you're a classic DTC seller today, you come up with a brand and you sell that product direct to consumer, that was hot for a while. Those are not generally good businesses. And the problem is you're ultimately competing on your brand because the product is fungible. Other folks, you can think of some of these away sell suitcases and they got knocked off dramatically right away. And almost by nature, you go down any category, there's no secret. Once you start selling the product,

once you start selling a mattress, direct to consumer, 500 mattress sellers emerge. So that's been a less defensible business. Then you started getting into the services. And here I think is where, on a prospective basis, I think it's pretty well known today. Marketplaces, Third Party Marketplaces are very good businesses. I think people have come to a pretty strong view on what first party selling is. Amazon makes money. A few other people make money. But in general, it's a very difficult sale because you're competing in a price transparent, high returns, high shipping cost world. No one has really made much of a go there. Then you start getting into these physical nexus. And let's talk about ride sharing.

So ride sharing there under my framework was homogenous service, which is essentially that the supplier is a commodity in that you might care between X and black, but within Uber-X, you don't care if it's a Prius or a Camry. The supply of the service is relatively homogenous. And there, there's real questions. Are there network effects here? I didn't really talk about, obviously, the reason that heterogeneous product has this tremendous outsized impact is that network effects there are just massive. As you add more sellers, buyers come because they can find more products. As you add more buyers, sellers want to access that demand. Classic network effects. So the question with ride sharing was, and I think people still debate it today, I have

views on this, but are there network effects when there's a commoditized service being offered, and particularly where it seems like that network effect is localized because of the physical nexus. I think it's clear there is a network effect, because if you try to start a ride sharing business without any suppliers, it's not going to work. So you do need drivers, and they do want to access to customers. And so as you add each additional to the sides, to each side of the marketplace, you get a better and better business. The wrinkle that we learned was the network effect mattered up to a point.

And it was really on arrival time of the driver. So what I think Lyft found was when they were able to cut arrival times of their drivers, I forget if it was three or five minutes, but basically get under that promise. They could also kickstart their network effect, even if Uber was already there. It's clearly a less defensible network effect than a monopoly-like third-party marketplace might be. But even then, when you have one and two, to become the third purveyor of a ride-sharing network at a market is almost impossible, and I'm not really sure, sustainable in the long term. So what you probably have is an emergent duopoly in certain markets where someone has spent the capital.

I think longtime shareholders of Uber have talked about this, that Burtford lifts ability to raise a bunch of money and bear the cost of building the network to get under that four or five minutes. Uber probably could have run away with this. I think today you're probably in some sort of equilibrium where in the markets that someone has established that strong second position, they can function because the network works, but there are no new entrance. And in markets where they weren't able to achieve scale, the incumbent has much more monopoly-like characteristics. That's sort of those three quadrants, as I thought through them. And then the fourth quadrant, which is very interesting and really has not been done, is sort of what I characterize as heterogeneous services. And this is being able to, on a local level with a physical presence, provide a digital

on-demand-like service across multiple, multiple categories. And essentially, it's attacking local because the challenge with local is you need frequency to really build a marketplace. The average, I think when they disclosed it, Lyth riders, it's 38 or 39 times a year. Food delivery was high single digits going into the low double digits. But to really stand up a local business, you need very high frequency because the average transaction sizes tend to be small. and the average gross profit dollars per transaction tend to be very small. So without high frequency, the aggregate gross dollars per customer is simply not enough to overcome the cost of building that network.

So the one that jumped out at me and that I put on that slide was home services. And it's one that I've spent a lot of time thinking about. It's a very interesting category because a number of folks have tried to do the traditional, Donovo startup here, where from a cold start, you build both sides of the network. It has not worked. And the reason it has not worked is you have the cold start problem. You have to spend a ton of money acquiring demand. You have to spend a ton of money acquiring supply. And even if you do bring a 10x bread or product to bear, the frequency has historically not proven high enough that you can make enough money doing this. And a good example is house cleaning, which is kind of the highest

frequency use case here. I think it was home joy, Handy, a number of folks. They went after this category and Handy was probably the most successful and they had an exit to a company called Angie Home Services that we'll talk about in a second. But even then, and they were very good at what they did, they had high fulfillment rates, they had high NPS. The business could not scale before they ran out of money. So there's one really interesting question is, what if you start out with an existing asset in place and you don't have to do the cold start problem. And that's what Angie Home Services is trying to do. They own a business called Home Advisor, which is in a sense of marketplace. It's a two-sided network where consumers come in and they submit a bunch of information about a

type of project they'd like to work on. And on the other side of that, you have 250,000 or 220,000, what they call SPs, service providers who are trying to access that demand pool. Historically, this has been what you might characterize as a lead gen business, where they would then forward on that project to two, three, four service providers who have the opportunity then to connect to the customer. But the point is, what you have in place is an asset, which is around 26 million service requests a year coming from something like 15 to 18 million households. So you don't have the cold start problem. You have the demand side.

So the question now is, okay, can you fulfill the? that demand in an on-demand environment and build the product that everyone knows is 10 times better and further own the demand in a way that over time, this becomes the go-to. And I will say, we talked earlier about iBying and Uber. It seems to me from first principles, it is so obvious that everyone 40 and below, 38, whatever it is, would much prefer to go into their app. and book a plumber that way. Then to have a conversation with someone and try to talk through and I can't come next Tuesday. How's next Thursday? Now next Thursday, I got to take the kids to the doctor. Like, you go in the app, it shows that the plumber is available Tuesday at 1230.

That seems so obvious to me. Like, you almost ask why this doesn't exist. Well, there's a really good reason it doesn't exist is it's really hard to build. So Home Advisor talks about, I think they do 500 services and 400 markets. And if you think about that matrix, that is a really complicated matrix to get right and to get not only the demand pulled in where I think it's self-evident over time the demand will want this.

But can you fulfill it on the supply side? What's so interesting to me about this is, it's been tried before, but it's never succeeded in this heterogeneous services. And can, by virtue of leveraging an existing asset and demand pool, can you beat the cold start problem and build the product that, everyone knows should exist.

And let's be honest, there's almost no reason to believe it won't exist in 10 years. It's just what's the path there. I'm thinking now about your earliest points about underwriting the future. We've also joked in the past that if you had to just confine yourself to one sector or industry to make investments in, you'd choose communications because you'd always have a monopoly to pick from. It makes me wonder, like, what is the argument for focusing on anything but marketplaces, communications, network effect-driven businesses in this?

world that we live in. Is it just price? Is it just that these things could get so dramatically overpriced or fairly priced because everyone gets it? I'd just be curious to hear your thinking, and so much of your thinking seems to center on businesses that have one of these features. What's left out? What other features of business fascinate you that we haven't talked about? Yeah, I wish you had asked me that question about seven years ago and told me to just do that. I think some of it is just my background as a traditional generalist of sorts, although I have narrowed my focus or eliminated certain categories. I am at heart a generalist and I'm always looking for interesting asymmetric opportunities in all sectors. I would say being honest with myself, the vast majority of

my alpha has come in consumer internet and communications type businesses. So you're probably right. I should focus on that. But there are certainly times where the conditions that I look for, which is oftentimes overreactions and good businesses to temporary hiccups occur outside of this space. But if I was resigned to having to only invest in one space, yeah, it certainly would be this. Now, I joked about that communications one, but then I've thought more about it. And it's even better. If you have the opportunity to invest in the unregulated monopoly networks, you should do that. And what's so fascinating to me as someone who has spent 15 years stuttering the regulated

communication networks, which are the cable and telecom companies who are regulated by the FCC. Some may argue not strenuously enough, some may argue too strenuously. But the fact is, their telecommunications act under which they operate. The largest communications networks are nominally regulated by the FTC, but not under any formal congressional law. My takeaway from that was if you ever see a business that looks like a monopoly and it doesn't have a regulator, probably go spend a lot of time on that one and less on the regulated monopolies. Although you can't say that regulated monopolies come with their advantages, which is usually they earn very good returns, but perhaps not super normal because they won't be allowed to do that.

What else that you've been exploring in markets given the current dynamics has your attention most? We could stick with marketplaces. If there are features of marketplaces that you've been unpacking or exploring in more detail or really any other major topics that you think are important right now. Within marketplaces, I have always been fascinated by the ride sharing guys. Because of the dynamic I talked about where if you did a market sizing exercise five, seven years ago, you were just so wrong. It strikes me that the consumer signal is massive there. And prior to going public and immediately after going public, I think there were real questions about the underlying unit economics of that business. And maybe I do the math wrong, but when you decompose

Lyft's financial statements into per ride economics, it certainly looked to me like by the end of 2019, they were earning something like a dollar plus or minus in what I call contribution profit per ride. Now, they call contribution something else, which is a banana's definition. But I think a contribution as revenue minus gross profit, minus the cost of operations, minus marketing, which is essentially, how much are you making per ride to fund the expenditures in R&D and G&A? When Lyft went public, they, in the fourth quarter of 18, I think it was they were losing like 20 cents a ride on that basis. You read the S1 and you looked at this and you looked at their history and you said, no, this actually is an upside down economic model. And then by the end of 2019,

one year later, you had a business that appeared to be making. It could be 95 cents, could be a dollar. I don't know the exact number. But it did seem to prove out the thesis that, wow, this is a unit economic viable business. And now the question is, are there enough rides in the system to cover the R&D and GNA that they spend? And you could probably start to conclude yes. And both they and Uber, obviously at that time, we're pointing towards EBITDA break even in the near future. So I think the dynamic there is interesting because to this,

day in spite of that, it does seem like the bias and the prejudice is against them being good businesses. I think the other issue is what we talked about. The network effects aren't quite as dominant as they may be in other areas. Uber in particular is a horrendously complicated business to get your arms around because multi-product, multi-country. But I am intrigued on the ride-sharing side. Food delivery similarly is one that I think is even less proven than ride-sharing because we don't really have a pure play logistics operator out there. I'm very anxious to see Dordash's numbers and try to perform a similar calculation as I've done on Lyft, because not only will that give you insight into Dordash's economics, but then you can start to map that onto Uber Eats and the logistics

businesses that Just Eat Takeaway and Delivery Hero and some of these other folks are building around the world. So again, looking at these businesses where demand is very high, consumer signal very strong, but there's still an element of scoffing or perception of silliness persists. And is there an opportunity there? And, you know, it's TBD. I think obviously you have to talk about the impact of macro and rates and all that. Certainly, we have seen a surge in demand for two things. One is businesses that have duration, their cash flows are long in the future, and then businesses where the certainty is very high. I think it's actually two. different strategies. It's a quality bias and then there's a growth bias. Because there are

businesses that grow five, six, seven percent a year where their pricing is every bit as anomalous, you would say, historical to past valuations as the growth stuff. And it's because of the very high level of certainty that people are ascribing to the business models and certainty of terminal value there. I think that's one time of business. The other is obviously the long-duration high-growth companies were culminating on September 2nd, there was just a rush into businesses growing 20, 30, 40, 100 percent, and people saying, I am willing to pay a very high price for this in a very low-rate world. So that dynamic cannot be avoided because the bifurcation of the market from the last time we talked when we both were sort of commiserating over the

struggle that value and other strategies had undergone and how spreads were somewhat elevated. Well, spreads today are other than looking at March, April timeline of this year, they're still at historical anomalies. So that bifurcation, I think, is something that everyone has to wrestle with and how does it close? Because history says it will. I'd love to try a new experiment as we try to steer the podcast towards really educating people on businesses and business strategy, you point out, like, that's the new toolkit, right, is understanding competitive strategy, positioning, product, et cetera, by exploring a single business in a little bit of depth. And I think with you, it's hard to choose a business other than interactive corp.

And so I'm going to ask a series of questions that all refine through time, but hopefully will become somewhat standardized with a whole bunch of different guests to really learn from unique aspects of individual businesses. These can be points of inspiration. They can be points competitive analysis, more than anything, they should just be fun. And so I think the way to begin on interactive, a business that you know very well, is that just ask what the most unique or interesting aspect of that business is relative to others that you've explored. I think what's very interesting about them is, and I've never actually heard them express

it this way, but when I think about what their core expertise is, it's pretty simple, which is acquiring and monetizing users in a digital environment. That sounds incredibly sort of mundane. But if you look back at the history of the company from 99 on, they were very early into online dating, into online ticketing, into online travel, online home services. In each of these, and even we can talk about their search and applications business, which is probably the best example because it's such a silly product,

is that they are maniacally focused and maniacally talented at taking a product and figuring out ways to bring users to it in economically efficient manner and making a lot of money doing it. And certainly there's a lot behind that. They've figured out how to build products that people love and all that. But they have oriented themselves in very large end markets with high growth ahead. and they have figured out how to operate in them in economically attractive manner. And they've done it across so many markets and so many times that you would say there's a repeatability to it. So if you look at an investor, you say, is there a persistence to their strategy?

You would have to conclude that after 20 years, 25 years of doing it, there is a persistence to their success in finding new digital and markets to enter. and acquiring a bunch of customers and making a lot of money on. Maybe we could take a step back and assume that someone very smart is listening, but somehow has never heard of Interactive Corp and its story. And you could describe briefly the background of the business, sort of how it came to be, and literally what it does and what it's done through its history. That would be a complicated exercise.

I think the best way of describing it is it has been Barry Diller's vehicle for making investments in the digital landscape. There was a period of time in the late 90s where there was a traditional media component to it and all that. But if we just focus on the main drivers of value over time, what they have successfully done is what I just said, which is they have entered large growing and markets that were migrating from offline to online and made a ton of money in them. And travel is they were very early in travel. They ultimately acquired by the end. They had Expedia.

they had Hotels.com, they bought TripAdvisor. That business was spun out into its own because the online travel market is an enormous market and that business could stand on its own. But so they were very earlier to that and talking about taking friction out of a process. No one our age remembers what it was like to deal with travel in a pre-digital world. But you can only imagine you're calling hotels, you're calling multiple airlines. is, hey, how do I get to Boston two Tuesdays from now? What are the available flights? You could just think of that process.

So digitizing that process, they were very early too. And Expedia has obviously gone on to be one of the two largest global OTAs. Online dating, a market that they purchased Match very early on. They purchased OKCupid, plenty of fish. And then they incubated Tinder, which has revolutionized the dating category by virtue of its mobile first nature and global presence. So another and market. They had bought Ask Jeeves, a sort of also ran search engine, and that combined with a desktop toolbar business that you and I would probably never download a desktop toolbar, but a lot of people did. They managed to make a couple hundred

million dollars a year in Ibetah in this business for a long, long time, and it funded a lot of what they did. So over time, they've moved into travel. They owned Ticketmaster at one point. And And then in 2008, having already spun off Expedia, they did what was called the Quad Spins, and they broke up into a bunch of companies spun off ILG. They spun off Ticketmaster. I'm going to forget all them, lending tree. But essentially, they deconglamatized. And Diller has said they are the anti-conglomerate.

And from there, they rebuilt the business around Match. And then subsequent to that, a business that they owned and it operated for a long, long time and not gotten much traction in service magic, which was rebranded as home advisor. And there, that business is now undertaking the exercise of becoming the dominant on-demand player in home services. And now they're looking to plant new flags. They just bought Care.com. And that was a business I knew well, which was a public company and was really struggling

under the weight of being public, not having much capital, and really stagnating. And I'm enormously optimistic about that because if you think about the world today, value of child care. Just look at the challenges people are facing in COVID. I don't think businesses are going to go forward without having some sort of benefit for backup care for their employees. And that plays right into the market that care.com plays on the business to business side. And then on the business to consumer side, they've spent something like $400 million in advertising of the last decade building that brand. They bought the business for $500 million. Just finding new verticals to bring that expertise that they have.

and figure out way to delight customers and make a lot of money doing it. Can we say a bit more about that expertise, specifically the secret sauce or the ways in which they are so good at bringing people into these ecosystems? And one thing you've mentioned over and over again, it reminds me of Rich Barton's idea of power to the people, which is that many of those businesses, fundamentally what they did great was surface information for consumers easily on the internet. And whether that's what flights are available or who wants to go on a date or whatever it might be, is that the primary driver, do you think of their repeated success, was just

making stuff legible to software and consumers in the internet? I think I don't want to disparage them. That might be giving them a little too much credit, because in many cases other than Tinder, they certainly, I don't think they were the category initiators. I think it was more that they had the ability to very early on spot that those were going to be big end markets and that someone else had figured out this legibility issue. So I think it's like one step further in the process, but what they then did was turbocharged that exercise. I'll be honest, because I'm not an operator, because I'm not on the inside and having seen how other folks would try to scale these businesses versus how they do, I don't really know why they are so good at it. I know in talking to them and their

executives and people have left and people have competed against them, people find them their machine-like. They're very workman-like. They don't have utopian dreams. They are very workman-like in what they're trying to do day in and day out get better and better and better. And the digital customer acquisition world is much like that. It is a hand-to-hand battle each day to get customers and you have to do it in an intelligent way with a certain set of skills. But I think it's being very good at identifying these large growing end markets, finding assets that are already there, and then turbocharging them into leadership positions. Can you say more about what you think Diller's superpowers are as a leader of this business

and what makes him so unique because he seems to be such a unique player in the landscape? Look, again, I have not spent any time with him, so I don't have that firsthand knowledge. I've read many of the books and articles talking about his sort of interregnum in the early 90s when he was looking for his next thing to do. And at the time, he went to go visit with cable operators, media operators, and he saw QVC. And it really changed his view on where the world was going and probably kickstarted the entire interactive exercise,

which was he saw the two-way communications involved in someone putting on a TV show and then viewers at home interacting by calling on and buying. And that the hosts were speaking to, to the audience. So that was really a foundational experience from him. And whether it was pattern matching or just incredible foresight, he was able to leverage that learning and say, not dissimilar, right? If you read the Everything store, if you read the background of Jeff Bezos, he was at a hedge fund. And he said, this internet's going to be huge. I got to figure out how to get involved. And I think to Barry Diller's credit, he saw that two-way interactivity was going to leave

the traditional media world in the dust. And the future was finding a way to participate in that. He's traded a bunch of assets. He's bought. He's sold. He's made a bunch of mistakes. But they've been able to find these big growing end markets and participate in them in enormous fashion. If anything else, do you find fascinating about it that others out there might not know as sort of a closing thought for why have you spent so much time exploring this company? I think it's curious, as the company has noted, in the current environment, that people put conglomerate discounts on them and they have a couple billion dollars in cash, so effectively haircuting cash. And there are SPACs trading at 8 to 20 percent premiums to cash. But even

leaving aside the SPAC phenomenon, if all you said was this is in a vehicle that has compounded mid to high teens for 25 years, which any asset manager would kill for. They are sitting on a handful of cash to be deployed. Perhaps the usual market skepticism is this isn't going to go well, but you would think that they would get the benefit of the doubt in that situation, but they certainly don't. So I think that's one thing overlooked. And then two, I think rather than myopically fixating asset by asset,

which I understand why people do, I mean, if I was new to the company, the first thing I would try to do was understand each asset and what's it worth and why is it doing what it's doing. I do operate from one level above in thinking about what their core expertise is and saying, okay, how is that core expertise being applied to each of these assets? I think that might be a little nuance. I'm never arrogant enough to say, I'm thinking about this business completely different than anybody else or anything like that. I might have slightly different frameworks to do the analysis. But there are a lot of very smart people who spend a lot of time thinking about interactive. If people are interested in interactive and want to study other companies, what would be the

one, two, or three related other companies that you would encourage people to go explore? Well, I have friends who, if I don't say, Liberty Media, will probably stab me when I'm not looking. So it's a similar type situation where it's owner operators with very, very long track records in the media and communication space. So that's certainly one. Look, there aren't a whole lot trying to do what they're doing in the public markets. Certainly, Facebook and Google have aspects of it because they acquire companies and move into different areas. Facebook probably more so because they, I think something that's super interesting about Mark Zuckerberg and Facebook is they're hyper aware of whenever the next platform shift occurs.

They have done everything in their power to make sure they are participants in. that. They've placed some bets that may not end up being correct, but they've been very aggressive in looking for big, large growing markets. It's sort of where the world is going and playing there. I would never draw comparisons between the two because Facebook is the best non-search ad unit ever invented. It's connected half the world. Instagram is the digital shopping mall. But whether it's Oculus, whether it's WhatsApp, thinking about what are the future large consumer and markets and how can we participate there is one that comes to mind. But sort of in a small and mid-cap scale, Interactive is relatively unique in this sort of repeatable process of find end

market, enter, spit out company as standalone, do it again. Well, this has been so much fun as every single one of our conversations is. I learned a ton new stuff, new things to think about. As always, thank you so much for your time. Great. Thanks so much. If you enjoyed this episode, you can sign up for a new email newsletter sent out each week called Inside the episode. Each week I condensed that week's episode to my favorite big ideas, quotations, and more. I've been recommending books to members of this email list for years, and we'll keep doing so in this weekly email. You can sign up at investorfieldguide.com forward slash book club.