“S” Adoption Curves | The Acquirer's Multiple®

During his recent interview with Tobias, Matt Joass from Maven Funds discussed “S” Adoption Curves. Here’s an excerpt from the interview:

Matt: Yeah. We think a lot about the limiting factor of the business. One of the big areas we disagree, I think the whole framework of how we think about investing is slightly wrong, because we think about return on capital as being the primary limiting factor and endpoint, which is definitely how the world was, but I don’t think it is anymore. I guess, capital is now so abundant that I don’t think it’s a limiting factor in a business. You can think about it like there’s a lot of different inputs to a business, we’ve just chosen capital has been the one that we typically measure, generally investors, but you could say something else. You could think return on land. Every year, they get some province, they reinvest in more land, but you don’t think that because it’d be ridiculous because businesses, that’s not the constraining factor.

It’s the same for a lot of the technology businesses we look at. The constraining factor isn’t the capital, because there’s so capital-light and looks like, if you actually calculate the return on incremental capital for high-growth technology, it’s just so large, it’s like abstract, it’s not really a factor. I think often for it, it’s more of the adoption curve. We think a lot about like S-curves of growth, which is like the derivative of the adoption curve, if you look at how things go. So, we’re trying to find when they’re inflicting at the start of that adoption curve. That’s how I think about modeling it, basically. It’s trying to think of at what rate will adoption happen as things I can do to tip adoption forward. That’s probably the best inflection point if I can find it as that hypergrowth just getting up that phase of the S-curve. I think that’s also why it’s undervalued.

People tend to linearly project forward, I don’t think we think exponentially. We just can’t basically, our brains don’t work that way. Everything I do– that’s why I say I’m a value investor still, as I’m still thinking of pockets of mispricing. Basically, at the start of the S-curve, people project linearly forward, but the S-curve is going to start going like this. Then, that starts, people have to constantly rewrite and realize what the business is going to do. At a certain point, at the top of that S-curve, people are projecting forward too much, and the S-curve starts flattening out, and that’s when you want to start getting off. That’s why I think valuation still matters because I think if you’re never sell land, and you just get caught in that, if there’s not another S-curve to catch you, I guess, you get caught there. Thinking about that is the limiting factor, I guess, of the business, that’s more so than capital.

Tobias: That’s an interesting comment, because I did notice that when I worked in a reasonably high-growth telecom company for a long time and never earned more than 13% on equity but grew six times over 10 years because they were raising capital and reinvesting in a very hot ride, the natural question from that is, how do you know where you are on the S-curve?

Matt: Yeah, good question. I think it’s just having a good idea of the market size itself and talking to people in the market and get an idea of who’s adopting really. If you have a really good idea of the market size and who the other competitors are, you can see how much they’ve signed up of that business. If they’re starting to get into the mainstream and then late majority, that’s when you start tipping past that point. That’s probably the main thing, is having a really good idea of what stage of the lifecycle just by knowing market share, basically for all the participants. Not really market share because they’re creating the market as they go. It’s more like total adoption share. You do start to see it– I think this all just fits basically, Peter Lynch talked about sell when they’re not growing earnings anymore, because you do start to see it come through in the fundamentals. I think that can be a trap for a lot of quality value guys, because they see a really great company that has a bad quarter and that’s where often people want to pounce, I think it can be the worst time if it’s because they’re starting to flatten out. So, they just spinning their wheels now because they’re not getting those early adopters.

There’s a real book that influenced me, Crossing the Chasm, and it’s another one where a lot of companies just get stuck even earlier than that, where they don’t kind of talk, it’s not actually a smooth curve. There’s this chasm between the two, between the early adopters and the early majority. That’s probably the hardest part, I think you see some early traction, but maybe they just stall out there. They never really make that jump from being something that’s good enough for really passionate techno or whatever people to everybody else.

Tobias: Just too hard to use to get across from that first group of prepared to where the arrow is.

Matt: Yeah, I think that’s a tool to use, and maybe the technology is just not there, or maybe they haven’t really solved the problem well enough, because the first people willing to close their eyes and endure a lot of pain to use your product, a lot of people if they get too cocky with that stage, they’re not constantly thinking bigger and improving and what they can do.

Then, it just often we just see it stall out. Maybe it’s bad management as well. That’s why you need to think of the management team really there to be a global company. Because it’s hard, man. I’m not managing a global company. The more I learn about it and culture and everything else, I have an appreciation for these guys, how hard it is to grow a business to be 500 or 1000 people. It’s just phenomenally difficult. I think Andreessen had a– or maybe Paul Graham had a line that most startups self-destruct, they don’t get destroyed by a competitor. I think that’s the biggest thing by far, is just looking for avoiding those signs of self-destruction.