An investing idea from the world’s sweatiest financial conference

I went to a conference yesterday. It was called “Camp Alphaville”, and it was set in a bunch of enclosed (non-air-conditioned) tents in Central London. In 34 degree heat!

I went to a conference yesterday.

It was called “Camp Alphaville”, and it was set in a bunch of enclosed (non-air-conditioned) tents in Central London. In 34 degree heat!

Look, I’m not saying that Novak Djokovic had it easy out on centre court yesterday.

All I’m saying is, Djokovik didn’t have to keep up with a debate on the finer points of investing strategy with a notebook on his knee, perched on the edge of a tiny plastic stool, in a greenhouse.

Great day though. Speakers flew in from all over the world to talk about pretty much everything.

The “Greatest investor in history”, 27 year old Max-Hervé George, talked about his impending takeover of Aviva Insurance…

The “transhumanist philosopher” Zoltan Istvan explained his plan to live forever…

The economist Brad Delong worked the room from Berkeley California, via a motorised robot with a screen for a head…

The short-seller Dan Yu boasted about his attack on Quindell, the dodgy insurance company…

The former Chief Financial Officer of Enron explained his part in the biggest accounting scam in history…

… And about 27 economists chipped in with their thoughts on various complicated macroeconomic debates. They’re probably still arguing.

Here’s how it looked by the way:


The path to Godhood

Towards the end of the day when the temperature had dropped to a balmy 28 degrees, one talk in particular caught my attention. It was titled “The Winner Takes All Model – the Path to Tech Godhood”.

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“Winner takes all” is a big idea in the world of technology investing. Winner takes all markets are those where a couple of the very best companies take over the entire market, leaving nothing for their competitors.

In ordinary markets, a company grows by making products and selling them to customers. And it gets bigger if it is able to make its products more cheaply using economies of scale, and then beat its competitors on price.

So what’s different about winner takes all markets? Well often, a company in a winner takes all market creates a network – like Facebook, for example. A network gets more valuable the more people use it. So over time, the company which owns the best network takes over the entire market. And they’re getting more common.

Why is this happening? Here’s how we explained the idea in our paid newsletter last year:

“eBay is the best place to sell your stuff online because it has the most buyers. And eBay is the best place to buy because it has the most sellers. That’s why it’s so dominant – why would you use any market other than the busiest?

It’s the same with Facebook. Or with the Microsoft Windows computer I’m using to write this newsletter. All of these are examples of something called network effects. Network effects are the holy grail of online business.

The economist Noah Smith tells a good story about network effects: he asks his MBA class to raise their hands if they like Facebook. Nobody does. Then he asks them to raise their hands if they’re on Facebook. Everybody does.

Network effects make a good product or service more valuable the more people use it. If a network can attract enough users to begin with it can create critical mass, whereby the bigger it gets the more attractive it is to new users. Growth feeds more growth, until the network ends up as a monopoly. And as an investor, a monopoly is my favourite business model! Network effects are the reason eBay is a $70 billion business.”

So what does this mean for investors? Well, winner takes all markets tend to pop up very suddenly, out of nowhere. If a small business is very very good at bringing people together, it can harness network effects and grow incredibly quickly.

I’ve been looking into this for the last few months. I’m trying to work out exactly what characteristics these businesses show before they make it big. More on that in future issues of Penny Sleuth.

Best wishes,

Sean Keyes
Penny Sleuth

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