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WCM Investment Management | Insight | Beach Reads 11 - 24 | Welcome to a somewhat shorter Thanksgiving week edition of Beach Reads.
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Beach Reads

November 24, 2020

Welcome to a somewhat shorter Thanksgiving week edition of Beach Reads. If you only have a brief moment to read before taking a post-turkey snooze, then I highly recommend heading straight to the thesis on Mexican retailer FEMSA and the interview with Eugene Wei. Below, I outline the articles covered in this edition.

  • Disruption: Understanding the innovator's dilemma
  • Insights on two companies: FEMSA and McDonald's
  • Thoughts from Eugene Wei on networks and scarcity, and a podcast with Dennis Lynch
  • Reflections: Learning from the past and predicting the future

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Conor Deveney

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ABOUT Beach Reads

Welcome to Beach Reads, a collection of interesting links that we at WCM have come across and want to share. The goal of this publication is to engage with a broader audience in order to better ourselves and others. Feel free to email us at insights@wcminvest.com with any thoughts or feedback, and click here to subscribe!

01. Disruption: The Innovator's Dilemma

Intel's Disruption is Now Complete

With a striking headline, the author of this Medium post argues that Intel's inability to keep pace with competitors now puts it at risk of ARM-based chips beginning to erode its "last refuge: the server business." While previous Beach Reads have highlighted Intel's struggles, this is the first post I've come across that looks at the involvement of Clayton Christensen, author of the 1997 book "The Innovator's Dilemma," with the company. The then-CEO of Intel, Andy Grove, worked with Christensen to better understand the famous innovator's dilemma: "The causal mechanism behind disruption that Grove so quickly understood was that even if a disruptive innovation started off as inferior, by virtue of it dramatically expanding the market, it would improve at a far greater rate than the incumbent," the article says. Grove's Intel disrupted itself by introducing less profitable products that compensated for the cannibalization of existing ones through much higher volume, which helped the company to fund additional R&D. However, the author says Intel lost sight of this after Grove retired as chairman in 2005 (he was CEO from 1987-1998), most notably when it missed out on providing chips for the first iPhone because it preferred to stick with its highly profitable design and manufacturing model rather than chase a high-volume, lower-margin business by fabricating Apple's designs: "He might not have realized it at the time, but when Grove was reading Christensen's work, he wasn't just reading about how Intel would go on to conquer the personal computer market. He was also reading about what would eventually befall the company he co-founded, 25 years before it happened." With companies in practically every industry vulnerable to the innovator's dilemma, understanding risks posed by a lack of flexibility is key in forecasting the future for businesses.

The next big thing will start out looking like a toy

This article also cites Christensen's "disruptive technology" theory as it examines why incumbents often downplay the Next Big Thing by likening it to a toy. "Disruptive technologies are dismissed as toys because when they are first launched they 'undershoot' user needs," the author says. A literal example that quickly comes to mind is free-to-play video games such as Fortnite, Roblox, and Among Us, which are challenging the hegemony of traditional, AAA video games. Having said this, the author makes an important point about the interplay of external and internal forces regarding the adoption of toy-like disruption: "To distinguish toys that are disruptive from toys that will remain just toys, you need to look at products as processes. Obviously, products get better inasmuch as the designer adds features, but this is a relatively weak force. Much more powerful are external forces: microchips getting cheaper, bandwidth becoming ubiquitous, mobile devices getting smarter, etc. For a product to be disruptive it needs to be designed to ride these changes up the utility curve." Like everything else, timing and circumstance appear important in enabling disruptive technologies. But perhaps identifying important tailwinds and then producing a toy-like product that takes advantage of that trend is a good recipe for successful disruption.

02. Company Theses

FEMSA: The Most Interesting Company in Mexico

This long form thesis on FEMSA is worth reading if you are unfamiliar with the Mexican retailer. In the piece, the authors highlight how FEMSA can and should capitalize on the ubiquity and popularity of its physical network of OXXO convenience stores in order to unlock a large digital opportunity. Describing the popularity of OXXO stores, the authors write: "Every day, 14 million, or more than 1 in 10 Mexicans, shop in an OXXO. An average of 735 people frequent each small OXXO per day, and most multiple times per week. When the OXXO is only two minutes away, people can visit OXXO more conveniently and frequently than they visit most websites." With a large and loyal customer base, the authors see OXXO as being capable of building a "super app" that would partially come in the form of a platform for payments and other digital transactions, along the lines of China's WeChat and Alipay, or Indonesia's Gojek: "Building the digital wallet is a multi-billion opportunity in its own right. But it also means grabbing the lead position to add more services and build the leading Mexican, and potentially Latin American, SuperApp." To sum up: "The bull case for FEMSA is that it leverages its distribution advantage and consumer touch-points to launch the leading digital wallet in Mexico."

Takeaways from McDonald's remarkable comeback

The recent turnaround at McDonald's, started by former CEO Steve Easterbrook and now stewarded by Chris Kempczinski, centered around the overarching idea that the company had become too complex, offered too many food items, and that stores had begun to look worn out. The solution was "a simple decision that is surprisingly easy to get wrong: go back to basics," this short Economist overview says. "From 2015 onwards, it pared back its array of menu offerings and focused on price and quality." Illustrating the adage "never let a crisis go to waste," the adaptations have continued during COVID, partially made apparent through digital initiatives: "McDonald's has used the crisis to step up the pace of its transformation, resulting in big sales surges in recent months, especially in America. With the interiors of many of its restaurants closed, it has relied on the roll-out of its digital, drive-through and delivery initiatives, all of which encourage a more 'contactless' experience that it believes will outlast the pandemic." Coming out of COVID, I'm curious to see how digital investments continue to pay off. 

03. Investing Philosophy

Status Games: Engineering Scarcity in a World of Abundance

This podcast and accompanying article featuring Eugene Wei tie together a lot of recurring Beach Reads themes. The article provides an overview of 12 ways that scarcity is artificially engineered to create demand to help kick-start network effect business. Wei, whose work is often featured in Beach Reads, argues that networks are built first on scarcity, then pivot to utility: "A lot of networks that have achieved super scale had some sort of status incentives or status games built in, very early on," he says. "It helped them to get that kinetic energy that you need in order to achieve scale that then increases your utility. Those networks were paying you to develop the network – paying with ego, with status, with a sort of an emotional payback rather than a monetary one." It isn't so straightforward, though, as managing status is incredibly difficult: "One of the important things to understand in the long run is that managing a network and the status dynamics within it evolves over time. It's the precarious nature of status. We all know that there will be some hot nightclub in New York one year, and then just one day, it will die off and will have to be shuttered and rebranded as something new."

Masters in Business: Dennis Lynch on Global Portfolio Management

In this episode of the Masters in Business podcast series, Barry Ritholtz interviews Dennis Lynch, the co-CIO and PM of investment firm Counterpoint Global. The wide-ranging discussion covers Lynch's ideas on what constitutes a good investment culture, touches on portfolio management and construction, and outlines his firm's investment process. He also speaks about team member Michael Mauboussin's thoughts about complex adaptive systems and accounting for intangibles (more from Mauboussin here). I enjoyed learning more about Lynch's process and appreciate his unique approach to the world of investing. 

04. Reflections

The Big Lessons From History

Morgan Housel recently published another thoughtful blog post – this one about how to best understand, interpret, and learn from history. Housel, a partner at the Collaborative Fund and a former Wall Street Journal columnist, sums up his thinking toward the end of the piece when he says, "An important lesson from history is that the risks we talk about in the news are rarely the most important risks in hindsight." In other words, the future is unpredictable, and what we prepare for isn't what surprises us. Housel illustrates this point through a number of historic examples, weaving in other lessons along the way. One of my favorite insights: "It's intuitive to think you should either be an optimist or a pessimist. It's hard to realize there's a time and a place for both, and that the two can – and should – coexist. But it's what you see in almost every successful long-term endeavor." Balancing the good and the bad, being prepared and understanding that you can't always be prepared – embracing and living these contradictions appears to be a recipe for a happy life.

The Next Decade Could Be Even Worse

Talking of optimism and pessimism, let's end with this article from The Atlantic, a fascinating (albeit depressing) foil to Housel's piece. The author profiles Peter Turchin, who has come to believe that he can predict the future by applying mathematical models to history. And he's not exactly upbeat about the coming decade: "He has been warning for a decade that a few key social and political trends portend an 'age of discord,' civil unrest and carnage worse than most Americans have experienced. In 2010, he predicted that the unrest would get serious around 2020, and that it wouldn't let up until those social and political trends reversed. Havoc at the level of the late 1960s and early '70s is the best-case scenario; all-out civil war is the worst." So…yay. Underpinning Turchin's analysis is a trove of data, which has highlighted a 50-year cycle: "In 2012, Turchin published an analysis of political violence in the United States, again starting with a database. He classified 1,590 incidents—riots, lynchings, any political event that killed at least one person—from 1780 to 2010. Some periods were placid and others bloody, with peaks of brutality in 1870, 1920, and 1970, a 50-year cycle." Only time will tell how accurate Turchin turns out to be. However, I'm reminded of allegedly similar phenomena in the economic world: does anyone remember the Kondratiev wave, partially popularized by Joseph Schumpeter? Another ~50-year cycle, the Kondratiev wave is an apparently identifiable phenomenon that explains the timing of expansions and recessions. I wonder how well that maps onto Turchin's models.

And on that optimistic and uplifting note, I'll wish you all a Happy Thanksgiving!


 

Disclaimer: To the extent that Beach Reads discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. The companies and or securities referenced and discussed do not constitute an offer nor recommendation to buy, sell or hold such security, and the information may not be current. The companies identified and described do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the companies identified was or will be profitable. Beach Reads does not constitute a recommendation or a statement of opinion, or a report of either of those things and does not, and is not intended, to take into account the particular investment objectives, financial conditions, or needs of individual clients.

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