The Dodo Club (52nd Edition)- Making Good Money (5) – Early Birds (and Art) (2)

My Bi-Weekly Guide

Continuing the theme of renewal, we have taken a step away from some of the personal challenges mentioned in the previous couple of Newsletters – although I am glad to note that Mary’s arm is healing much more quickly than we expected.  The surgeon and the physiotherapist have clearly worked well.  

We are currently drinking in art history in Verona and the surrounding areas.  I can thoroughly recommend the excellent Siân Walters and her Art History in Focus organisation for both online lectures and in-person excursions.  

One of the real highlights has been visiting the Scrovegni Chapel in Padua with its beautifully preserved frescoes by Giotto.  It is awe-inspiring both visually and emotionally, and the survival of these works of art in situ for over seven hundred years is little short of a miracle.   

Making Good Money – Growth (and Art)

As introduced in Newsletter 48, we have been exploring a number of factors relevant to making good money in the broader (and narrower) sense.   In the last Newsletter, we focused particularly on one of the key factors in this, growth, noting both its importance and also the necessity of combining this with attractive competitive strongholds to generate sustainable value.

In this Newsletter, I’ll suggest that being an “early bird” in potentially emerging business areas is an under-appreciated, and hence under-deployed, approach to generating sustainable value.  Opportunities are being missed not only for individual private enterprises to prosper but also for this to accelerate the development of benefits to all.

Let me first return to Giotto as an - admittedly stretched – illustration.  Giotto and his team finished decorating the Scrovegni Chapel in 1305, more than a century before artists like Fra Angelico, Donatello and Bellini ushered in the flourishing of what we now refer to as the early Renaissance.  And these artists inspired household names like da Vinci, Michelangelo, Raphael and Titian.  I believe, however, that none of these artists would have flourished without learning from the artistic innovations and materials introduced by Giotto, and without Giotto’s style becoming appreciated by their patrons.  

Giotto was an early bird in breaking away from the flat, stylised art of the Middle Ages and, instead, showing figures and nature in more lifelike ways, with volume, recognisable emotions and a degree of perspective.  In the following detail from the Scrovegni Chapel, you sense the genuine tenderness in the kiss between Joachim and Anna at the gate of Jerusalem after they have been made aware that they will be blessed with a longed-for child – Mary, who will become the mother of Jesus.  

Giotto became a much sought-after artist and personally rose from a humble background to fame and wealth.  He generated significant financial value alongside the artistic value that inspired a subsequent creative era and a legacy lasting centuries.

Digging into these kinds of details can be very helpful in deepening our appreciation of a work of art and, in that spirit, we will now dig a little deeper into pointers for Early Birds!

5 Pointers Towards Early Bird Success:

1. There’s more to value than growth expectations (but they are important too):
   In previous Newsletters, we’ve noted how growth expectations factor into financial valuations, and these expectations will be raised for participants in fast-emerging markets.  However, the anticipated growth rate is just one of the two components necessary for generating substantial financial value. This also needs to be underpinned by securing competitive advantages that can sustain value creation above the cost of capital. Competitive Strongholds need to be built and sustained.  An inability to do this is behind the disappointing performance of several companies that have entered the energy transitions arena, in contrast to companies like NextEra Energy and Tesla that still maintain substantial market value.
   

2. Opportunities for the Early Bird to secure competitive strongholds:
   The Early Birds that sustain success manage to secure competitive advantages through locking-in key supply chains, integrating tacit knowledge that remains obscure to others, developing key advanced markets and accessing key policy supports. This has been possible through early actions in advance of competition.  While success is never guaranteed, securing long-term competitive advantage may be possible through such early moves, but these opportunities will be lost to later followers facing greater competition in more transparent business conditions.
   

3. Asking the right strategic question:
   An understandable, but often misleading, human bias is to over-emphasise the significance of the present moment and to consider “change” as proceeding from today at either a slower or faster pace.  The types of questions this mindset stimulates are how to position for faster or slower changes and what signals will indicate on which pathway the world is proceeding.  As outlined in the previous Newsletter, however, competitive dynamics most frequently drive change to be explosively fast once the stars align to tip a competitive equilibrium.  The appropriate strategic question is not “faster or slower from today?” but “will the stars align earlier or later?”.  Up until the stars align (technology, policy, premium markets, business pioneers, supply chain orchestration), change will appear to be on the slow path to those who have been asking the wrong questions, and they will then be caught out by the often-explosive pace of change once it takes off.
   

4. Weighing up potential regrets:
   The timing of take-offs can never be predicted with any accuracy in advance.  The strategic question then becomes whether it is better or worse to be a little early or a little late in investing in a potentially emerging area.  The potential regret of investing to be an early bird may simply be disappointing returns for a period until take-off actually occurs and substantial rewards can be secured, while the potential regret of waiting may be foregoing significant long-lasting economic value because of a poor competitive position.  In my experience, unfortunately, most investment evaluations used in large organisations neglect this perspective. Adopting this more appropriate framing, however, my own evaluations indicate that it would already be economically and commercially shrewd for businesses to invest seriously as pioneers in many areas that are primed to take off during the timescale of energy transitions (see also Smart Business).
   
   (For those interested in a more mathematical underpinning of this insight, a simplified analysis can be found in this linked Appendix.)
   

5. Spotting the tipping points triggering future growth opportunities:

   Asking the right strategic questions can guide early birds towards sustainable success.  Where may the stars align in the foreseeable future, where may competitive strongholds be secured in advance, how will rapid change disrupt the relevant business landscapes, and when do the advantages of being an early bird outweigh the potential disappointments?
   
   As outlined in the previous Newsletter, in considering the first question, a leading think-tank has recently published an overview of realised and anticipated energy-related tipping points (see Systemiq Report).

In summary, this Newsletter has taken a deeper dive into pointers for Early Bird success.  I hope this is a useful guide for readers in many kinds of situations to realise the idiom “The early bird catches the worm” and to avoid the traps suggested by the idiom “The second mouse gets the cheese”!  Certainly, in the energy transitions and industrial decarbonisation arenas, we will all benefit from accelerated change driven by successful early birds and their encouragement.

Our next Newsletter will take a closer look at the next factor identified in our first edition on “Making Good Money”, and that is “sweet spots”.

Rearranging the formula to focus on time-window guidance (T < -(1/r)ln(2-X)), and using a discount rate of 7%, suggests that with an X estimated as low as 1.5, then serious pioneer investment should still already take place now if the timing for take-off is estimated to be within 10 years.  With an X of 1.7, that would be take-off within 17 years, and with an X of 2, that would be with take-off happening “ever”! 

What this suggests is that it would already be sensible for more businesses to invest seriously as early birds in a number of areas that are likely to take off during the timescale of energy transitions.  The failure to recognise this is not only a lost opportunity for individual businesses but also an overall drag on transition that affects the quality of life for us all.  

Please note: 

The arguments presented in these Newsletters are not providing investment advice and suggesting that you will generally find good investments for your funds wherever you find a high value ratio or high growth.  Such a high ratio, however, may be a signal that a company has been able to generate competitive strongholds of some kind.  If you are able to identify the nature of these and subsequently conclude that they are sustainable and expandable, then that may become an indicator of a potentially attractive opportunity.  

Question of the Fortnight: 

Where have you seen early birds succeed or fail? Question of The Fortnight

Every fortnight, I’ll be asking a thought-provoking question in hopes of sparking interesting and enlightening discussion.

I’d love to hear your response! You can do so by simply responding to this email.

Today’s question is:

Where have you seen early birds succeed or fail?

Appendix:

The following simple model can give guidance in grappling with the too-early/too-late dilemma and should also give investors more confidence in early-bird moves.  

The exact timings of market take-offs are completely unknowable.  However, these will generally fall within relatively clear boundaries.  For example, the conditions for the take-off of hydrogen fuel use will eventually come together under the pressure of grappling with hard-to-electrify/abate sectors and green ammonia/fertiliser production, but this could happen soon, or it could take as long as another decade or so.  In these types of situations, leading economists (e.g. Arrow and Hurwicz) have shown that decision criteria should logically only be based on outcomes in the boundary cases.  And the most sensible (risk-balanced) criteria to adopt is to minimise the regret of either a disappointing outcome from investing or a missed opportunity from not investing.  

With a “window” of time “T”, it is possible to compare the cases of investing now (i.e. taking an early bird position) or investing at time T.  Of course, there is also the option of choosing now to invest at some intermediate time, but it can be shown that adding this option doesn’t alter the insights or outcomes from the analysis.  

So this model reduces to a “2x2” matrix, with the axes being the Market taking off Early or Late and the Business choice being to Invest either Earlier or Later.

As a simple model of outcomes, it can be assumed that the Investment is C, that the Value generated by the investment is XC if it perfectly hits the market take-off wave and creates the aspired competitive advantage.  However, the value generated is only C if it is late in entering the maturing competitive arena (i.e. only a cost of capital return). Also, it can be assumed that the discount rate is “r” for converting future value estimates into current Present Value.  

With these assumptions, and the time scenarios being either now (Time 0) or T years from now, the Net Present Value table can be constructed as follows:  

From this, the following “Regret” Table can be constructed.  This shows the regret for an action compared to the “best” choice for each scenario, and hence the maximum regret associated with each choice.

For the minimum regret under uncertainty to be to invest early, then C(1-e^-rT) should be less than C(X-1), which is equivalent to X > 2 - e^-rT. 

The form of this expression makes intuitive sense.  The case for being a pioneer depends on the expectation of generating a high Value Multiple (higher X), and this needs to be higher if there is potentially a long wait for take-off (higher T) and a higher discount rate (r) for the inefficiently sunk Capital prior to take-off.  

The usefulness of this expression, however, is that it helps in getting a feel for the key considerations involved, e.g. how large or small might X need to be and how does this match up against potential time windows of, say, 5, 10, 15 or 20 years?  

As indicated in Newsletter 50 , for example, a value multiple in the range of 1.5 to 2 may be a reasonable proxy for an investment in a growth area underpinned by secure competitive advantages.

What this suggests is that it would already be sensible for more businesses to invest seriously as early birds in a number of areas that are likely to take off during the timescale of energy transitions.  The failure to recognise this is not only a lost opportunity for individual businesses but also an overall drag on transition that affects the quality of life for us all. 

The Dodo Club Online Course

If you would like to learn more about the kinds of topics covered in these Newsletters, then please consider signing up for the introductory online course.

This covers scenario/systems thinking for grappling with uncertainty, an introduction to energy transitions, and the development of strategic character in leadership.

In the interest of avoiding the fate of that unfortunate bird, the Dodo, this course aims to help us secure our own personal legacies within a changing world and the energy transition - and to leave a healthier planet for future generations.

You can access the course through Udemy using the link below!

A series of follow-up courses that treat the main topics in increasing depth and detail will be provided if there is sufficient interest.