#240: The Long Tail by Chris Anderson, Misuse of Metcalfe's Law, Constellation Software's Long Tail, Thoreau's Walden...
“Mass culture will not fall, it will simply get less mass. And niche culture will get less obscure.” - Chris Anderson
Hello! This week starts with a series of essays about the Long Tail and Network Effects all intertwined. It starts with my book notes from Chris Anderson’s book, the Long Tail. What better way to prime yourself for the next two essays on how our application of Metcalfe’s law may be inaccurate and applying the Long Tail concept to one of my core investments—Constellation Software.
The premium essay the past week was the fourth installation of Berkshire Hathaway letters. This was a pivotal one for myself as I found the letter that dispelled years of misinformation and misquotes by the greater investor community. At least, in how they seemed to interpret what Buffett said and how I took those learnings. Turned out, Buffett preferred great management over great businesses.
Then, I reflected on letting go of Thoreau’s Walden and taking an “L” there. After which, I share some introspection on everyday gratitude and narcissism in writing.
As always, feel free to pick and choose from the categories below and I hope one of the things I wrote is of some value to you.
Business & Investing
Culture & Systems
Introspection & Habits
Business & Investing
The Long Tail by Chris Anderson
Review & Rating: Uplifting & Informative / 10
This is a book I wish I read ten years ago. Implied in the wish is a timeliness of the book. That’s not to say the Long Tail model discusses isn’t timeless. But Anderson's application of the model with various businesses and stories gave me the visceral reaction of lamenting my misfortune at not reading it sooner.
The accuracy with which Anderson’s views played out made me feel “oh god I’m too late to the game” at various moments. Though this effect was great in magnitude, it lasted a few minutes. The majority of the time was filled with hope and awe at how lucky I was to be alive today, to be in an era where the Long Tail was getting fatter and fatter for weirdos like myself.
Now, you may wonder what is this Long Tail? Ask Google. If you’re still interested, then this book may be worth a read to gain another perspective on the topic. That was why I read it.
If I were to summarize the book in a sentence, it would be: the internet allows niches to thrive. But you wouldn’t read for summaries. You read for context and the joy of the literary adventure. What is life without adventures?
Sometimes, a book can push the reader to start his own adventure. Sometimes, it works as a cheerleader supporting a past decision to start the adventure the reader is already on. The latter was what this book became for me.
Book Notes:
Read my notes here
Rethinking Metcalfe’s Law
Enter a room of investors and entrepreneurs and it would be hard to leave without having heard the term network effect. It’s network effect this, that, and everywhere.
Network effects have been considered the be-all and end-all of business models. In the “if you could pick only one” of competitive advantages, many would scream for network effects. Incubators and venture investors have decided to exclusively look for network effect businesses and I don’t blame them.
Network effects reference Metcalfe’s law to explain the concept. It’s not a real scientific law. It’s a law from empirical observation that states an additional node in the network has exponentially greater value. So 5+5 doesn’t equal 10 but something like 20.
Think of it like Facebook. It got more valuable to you when more of your friends went on it.
Scaling networks can appear limitless thanks to the internet. Combined with human optimism and exuberance, we can argue for Metcalfe’s law taking effect in all kinds of companies (i.e. network of homeowners, car-owners, dog food, some bloody software). But what if people are basing everything on an incorrect understanding of an empirical law?
The article that inspired this thought is here.
Consider the effect of Ziph’s law, which is what the Long Tail is about. Practically, the 1st place is valued at K and the second place is valued at 1/K…so it’s worth half as the 1st and so it goes. This shows a view that each additional increase to the network is less variable than the first (i.e. the 80/20 of book sales, songs, movies).
Ziph’s law (i.e. the long tail) is why e-commerce stores will thrive online as niches. It’s why Amazon’s limitless online catalog trumped the physical limitations of brick and mortar shelves. Amazon was able to capture every niche audience not covered by the 80/20 selection of brick and mortar.
It’s not that the 1000th item had zero value. Physical stores just couldn’t justify the opportunity cost of shelving niche products. But online businesses with zero inventory costs can.
Metcalfe’s law is predicated on the belief that each additional growth in the network is considered exponentially more valuable (about a quadruple increase in value for every doubling). But the question is whether each network is of equal importance.
We have weak networks and strong networks in our lives. That’s the same for a community. Some of the networks the platform crated will be valuable and some won’t. They aren’t all equal.
Think about a platform business like Facebook with the view of Ziph’s law over Metcalfe’s law. The first 20-50 networks (i.e. friends or followers) may make up the majority of the value for the network with continuously diminishing value for every additional network. Now, it doesn’t mean they are devoid of value and the platform’s ability to supply you with a near-endless supply of possible people to add to your network is valuable. But that’s to a degree as each addition will be less and less valuable to you.
That is made clear by Ziph’s law. But people forget this phenomenon when looking at tech companies and saying they have the chance to get massive because of Metcalfe’s law. There is always a limit to how valuable the network can be.
If each additional network in my life is log(n) instead of n^2, wouldn’t that be applicable to the overall platform as well? Not all networks have the same size and they have a different point of diminution.
Metcalfe had first used the law to showcase a crossover point where the network could become large enough for it to be sustainable. But after reaching this point, it seems irresponsible to think the curve will continue to hockey stick up instead of curving out like an S-curve. All good things come to an end and that’s the wonderful thing about them. Some will last longer than others but it feels we assume too many will last a while.
Constellation Software & The Long Tail
On this thread of Long Tails, does that mean Constellation Software, with its 500+ software companies is an acquirer of long-tail niches?
Frequent readers will be used to how often I write about Constellation and its reference in many of my learnings. It would be apt to add the disclaimer that Constellation’s family of companies make up ~50% of my net worth.
Consider companies like Netflix and Amazon, both businesses that acquire long tail niches with their inventory of shows and products. They acquire small niches that are uneconomical for competitors at a low cost (i.e. customer acquisition cost - CAC). But these niches are important for the users because of how scarce it is and usually result in higher lifetime value (LTV). The result is a higher return on invested capital for the business as you acquire customers for low cost, they stay on longer and so the return from the low cost keeps on compounding.
Is this not the case for Constellation with all the niche software companies they acquire? The weird mission-critical software for livestock auctions, traffic control, notary, legal court systems, hospital administration, all in different languages are all too niche for any VC-backed company to justify pursuing.
Constellation has no inventory cost either since they are a completely decentralized company that doesn’t even centralize most finance, HR, and back-end operating systems either.
The question has long been the number of companies available in the world for Constellation to acquire. But the world is always growing. There will be more people, which leads to more entrepreneurs, and more niches to uncover as the cost of building software companies goes lower.
Doesn’t it make sense that there will be more niche software companies in the future? If the Long Tail is fattening for content (i.e. TV shows, music, movies, books) then wouldn’t that apply to companies like software, food, etc. as well?
I think we will see a greater number of small niche software companies instead of large enterprise software companies in the future. I don’t think we’ll have other Salesforces, Workdays or Oracles. I think it’s possible to see a world of more smaller ones.
Everyone thinks all the $10b software companies can get huge but what if we liven a world with hundreds of $1bn companies? I think the niche software market has only just started getting bigger for Constellation. Today, they are still acquiring companies started in the 90s when AWS and Azure didn’t exist. Being a developer was not cool back then either. Imagine how many more niche software companies will exist in a world where everyone can be a developer, it’s a job with decent pay, the barrier to entry is lower to be a developer and bootstrap a software business?
Applying the Long Tail of content to software businesses, it appears that Constellation is able to acquire niche software at low CAC, high LTV for high ROIC. That’s my grain of salt.
Last Week’s Premium Newsletter
Berkshire Hathaway: Families of the Sainted Seven via 1987-1991 Letters
"Berkshire is my first love and one that will never fade: At the Harvard Business School last year, a student asked me when I planned to retire and I replied, 'About five to ten years after I die.'”
Culture & Systems
Rejecting Walden
The two books I’m writing would fit under the category of “People & Places” per William Zinsser’s categorization. Some would call this travel writing. But what people call travel in the day of bucket lists and Instagram gives me the belief they are mere collectors of pictures and tickers of to-do lists. Not travelers. Still, travel is a wonderful word and I shouldn’t let the mass behaviour of people sully the proper use of the word.
With that, I decided to read Thoreau’s Walden a few months back. Yes you heard correctly. A few months back.
It’s my experience that a great book takes a day to read. A great and long book may take a week. Most good books take a couple of weeks. If a book takes longer than a month, then there is a problem. It’s a failed relationship I’m just sticking out for the kids, not realizing this will make them blame their existence for the unhappiness of their parents.
In this case, I didn’t want to let go for the sake of my ego. “They,” said Walden was one of the best-written books on people and places. Most writers I admired quoted Thoreau and spoke highly of Walden. I wanted to be in their circle. But alas, I had to let it go.
No doesn’t mean never and that’s the case for books. I wrote this fact on multiple occasions. Yet, here I am writing about it again after failing to adhere to my advice and agonizing over how much I disliked reading the book but willing myself to give a shit about Walden pond.
I have no doubt Thoreau is a wonderful writer and Walden a great book. Maybe it just means I’m too early in my development to appreciate greatness. That was the case with Dan Harmon’s show, Community. It took about nine years to pass before I learned to appreciate that show.
Still, I can’t help but feel it such a major defeat to reject a great writer. It feels akin to admitting I’m a young grasshopper that is not ready. But alas, I’ll have to conclude it is I who is not ready for Thoreau.
I may not ever appreciate Thoreau either. I don’t find ponds interesting, and hikes in nature a bore. That’s not to say I love long walks but I love them through a quiet city. I also find America in the 1800s hard to visualize and appreciate. Why is New England special? I still do not understand the fascination with U.S. presidents. But that’s just me today and this may change.
A book is stagnant. It is the reader who changes and it really sucks to admit it but I am not ready for Thoreau yet. I thought I was because I decided I’d be a writer and I’d read some 100+ books now. I thought I would be part of the group of people who understood Walden and could quote Thoreau like I could the chorus of a movie soundtrack.
Not yet. Not yet.
Introspection & Habits
An Ode to Gratitude:
There are so many. First, there’s the window cleaner. I smiled at him as he descended down the cable to clean my apartment window. He reciprocated with a smile back. That was kind of him.
My god isn’t Google Maps amazing? I used to print out maps of cities and carry them around with me when I traveled. Take all my user data, I don’t buy anything anyway. What an amazing tradeoff! Track me all you want, if that means showing when the next subway comes and continues to make my life easier I’m game.
A Confession from a Work in Progress:
Narcissism. Am I any different from the bodybuilder who poses, flexes and stares at himself in the mirror? I loathe such actions so much. But I would be lying if there wasn’t a tiny part of me that was jealous. In honesty, it’s possible the part that loathed him was small but accentuated disproportionately. Because isn’t that another misconception? That how we feel about something needs to have a parallel relationship to how material it is in our scorecard of values?
Regardless, am I any different from him when I write my essays? How can these thoughts I share be any different? If I consider him narcissistic for praising himself with the mirror as a reinforcement of such action, am I no different by sharing my thoughts on a newsletter blasted to hundreds of people? No, I am no different.
Now, I do believe bodybuilding is an art. It is akin to sculpting the self. In a way, how wonderful is that? To sculpt on the base of your human body, a piece of meat that is imperfect in comparison to a beautiful slab of marble that can be cut to precision and perfection. It’s like being told to sculpt using a tree once blasted by lightning. There’s beauty in the work and craft that goes to bodybuilding. I may not find it beautiful personally but that doesn’t mean I can’t appreciate it as a craft on its own.
That’s how I feel about writing. Writing is art too. I’m sure this isn’t a foreign idea to people. So is there a difference? Between the guy posing at the mirror and taking his selfie and me who vomits his thoughts onto a screen for everyone else?