VP CHINTAN BAITHAK GOA 2016: A Self-Reinforcing Business Model?

Accelerated Learning
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@Donald read through your explanation of the model. It seems to me that Self Reinforcing Business Model seems to have a strong dose of Network Effect.

Pat Dorsey described Network Effect as

Businesses that benefit from network effect are very similar; that is, the value of their product or service increases with the number of users

Now, this is strikingly similar to your examples, quoting one here

The more Business Segments you have, you bring in more adjacent customers. The more customers come into the addressable pool, the more business segments you can serve. The more business segments you can serve, the more Retail Points of Sale you can address. The more Points of Sale you have they bring in their own set of new Customers, which again addresses the customer pool …and better targeting …

Dorsey exemplified Network Effect in Card Networks (Visa, Master, Amex) due to their huge network where the cards are accepted. The more places you can use your Amex card, the more valuable that card becomes for you. The more valuable it is for you, more places would accept the card. He further explained that Network Effect is much more common among businesses based on information or knowledge as information is a “nonrival” good as called by economists.

Now these explanations are quite applicable for the BFL example. The Core competence of BFL being Analytics engine (per your note) which is clearly knowledge. BFL has done well to create a huge network of points of sale and responding to customers at “velocity”. The better network and velocity of BFL leads better value for customers and then to stronger network has been described well by you

It impacts Customer Cross Sell - Why? because it has in-built customer Sales and Risk Profile (Payments history). The more BFL Cross-Sells the Richer is the Sales/Risk Profile. The Richer the Sales/Risk Profile, the faster is the Approval Velocity. The faster is the Approval Velocity, the better is the Customer Experience. The better is the Customer Experience, the more he is pre-disposed to a Sale. The more Customers take the Loans, the more delighted is the Retail Partner. The more delightes is the Retail Partner, the more likely he is to recommend BFL.

So I’m trying understand the delta between Self Reinforcing Business Model and Network Effect. It’s just easier to add to model than getting a hang of a completely new model :slight_smile:

Thanks!

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Network Effect is good to notice. You are quite right about that. I have not studied the Credit Card industry dynamics, but from personal experience - I guess that there is ONLY the Network Effect at play there. Customer Mining, Customer Experience are all pretty standard across the Cards. There is no big differentiator among Visa, or MasterCard, though Amex may offer a few more premium facilities. Undifferentiated Product

Anyone who attains some scale, network effects may start to follow. Does that mean its always teh first-mover who continues to take all the Moolah away will be over-simplification…that will be the wrong conclusion to make. That’s the peril of lazy short-cuts, the System1 think Daniel Kahneman warns us against.

Google wasn’t the first Search Engine or Browser, right…so the answer lies deeper in the understanding of the business. What causes Network Effect to come into play…and Perpetuate? Why is there a Hugely Differentiated Product

Hugely Differentiated Product/Service + Network Effect - is a better way to think.
But I must warn all the SMARTS against the dangers of over-simplification like this. Unless you get down to the nuts and bolts of the moving parts of the business - your understanding of the business will be very very superficial. Our mind always finds it easy to use lazy System1 thinking, but makes us feel smart about our decisions. Whereas usually its the reverse - we must learn to use the more deliberate and hard System2 thinking to expose the weakness of above shortcuts.

Its better to work your way very hard from the bottom to the abstraction upwards. The insights that are gained in the process are so powerful - yet the most simple.

Rishi - You haven’t gone deeper in the diagram. What causes the differentiated product is better to focus on. Learn to ignore the seduction of System1 thinking (its tough, i know), but train your mind to go deeper into asking why? Why? An easy way to avoid System1 seduction - I have found is to ignore all Labels, Moats, Patterns - that seduce us - instead keep asking why/what/how this business is becoming special.

I always go back to what Mr D never fails reminding me
Remember Kungfu Panda: Secret Sauce…and finally the realisation - There is no secret Sauce :wink:

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By extension , I read that there is more than Network Effect at play at BFL and in the thinking of Self Reinforcing Business Model. I agree and my point was that Network Effect seems to be a big part of it, the reason of using “big dose”

I would doubt this. Network effect is where value of product/service increases with more users and vice-versa. This does not follow scale and actually it’s not that common to find this in large companies. Suggest reading Network Effect explanation by Pat Dorsey in any of his books. Maybe the close relationship between your thinking and the message would become more apparent.

The mind works best by tagging new experiences with older ones. On the other hand, learning comes from continuing to question existing beliefs. This process takes time and in no way I had implied that I had gone deep down in the diagram especially when I consider NBFC industry not core to my competence. Though learning new models is always fascinating!

Cheers!

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Ya sure, will do that, Thanks.
We have just come up with an apparently strong hypothesis. Have to let things sink in organically, and apply consistently. As we apply more and more and become good at identifying self-reinforcing models, will be the right time to expound more.

We have just taken baby-steps :wink:

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A model/framework is POWERFUL when it is SIMPLE.

SIMPLE to me means, when it is easily implementable - does not mean it will come easy. An untrained mind will struggle to get there, I struggled for 2 months to get here. Once here, I can now do it for every business - either it exhibits self-reinforcing characteristics, or it doesn’t. SIMPLE is repeatable.

SIMPLE is also, when I can use this to describe the business, using as few words as needed. The smarter the recipient, the lesser words are needed. Communication is almost instant (Semantics Gaps are fast eliminated). When that happens a few times to you, 3 things happen

  • YOU KNOW, YOU UNDERSTAND (something about the business),
  • the RECIPIENT KNOWS, YOU UNDERSTAND
  • you and the RECIPIENT, start a virtuous circle
    I am in the business of Conviction-Building across the board, all my life (First in Product Management, and now in Investments for last 6 years), so I believe I know a thing or two when I encounter something SIMPLE, and therefore POWERFUL.

I have been evangelising BFL for last 2 months and more, without buying a SINGLE SHARE till I could translate my enthusiasm to a simple diagram of the moving parts of that business. I was completely convinced I was on the right track though, as I kept evangelising to learn more. Finally on 20th July night Sandeep Kapadia helped me nail-down the picture. Some events unfolded since then, now I KNOW I KNOW.

Point is, how to make this useful for everyone?
For example, I KNOW I can do the same for a PI industries, and a Shilpa Medicare. Doesn’t mean it can be done for an Ajanta Pharma, I will struggle there without much of a clue. I certainly would ask the Ajanta Management when I meet them next to elaborate to me the moving parts of its business - key activities, key resources, success metrics, and performance culture that feeds on one other, reinforcing one other. The dialog may or may not establish self-reinforcing model or not - it surely will make for a richer understanding of the business.

Similarly if someone comes to me saying a Syngene, or a Wonder La, or an MCX exhibits a strongly a self-reinforcing business model at work, I think it will not need much debate if the idea generator can talk this language of moving parts of a business model, the causality model - what affects what, and what moves the needle the most. If I am a Fund Manager, I would start insisting every Analyst starts talking this language.

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We have often been asked to explain why Team VP style of investing works?

With this now, I am more clear and positively coming round to articulating why and how the VP process/model of investing in Early-Stage businesses work. The way I see it - the most important part of investing in Early-Adopter kind of companies (apart from getting as good a feel as we can on Management Quality, and Business Quality) - is to KNOW WHAT TO LOOK FOR, 6 months down the line, a year down the line, 2 years down the line.

If we tried to understand the Business as well as we could - we would have a “Moving Forward Hypothesis” (for want of a better word) of this early-adopter business 2 years down the line. I could not articulate it at all initially, just focused on understanding as much as we could - put as much as possible on the Table.

What I did have always worked out though in my mind, was the clarity about the NEXT LEVEL for these businesses. For a Mayur, it would be when they could get in a BMW, Mercedes in its Order Book - that would have meant it has crossed the Chasm definitively for me. for a PI Industries, it meant large scale Commercial Success fro one of its 13 R&D stage innovator molecules; for PI it also meant when the Innovator: Generic agro chemical sales would reverse? For Shilpa, it was when would it breakthrough in Japanese/Chinese Markets?

Not saying we had a very clear picture everywhere, but my largest allocations/de-allocations in businesses would be on what I could clearly hypothesise as a very plausible picture happening/not-happening in 2-3-5 years. So when there was no progress on that Mayur - whole of 2014 and 2015, I had no option but to exercise a gradual sell off after holding for 5 years. But where there was definitive progress, it meant I would allocate more.

This basic thought process was always there, the hunt for understanding the next level of the business was always there, hunt for what moves the needle the most was always there, just didn’t know then - that it worked best if we could articulate with clarity the moving parts of the business, or its causality model.

As we have matured, and are exposed to smarter and smarter folks, we are also getting better at articulating why there seems to be a process behind successfully investing in early-stage companies, even before they have crossed the chasm.

We believe the quest for a self-reinforcing business model is at the heart of the VP Investment style in early stage emerging businesses. When we can decide for ourselves if a certain business we are investigating exhibits the characteristics of a self-reinforcing business model (in parts or full), we will know for sure if the Business is becoming STRONGER or WEAKER in the years that we are invested in. It will help us progressively make investments in that business more, as the business gets stronger. It is not merely Luck, there is also a HARD-CORE Process behind that.

Although we could not articulate it well before, I am convinced now - this was and is our Secret Sauce - trying to understand the business and moving parts as well as possible - to be able to hypothesise the next level for that business, its moving parts, its key activities, resources, and success metrics - and what moves the needle the most - that is the key to Understanding the Business and its Vulnerabilities (read Risks) and thus Valuation of an EARLY-STAGE business - key to successful investments in these businesses.

In other words even when you know you cannot assign a Terminal Value to these early-stage emerging businesses, there is surely a way through that madness!!

Obviously a self-reinforcing business model (if it exists) will be exhibited most strongly when it has successfully crossed the chasm, and has joined the ranks of early stage maturing businesses. That’s when the Impact will be the most powerful, because it is simple, for everyone to catch.

To catch 'ere that, we have to work that much harder at the ART form :blush:

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At the risk of adding clutter to this thread, let me congratulate you yet again in bringing up such a powerful insight . I was getting a little disenchanted with valuepikr over the last several months as there was a lack of thought provoking discussions which were clearly breakthrough and not incremental. This is one such exercise.

In my B school, we were introduced to a course called systems thinking and we had the best professor of the course teaching that. It was based on a seminal book by Peter Senge Called The Fifth Discipline : The art and practise of a learning organisation. This is a must read book for all and the causality that you describe is the reinforcing loop which is very well covered in the book. I am not sure if you have read this book. It also covers other archetypes like Limits to growth which is the reverse of the reinforcing loop as to why things would collapse.

The whole idea of disproportionate growth that we had discussed over three years ago is based on the reinforcing loop archetype. The growth can only be disproportionate if the previous element in the loop somehow provides a bigger push than the earlier one till the whole loop achieves a velocity that is ever increasing. This has also been very well described by Jeff Bezos when he talks of the flywheel while talking of the Amazon Model very early on.

I always wondered how some people are so good at identifying successful businesses so early and they do it with an uncanny regularity. I agree with you that it is an art and more of a business model identification exercise than a mere look at numbers like PAT/ROE. You are on to something very important.

Regards

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@piy_sharma
Fantastic value-add. Your posts always add some intellectual rigour to our home-grown exercises. I have never forgotten the beautiful way you had summed up about the “Disproportionate” Smarts enunciation. To quote, verbatim

My takeaway from this analogy is that we should look for companies which have laid the building blocks for disproportionate future growth. Laborious stocks will produce a rupee worth of incremental growth for the extra rupee of incremental input. It is not a one to one relationship but an extra rupee wouldn’t produce two rupees of incremental growth in this category. Smart companies will produce disproportionate growth.

Re-energised to read up on the Fifth Discipline. Ordered it on Amazon Prime to get it tomorrow :wink:

Thanks again. Will have to get in touch with you, this time.

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The book is absolutely brilliant. it is a core concept of Operational Excellence and helps in viewing problems/business holistically. Also, it helps u identify the key competitive advantage of a business.

I remember making one for eBay when i was working there. And the key competitive advantage of ebay/amazon is their ability to build trust. If sellers trust them they list more, if buyers trust products more they buy more. So while to to external eye pricing, discounting might appear they key component but actually its this trust engine. In bajaj its the risk engine.

i am attaching a very simple system diagram of how to work smartly & an index to read system diagrams.

to make them we can use the free tool called Vensim.

sterman-repenning-sd-diagram.png752×588 40.5 KB

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Business Models that generate virtuous cycles - Ryan Air

blob.jpg912×621 201 KB

The concentric circles of opportunities and the virtuous circles goes well with some of the successful companies that we keep discussing here and because the concept is new (at least to me) I tend to apply it to every company in my portfolio and torture my mind to bend the business to fit into “that” business model. This is not the way I wanted to use this learning and therefore I started thinking about businesses where the same virtuous circles are in play but in a negative way.

From the article

“Our research also shows that when enterprises compete using business models that differ from one another, the outcomes are difficult to predict. One business model may appear superior to others when analyzed in isolation but create less value than the others when interactions are considered. Or rivals may end up becoming partners in value creation.”

This made me think why not pick the competitors of your business and see if they are going through the negative virtuous circle and whether that has anything to do with what your mind thinks is a positive virtuous circle that your business is currently enjoying. Perhaps the company having bad virtuous circles are giving away market share to those who are going through good virtuous circles? What could be causing this and where do these business models interact/intersect that might be causing this?

Example: I am tempted to pick Ujjivan Finance as a example and examine its business model in comparison with its competitors such as local money lenders, public sector banks and other NBFC’s. Perhaps the local money lenders in Tamil Nadu are loosing market share to MFIs? PSU banks inspite of being in existence for decades have not done enough to provide real banking for the unbanked. MFIs with their business model have taken a stab at this market and are strengthening their virtuous circles by reducing their dependence on PSU banks. My intention was not to diverge in to a MFI discussion but the emphasis was to look at business models of rivals and see how they inter-play, and understand whether businesses are strengthening or weakening their virtuous circles.

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@madhug
Fantastic value-addition again. The article that you referred to is a “hidden” gem again. I find it fantastic because it clarifies very cogently the inter-related but essentially distinct levers a learning organisation has at its disposal for creating/sustaining its Unique Value Proposition - Business Model, Strategy, Tactical Responses.

The best part is there are lots and lots of examples that can open up our minds on what makes for self-reinforcing business models

Thank you Madhug. But we demand that next time when you point us to such beautiful resources, you must write a para or 2, what you liked/valued in the article. Else, in our information overload and even scarcer time for reflection, we can miss “Gold” even after being pointed to. I insist you write a para or two on a follow-up post immediately please - come out of your shell :), so we can appreciate more - the topic, and your well-hidden qualities😉

Everyone needs to “care” (learn to care) to add a para or two for any link we provide - we add value to ourselves, and help the community qualify and prioritise what to pay more attention to. Guys, don’t tag “likes” here, vote up Madhug’s link - and Piy_Sharma book recco post - 50 times - yes that’s how valuable these resources are. That way, everyone will be curious to learn more, read more through great stuff as these, that will make more of us reflect more on such an important topic. Consequently, this discussion will be far richer, we will be richer :blush:

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Got my hands on the Updated Fifth Discipline book by Peter M Senge, yesterday, and started leafing through it this morning, and after just 5 pages - started jumping up and messaging my investor friends and Guru friends :slight_smile:

Most MBA students might dismiss it from earlier reads (as something known, already), but there is huge value-add in the new version. Here are my enthusiastic initial comments s sent to friends, so treat them with a good pinch of salt, but hey you cant ignore this seminal value-additive topic, anymore!

The latest edition is significantly improved - with 100 new pages - the author stresses how the complexities in the world has changed drastically over last 15 years since publication, and how in latest version - the scope has widened that much more - and more learnings incorporated from discussions with other leading management thinkers of last 15 years, and the refinement in the fifth discipline practice of last 15 years in major corporations around the world. There is an entire new section, Part IV: Reflections from Practice

Fifth Discipline - the Art and Practice of the Learning Organisation - and am mesmerised - just the book I needed at this stage of our quest in Understanding Complexity (Systems Thinking), Mental Models and Reflection, and Aspiration (Personal Mastery, Shared Vision) - as described by The author Peter Senge. Rated as one of the most seminal management books of the last 75 years by Harvard Business Review, sold more than 2.5 million copies worldwide, in its first edition.

Amazed again at how things HAPPEN - when the quest is intense and sincere. P sharma responded to our self-reinforcing model thread at VP quoting Senge, and highly recommending us to read the book saying - you guys may be onto something!

After a very long time I am reading a Management Book - and I am hooked - because it combines a bit of everything we are grappling with at the moment - Art side of Investing and its Practice, Science and what is measurable and reinforcing loops, Fallacies in Thinking, and Power of Win-Win Collaboration in Investing over Competing, and more.

Highly recommended reading for the “Curious” - on what makes for a superior business?

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Madhug,
That is a interesting perspective. Although we always do a proper Peer Comparison to place the Competitive strength in perspective, this is a new way of thinking for me. Thanks

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Just came across one of Warren Buffet’s letters where he is describing a similar self-reinforcing business when he writes “and so the circle goes round and round”

http://www.berkshirehathaway.com/letters/1989.html

If you haven’t been there, you’ve never seen a jewelry store like Borsheim’s. Because of the huge volume it does at one location, the store can maintain an enormous selection across all price ranges. For the same reason, it can hold its expense ratio to about one-third that prevailing at jewelry stores offering comparable merchandise. The store’s tight control of expenses, accompanied by its unusual buying power, enable it to offer prices far lower than those of other jewelers. These prices, in turn, generate even more volume, and so the circle goes round and round. The end result is store traffic as high as 4,000 people on seasonally-busy days.

  • Big volume
  • Buying power
  • Tight control on expense
  • (Lower price + Large selection) to the customer

Leading to more volume and the circle repeats itself. Nebraska Furniture Mart, Costco, Amazon and Netflix immediately come to mind as having similar models.

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@piy_sharma: Second your thoughts. This is what the VP ethos is about.
@Donald: Thanks for initiating this thread!

Couple of things I would like to share:

  1. I recently read a very topical article on athletes and the Olympics. The key takeaway (as has been stated several times in this forum) was the importance of the process and not the goal. The article emphasises breaking a goal down to its component parts and focusing on excelling in those. This is true for not only for Olympics but also for investing: where we have to focus on doing the small things right today (endurance/ strength/ fitness a.k.a. fundamental analysis, understanding the DNA of the business, financials…) for the payoff (qualification for Olympics, medal…compounding multi-baggers) which may or may not happen in the distant future

The article gives the real life example of an athlete who was is prime position to win her favoured event (800m olympic qualification) but tripped and fell 100m from the finish line. Instead of getting down on herself she focused on what she needed to do right i.e. focusing on her next event (1500m) for which she qualified! Worth a read.

My long winded point being this thread goes back to “separating wheat from the chaff” (signal) philosophy as opposed to “is this stock the next PAGE/ GRUH/…multibagger” (noise) :slight_smile:

  1. As I read through the thread I was reminded of high school chemistry - Auto Catalytic reactions. This is a mental model that Munger has talked about in his letters. Basically it is a self sustaining chemical reaction where a product of the reaction acts to catalyse the reaction further. This leads to a Sigmoid (i.e. hockey stick graph) like non linear effects. So to para-phrase the HBS article “choices and consequence building on each other leading to desired business outcomes”. This mental model provides a way of looking at the business model from an inside out vantage point.

  2. However, as the HBS article states, we also need to evaluate how the model interacts with other models (outside in vantage point). This where I am in my learning curve.

Thanks once again.
VD75

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Please advise the Author?