Quick snippets from our morning read on Monday, 26th April 2021
Scaling is important in business, but what are the consquences that coming with scaling in business? In today’s morning read, we read about the challenges that comes with size or business growth.
Two scientists, Aaron Clauset of the Santa Fe Institute and Doug Erwin of the Museum of Natural History, explained why in a paper that is dense but summed up in a wonderful sentence: “The tendency for evolution to create larger species is counterbalanced by the tendency of extinction to kill” off larger species.
Body size in biology is like leverage in investing: It accentuates the gains but amplifies the losses. It works well for a while and then backfires spectacularly at the point where the benefits are nice but the losses are lethal.
Size is nature’s leverage. Sought after for its benefits straight up to the point that it ferociously turns against you. Same thing applies to companies and investments.
Facebook might fall into this category. Network companies only work when they’re huge, and the huger the better. But huge has a downside. I would bet no Facebook senior manager had heard of Cambridge Analytica, or the personality quiz it scraped data from, before most of the damage was done. Five million companies advertise on Facebook.
The important point here is that these companies didn’t get big because of greed or ego. They got big because economies of scale made them more efficient. Economic evolution pushed them that direction, naturally and rationally, so they could do their job better. Cope’s Rule in action. But that same force pushes them straight up to a level of self-destruction that can undermine all the previous gains, even put them out of business. That sounds crazy, but it’s been happening in nature for hundreds of millions of years. So of course it can happen in Mountain View in 2018.
There are two takeaways, neither of which is “don’t get big.”
One is that everything moves in cycles. You can’t extrapolate the benefits of growth because growth comes attached with downsides that go from annoying at one size to catastrophic at another. Rising valuations that come with investment growth is the clearest example, but it’s everywhere: Headcount, media attention, AUM, and influence have downsides that can eventually grow faster than their benefits. Remembering that volatility is attracted to outlier growth puts many things about business and investing in context.
The second is size is associated with success, success is associated with hubris, and hubris is the beginning of the end of success. Some of the most enduring animals aren’t apex predators, but they’re very good at evasion, camouflage, and armour. They’re paranoid. I always come back to the time Charlie Rose asked Michael Moritz how Sequoia Capital has thrived for three decades, and he said, “We’ve always been afraid of going out of business.” Paranoia in the face of success is extremely hard but in hindsight it’s the closest thing to a secret weapon that exists.
You can read the full insightful article by Morgan Housel here.
And as always, if you enjoyed this, check out the rest of our daily snippets, curated daily, right here on The Red Notebook.
