A Pace Layer Approach To Investing | The Acquirer's Multiple®

In their latest episode of the VALUE: After Hours Podcast, Brewster, Taylor, and Carlisle discuss A Pace Layer Approach To Investing. Here’s an excerpt from the episode:

Jake: This segment is on pace layering and it comes from this guy, Stewart Brand, who is an author and he’s a thought leader on a bunch of– He kept up this compendium, I guess you would call it, of the earth. He’s just done a lot of interesting work. I got to give a shoutout to my boy, Paul, in Ireland who reminded me about this topic when we were having a chat. I’d read this paper a couple years ago and then just totally forgot about it. But it has to do with how do you manage change and how do complex systems learn and keep learning. It was actually born out of a study of architecture. Like how do the different parts of a building change and how often do they change?

Going from fastest to slowest, and this is what Brand laid out at the very beginning, was things like stuff, the furniture and paint, those things turn over the fastest within a building and then the space plan, like the layout within it can change, non-load bearing walls, things like that. Surfaces, water, power, things like that change then at a slower rate. The skin of it changes, the exterior, and then the structure the skeleton of it, and then finally, the actual land site itself. This pace layering, it makes sense from architecture, but it also has a bunch of other explanatory power for different domains.

My background here shows the order that Brand lays it out in and moving from fastest to slowest. Fashion, and then commerce, and then infrastructure, then governance, and then culture, and then finally nature. So, Brand says that, “Fast learns and slow remembers. Fast proposes, slow disposes. Fastest is discontinuous, slow is continuous. Fast and small instruct slow and big by a crude innovation and by occasional revolution. Slow and big controls small and fast by constraint and constancy. And fast gets all of our attention, but slow has all the power.”

There’s a Mother Nature equivalent of this, which is there’s a hierarchy basically for the scale and the time, the size, and the amount of time that changes. First, the needles of a pine tree change annually with the seasons. The tree crowns that the needles grow out of change over several years. The patch of trees changes over decades. The stand that’s like a combination of patches changes every hundred years or so. And the forest every thousand years-ish. And then, the biome over tens of thousands of years. And so, all of these things have this interplay between them.

Actually, the turbulence and the slippage between the boundaries of these pace layers is where all the interesting things are happening. That’s where there’s a lot of uncertainty, surprise, innovation. It’s almost like intertidal zones in the ocean where there’s a lot of action that’s happening where the ocean meets the land. There’s a lot of animals, there’s a lot of energy exchanged. If you’re picturing plate tectonics from looking at this, you’re probably thinking about it.

Let’s make this a little bit more concrete. Per Brand, if commerce, that layer is allowed by the governance and culture, which is a slower changing thing. To push nature at a relatively fast commercial pace, then you risk the loss of that natural support of forests, and fisheries, and aquifers, and all the natural resources that support all the layers above it. Any governance system in that little middle area that doesn’t change– If it changes slower than culture and nature, then it ends up typically being in a revolution. And so, think about earthquakes that happened from the fall of the Soviet Union or the French Revolution. That governance layer wasn’t changing as fast as culture was. And so, perhaps, China today might fall somewhere within there, if they have a very ossified structure of governance that’s not adapting. That’s just a hypothesis. I’m not saying that’s true, necessarily.

It’s interesting that as people get older, their interests tend to drift more towards these lower layers and less towards the higher layers. Older people, they tend to lock in their clothing choices and their hairstyles from decades ago. They’re not as concerned about fashion. But young people are much more interested in fashion and less so in things like culture, languages, and religion tend to fall into that culture. Whether it’s social media, memes, or dance crazes, or whatever the hell’s going on that has this lifespan of a fruit fly, it tends to be young people who are in that kind of mindset and the older people are thinking about some of the slower-changing things.

The job of fashion and art is to explore the space and push boundaries and provide activation energy for commerce. Think about the automobile redesigns that happen every year. There’s a refresh of every single car and its design. And occasionally, good ideas sift downward from these upper layers and then get installed. This is how these pace layers are able to incorporate change, and make progress, and learn actually, but without allowing the whole system to just get out of control.

Infrastructure typically has long payback periods, like to build a bridge that’s going to run for 50 years. It often requires the intervention of a governance layer. The commercial world doesn’t think in such long timeframes. Of course, this can also go horribly wrong if the government is this guiding hand that’s misallocating capital into projects that turn into things that people don’t actually end up wanting like Go City’s, things like that. We talked, I think last week about Russell Napier, his recent interview where he talked about how Capex being guided by the hand of government over the next decade. I would say keep your eyes open for the potential of a misallocation of capital over the next 10 years.

Another interesting thing is that these deeper, slower-moving layers, they turn exponential curves into S curves. Something that seems to be going exponentially like a rapidly dividing bacteria in a petri dish, it runs into a resource wall, like nature slows it down and now, you end up with an S curve or even falling over. 19th century robber barons, the Carnegies and the– [crosstalk]

Tobias: Vanderbilts.

Jake: Yeah, the Vanderbilt’s, those type of guys. They ran into this governance layer of the Sherman Antitrust Act. You could say Amazon Prime really got going and was able to do this “free shipping,” because they really leaned on this creaking infrastructure of the US Postal Service for a long time until eventually it was forced to invest in its own infrastructure, all these delivery vans that you see driving around now.

Anyway, the different things that you can analyze with this pace layer mental model, I think, offer some interesting insights. Maybe it’s not the be all end all of mental models, but it’s something interesting to filter through as you’re looking and evaluating as far as how are things changing and how do successful systems actually integrate change into them so that they don’t become too brittle.

Tobias: That’s interesting. JT. Many investors try to avoid things that are fashion. Is that the same fashion? Avoid that high paced–?

Jake: Yeah. Right. To understand, let’s say that you could buy a hula hoop company for half a book value or energy company for half of book value. Which one would you maybe hang your hat on more of having relevant staying power and eventually becoming not being just a flash in the pan necessarily. This might help you to sort out where does something fall within that.

Tobias: How would you describe energy? Infrastructure? Commerce?

Jake: Yeah, probably somewhere in between those two. Maybe even nature. The physics of how we all live is based on hydrocarbons today. So, you take that peg out and the modern world just collapses.

Tobias: What about stuff like payment systems? Is that commerce or is that infrastructure like Visa, MasterCard, that kind of stuff?

Jake: Yeah– [crosstalk]

Bill: I’ll go with infrastructure.

Jake: Yeah. Definitely, the rails of the Visas and MasterCards seem very infrastructure like.

Tobias: So, rails are infrastructure.

Jake: There’s something– [crosstalk]

Bill: I think a lot of software as infrastructure.

Jake: Yeah, I think so. Maybe this is the difference between maybe a social media network being a little bit more in the fashion area and a little bit less in the infrastructure area as far as– [crosstalk]

Tobias: That’s an interesting point because I think that that’s true of social media in general. But I wonder if something like– I hate to say it, but I think Twitter’s like– [crosstalk]

Jake: Infrastructure now?

Tobias: Yeah. I think it’s getting towards infrastructure.

Jake: It could be. I read something interesting recently about product/market fit, which is a big topic for a startup. The analogy that was used was that if you don’t have product/market fit, it feels like you’re rolling the boulder up the hill all day long. When you do have product/market fit, it’s like you’re chasing the boulder down the hill.

Tobias: [laughs]

Jake: Twitter clearly found some product/market fit. This whole clown car crashing into a goldmine that Zuckerberg said, clearly, they found product/market fit and have been chasing that boulder down the hill.

Tobias: Yeah. I don’t know, why it’s so hard to run profitably? But evidently it is.

Jake: Yeah. No forcing function to do so thus far? Disintermediated ownership group?

Tobias: Yeah, that’s fair.

Bill: Well, you also have a CEO that doesn’t even care if it’s a company. So, there’s that. Or ex-CEO, who wants it to be a public port of call.

Tobias: Is he doing something in that space– [crosstalk]

Bill: it maybe hurts a little bit, the profit driving.

Tobias: But he was only doing it part time too.

Jake: Yeah. You have a 1/4th CEO.

Bill: Yeah. No, I don’t know for Twitter.

Jake: [laughs]

Tobias: Is that going to close?

Jake: Your guess is as good as mine, man.

Tobias: How do you feel?

Jake: The market thinks so, the spread’s pretty minimal now, isn’t it?

Bill: No, I think it’s [crosstalk] line.

Tobias: I saw it closed up and blew up.

Jake: It’s 52 now.

Bill: Yeah. But you’re talking about what like a week? Ah, 53.

Tobias: 53.

Bill: Yeah. All indications are that they’re going to close.

Jake: That seems like all downside there, if you’re trying to make that bet today.

Bill: Yeah. Well, you just need one thing to break. This is the problem in merger arb generally. You’ve got a lot of little wins and then you get whacked.

Jake: There were times where that spread blew out though pretty good.

Bill: Oh, yeah. Oh, yeah.

Jake: It’s not always picking up pennies in front of the steamroller.

Bill: No, that’s right. There are people that are really good at merger arb that made really good careers out of it. It’s just generally as a risk skew, not my favorite.

Jake: Yeah, definitely truncated known upside and deleterious downside.

Bill: Yeah. I feel like too you got to– You don’t have to do anything, but I feel I would have to size it. I don’t love stuff like that.

Jake: So, you’ve got to lever it up. That’s what I’m hearing.

Bill: Yeah, that’s right, and bro down.

Jake: [laughs]

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