Invest Like the Best with Patrick O'Shaughnessy
· Henry Ellenbogen
[00:00:00] S1: And partially this is our way of going back to school as an organization and partially is our way of giving back to our community. But the class is based on this, and the students literally do about six case studies a year, but over time you build out a library of them. So I would say you just start by basically studying the ones who've done it and then obviously trying to study the patterns of those who've done it. That's number one on how we do it. Second of all, if you go look at the data, they're diversified across the economy. So look, we're in a period of time where what's going on in AI is so impactful. My view on the impact of this is probably no different than a lot of the other speakers you've had. I would say what I think about when I think about the power of AI and really studying it, I don't only think about the companies that are the first or second derivatives, or maybe people would categorize as technology companies. I also think about the existing diversified companies outside of the technology space that could be huge companies here. So as an example, when you go back and you look at the era of cloud and mobile, for sure, you wanted to go own Amazon in that period of time, but actually if you look at retail, once Walmart and Costco really understood what Amazon was doing but still had relative scale, they leveraged their advantages. And since they basically got on the same curve, 62% of all retail has gone to those three. So for sure one might've been better than the other, but actually all three were good. What was the best Russell 2000 growth, or for your investors who don't know benchmarks small cap company, over that 10 year period in the 2010s? Well actually, it was Domino's Pizza, which was a modest growth company, didn't average 10% growth over the period of time. Why was Domino's so good? Well, it turned out having gone back and studied Domino's from the beginning, but obviously owned the stock for some period of time—if you look at the pizza market in the United States, when Domino's started its run, you basically had a third of the market that was local. So probably like a lot of listeners, I have my favorite local pizza place and I like it because the pizza's great. And then the other third, we know there's the nationals, Domino's, Papa John's, Little Caesar's, others.
· Henry Ellenbogen
And then the middle third, there used to be in DC this place called Armand's, that had about 30 places and they had local or geographic scale, but they didn't have the scale of Domino's and they didn't have great pizza. And what happened was when Domino's started its run, well first of all, it started by basically making the product a little bit better. But if you talk to Patrick Doyle, who was CEO at the time and you really study it, what they started doing was if there's three value equations in pizza, it's quality, value and convenience. And what they realized is if we really, really invest in technology, we can make convenience a lot better. And so they really invested in their app and they built a direct relationship with their customer. Very early on, they could then target that customer more efficiently with couponing, what have you, drive scale through that box. And then when you do something well, you improve the product, probably was slightly above average. You really iterate on convenience and now you have a direct relationship with those customers. All of a sudden the brand halo started getting a little bit better because people thought Domino's was with it, and it started to really help the brand. And you put all that together against a wonderful business model of a franchise business model, which is ROI light, you end up with a great stock. One of the things we think a lot about at Durable is which of the companies that are in distribution, trucking, healthcare; who are already good and maybe investing on a different curve, have the ability to use AI to either substantially lower their relative cost advantage versus their competition, gain more revenue scale and then reinvest that, in a way where you create something that's permanent over the companies that maybe get to this late, if they ever get to it. And often those are the best stocks when you go study the markets because you are already in a physical world business where the technology advantage transitions into a physical mode advantage or a distribution or scale advantage. That's one of the patterns that we've observed. We call that a good-to-great thesis internally.
· Henry Ellenbogen
The second way is people, if I think about the investments we have today, we tend to be in business with certain people we've known for 20 years now, and maybe they're doing the same thing or maybe doing the next thing, but we think these are the type of people who build great organizations. And then obviously we have to meet new people too. So one of our largest holdings today is Duolingo. So we first spent real time with the CEO Luis von Ahn during COVID. During the COVID era, as the markets reopened, it went to highs and the private markets were white hot in the zero interest rate environment. And people were meeting people on Zoom. And I remember meeting Luis with my colleague Julio. We got off Zoom with Luis like you often do back in the day, I called Julio up and I was like, what do you think? And he was like, well, it's a super impressive business. They're leading their market, they're on the right side of their consumer and the product's great. And I said, yeah, and I said, Luis reminds me of Tobi from Shopify. The last time I spent time with someone that technologically strong—Luis had been head of AI and ML at Carnegie Mellon, but also has that much business clarity and is so crystal clear at communicating that he can make complex topics simple that even I can understand them—was when I spent time with Tobi when Shopify was private. And I said to Julio, we're gonna basically clear our schedule and whenever Luis will spend time with us in Pittsburgh, we're gonna go spend time with him. And so I think, for lack of a better word, the understanding of the patterns and having studied them, the understanding of what creates the environment. Sequoia's famous for saying why now, and what could lead that not only on the technology side but across the economy. But I think the clarity you have when you spend time with at this point, thousands of executives and you have seen the ones who've done it, you wanna do more with them and then you have seen the ones who are trying to do it but remind you so clearly of the ones who have done it.
· Patrick O'Shaughnessy
[00:00:00] S0: Can you say a little bit more about this notion of Act 2 teams and management teams, and why that is an interesting concept to you when you're thinking about the relationship between an Act 2 team and a potentially very durable compounding company?
· Henry Ellenbogen
[00:00:00] S1: This is something that is so dear to me because one, it's something we invest in, but two, it's actually at the heart of Durable itself and it's one of the reasons that I think Durable is just different than other investment firms because we ourselves were an Act 2 team. The best way to explain it is by example. At my part firm I invested in Workday when they were at about $100 million of revenue scale. What was so interesting was that the two co-founders of Workday, Aneel Bhusri and Dave Duffield, had basically been the people who had pioneered HR systems of record in the previous client server world. They were literally the people who built PeopleSoft, scaled PeopleSoft. And then… a lot of history there, but there was basically a very aggressive takeover by Oracle. And so in many ways they had felt they hadn't frankly completed their vision, so they came together. But what really also lit up the vision was cloud. Now this sounds so obvious today, but 2012 when we invested in Workday, I think a lot of the understanding of the cloud was not as obvious by investors. And frankly, I'm not sure I fully understood it either, but what I did understand was this was an Act 2 team. By that I mean if you understand HR systems of record, there's a bunch of the stuff you have to build into the product that for lack of a better word, is exception management. And if you don't understand that exception management because you’ve done it before, you're gonna not properly be able to do it. And because this was an Act 2 team, they actually knew how to leverage the modern technology but also build the system of record in the way it dealt with the edge cases at super scale. And then obviously they also understood what segment of the market to go after, and then how to serve it. That to me is the image we have at Durable when we look at an entrepreneur who has solved and successfully won a product area or an area of business but now wants to go do it again. And there's huge advantage when you go do it again, you are essentially solving the same problem but with total clarity at the beginning. The other thing is if you've been successful, it allows you to align all parts of the organization, the people, the organizational structure, the investors, exactly how you wanna go do it.
· Henry Ellenbogen
One of the examples of that that comes to mind is Max Levchin, a lot of people know Max obviously is one of the co-founders of PayPal. We first invested in Max, actually it was one of my first private investments in my whole career. We invested in Slide, right? And for many years until recently, we're now investors in Affirm. I used to joke, I'm the only investor in Max who hasn't made a lot of money. But with all jokes aside, Max to me represents the best of an Act 2 entrepreneur. For those of you who don't have the benefit of knowing Max, first of all, he truly understands technology and he really understands how it can be used in very complex systems to solve problems. He can recruit exceptional people because he speaks their language. He's also a very good leader and people believe in him. He's also exceptionally resilient. We could talk a lot more about Affirm, and we could talk a lot more about the relationship with Max, and some of the things about how he transitioned to public markets later. But I would say to us, Max is a perfect example of an Act 2 entrepreneur that we had already been in business with. If Durable does anywhere from five to 10 new investments a year, a lot of times it actually is with Act 2 entrepreneurs. And then if we're lucky, and this happens because of compounding relationships for having done this for 20 years, a lot of times it's with people that actually we were investors in their previous act. And I think that's also great, because they know us and we know them, we know each other's strengths and we know exactly how we can help each other. The Maxes of the world get to do business with who they want. But I think what it allows them to do is with a clean sheet of paper, decide who they want to be in business with. But obviously from our standpoint we don't do a lot of new things and it allows us to basically really align our resources to support them.