Moore’s Law Will Comeback With Vengeance

During his recent interview on The Acquirers Podcast with Tobias, Bernard Horn, founder of Polaris Capital Management discussed Moore’s Law Will Comeback With Vengeance. Here’s an excerpt from the interview:

Tobias: When you look at the investment landscape now, some would say that the COVID shutdown has created some unexpected inflation. There’s an argument that it’s transitory. How do you think about that, and put it into your investment process if you would?

Bernard: Yeah, I’ve been saying for years– I’ll come back to this when it comes to our investment process, but for years, we’ve been analyzing a great deal of deflation in the prices of the goods and services that the companies that we can invest in. They’ve had a very difficult time pricing higher than inflation. When I worked at Gillette, the product managers in the 70s because of all that inflation, their instruction from the C-suite was to be sure that your products were priced ahead of inflation. Pre-COVID, that was not so easy, and many companies have had a very difficult time doing so.

But I think going into COVID, we were in a period of deflation. Coming out of it, we had this biggest working capital cycle in the history of business. You shut down the whole global economy. You don’t have any sales coming in, so, you collect all your receivables as quickly as you can. Pay your payables off if you can, work your inventory down, and don’t order anything, because you don’t know looking into the abyss, when the economy is going to restart. It’ll be a few weeks, it’ll be six weeks, then turned out to be a quarter, and it was two or three quarters.

But then, when everybody restarted that global economy, the working capital cycle has restarted. It’s the first time that the global economy has restarted all at the same time. Yes, there are shortages. I think you throw in the stimulus, shutting down schools, so parents can’t go to work, daycare is not there, people being paid unemployment insurance as a safety net, but that’s sticking too long probably from where it is. So, this restart of the working capital cycle clearly is putting upward pressure on companies, and they’re able to actually raise prices, which is for the last 10 to 15 years and longer for many companies, a real newfound thing.

Some managers have never been able to raise prices. Now is the first time they’re actually out there raising prices. They’re feeling pretty good about it, and the one thing as far as a transitory question you’re asked, the one thing that I see, that reminds me a lot about what I just spoke on in the 70s is that companies are telling us– We asked them, “Gee, you’re getting all these price increases. You’re can’t ship stuff. How are you dealing with those costs?” The normal answer pre-COVID was, “Well, we’re getting hit by higher energy costs, but we’re able to save money over here, because we can’t pass it on in pricing. Therefore, we’re having to really keep our operation running more and more efficiently all the time,” and that’s a continuous improvement process. Today, you ask the same question, and they’re saying, “Well, we’ve negotiated with our customers that we can pass along the price increase.” That’s happening more and more. It almost reminds me of that period in the 70s.

As far as is inflation going to be transitory, I would have said pre-COVID, not at all. Its Moore’s law will come back with a vengeance, and it will drive prices down, and if that doesn’t do it, low-cost countries where people are willing to work 50 weeks a year, seven days a week with two weeks off, that deflationary pressure on labor is going to persist. Look, I think it’s probably going to be– I think that those powerful forces of the deflation forces are probably going to come back, but in certain sectors, we’re definitely seeing pricing power that we haven’t seen in 15 plus years. I think it will be a little bit longer than transitory, but of course, the definition of transitory in the minds of central bankers these days– Central bankers have been trying to create inflation for over a decade. If that’s their definition of transitory, I don’t know what it really means for us in terms of inflation pressures, but yeah, I think that that’s the– Yeah.

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