Invest Like the Best with Patrick O'Shaughnessy
· Patrick O'Shaughnessy
[00:00:00] S0: You and I have talked before about this idea of push versus pull companies. Can you describe that difference, and how that's an idea that you care about when evaluating them?
· David George
[00:00:00] S1: It's magic when you find a pull business. So I have a Post-it note on my computer in the office that says, "Is the market demanding more of your product?" It's the most special thing when it happens. By the way, a lot of these AI companies, what's so magical about the way ChatGPT has grown, it's a billion users, it's organic, it's all brand. And the shocking thing about that one, by the way, is it doesn't have a network effect. That was one of the more surprising things for us. So is the market demanding more of your product? Is probably the most important question that we can answer, because when it happens, especially in consumer, it tends to create the most special companies in the world. So we've seen it in companies like Roblox when it really works, and that one has two network effects, and so it's super special. We also see it in companies that aren't network effect or consumer. Like in the case of Anduril, turns out the market really, really, really is demanding more of their product, and there's many reasons for that. We've reached all at the same time this confluence of AI capabilities, autonomy, know how, and how to navigate governments, mostly from alums of companies like Palantir and SpaceX. At the same time, that we have a desperate geopolitical need. The market is demanding more of their product, and that's really special. One of the things that I say about push businesses, which is you got to go sell it. Sometimes those are really successful, and there's industries where this is the case, like cybersecurity and things like that. They don't tend to get easier over time. They tend to get harder. If you have to go sell or market your product, the bigger you get, often it gets harder. So that's not always the case. Sometimes, you get increasing returns to scale from brand and things like that. But especially on the consumer side, it almost always gets harder if you're a push business. TikTok maybe is the exception of the rule.
· Patrick O'Shaughnessy
[00:00:00] S0: Because they pushed it early?
· David George
[00:00:00] S1: They pushed it early and so aggressively. And obviously, if you're Facebook, you probably sit around and think about that decision forever. Maybe it's not even a decision. I wasn't on the inside, obviously, but the growth of TikTok was fueled by advertising on Facebook in large part, which is crazy to think about. But especially if you're a Google or Facebook-driven ad business, it almost never gets easier. It always gets harder, and Google and Facebook are the ones who accumulate better economics over time at the expense of the people who advertise on them. So the push first pull thing. So right now we talk about this in the age of AI. I think there's how do we assess AI businesses right now? Is an interesting thing. One is ease of customer acquisition, and we see this with the really, really special ones like Cursor, which has been largely viral growth. So ease of customer acquisition, it happens even with things that need to be sold like Abridge. You got to go sell to hospital systems, it turns out hospital systems are dying for this because the doctors love it, and it's really good. It saves them a lot of time, and it's really valuable. So ease of customer acquisition is something that is sort of a must for us in this AI wave. The second is customer behavior, customer retention, customer engagement. There are some head fakes that we've seen of things that grow really fast and then they fall off, and they're experimental. So the things that have durable behavior, things like Cursor, where the users really, really use it and ideally or increasingly use it over time. Harvey is an example of a company where, as the models have gotten better, customer engagement and usage has actually really grown. It actually took a step change, which we've seen, which is interesting to see, because it happened at the same time as the reasoning breakthroughs. We were like, "Oh, that makes sense, actually. Lawyers need to reason." And turns out models got really good at reasoning and people use the products a lot more. So ease of customer acquisition, the behavior that we observe on customer retention and engagement, and then there's gross margins. And we give a little bit of a pass on gross margins right now.
· David George, Patrick O'Shaughnessy
We're in this funny environment where late-stage SaaS cloud, we would look at a company and it's like, "Oh man, if you're not 70% plus gross margin, you're not really a SaaS business or cloud business, whatever, and that's going to be a knock and people will trade you differently. And that's when you get valued as revenue versus gross profit or whatever." Now, it's like a badge of honor to have low gross margins, because we're like, "Oh, at least people are using your AI products." We get these pitches and they're like, "I have an AI thing, and I got 75% gross margins." I'm like, "Well, no one's using the AI stuff then. That doesn't really seem like an AI product to me." So we give a little bit of a pass on that. The expectation is the cost is going to continue to go down. [00:00:00] S0: Just inference cost. [00:00:00] S1: Inference cost is going to go down over time. I mean, there's so many existential questions about market structure that will predict inference cost. But the history of technology would suggest that it's going to go down over time. The cost of inference has gone down at the same time that reasoning happened. And so token usage has gone way up. So you haven't yet seen any improvement in gross margins, but I think, over time, that's likely to happen. [00:00:00] S0: Do you basically just not care? If a company has 0% gross margin, for example, but the revenue growth and the customer love and all this stuff, the pull is all there. Does it round to, "We don't care."?
· Patrick O'Shaughnessy, David George
[00:00:00] S0: Do you basically just not care? If a company has 0% gross margin, for example, but the revenue growth and the customer love and all this stuff, the pull is all there. Does it round to, "We don't care."? [00:00:00] S1: There's a big difference between having 30% gross margins and 70% gross margins. So we do care. Our expectation is if you're producing a lot of customer value, and if the models get a lot better over time, you're going to increasingly produce customer value, that the cost is going to go down. There's not going to be so much market power, the model providers, that it's going to settle out where these businesses are probably higher margin businesses. I think they'll be lower margin businesses than SaaS businesses, maybe they end up as 50% margin companies as opposed to 80. But the size of the impact and the usage and the amount that they'll be able to capture, to our point on the business model earlier, is probably so high that it's fine. [00:00:00] S0: How much do you care that the way the product behaves and the way it's distributed is truly singular and different than competitors versus just the best of a class of company? [00:00:00] S1: There's so many ingredients to the best of. There's a foundational point, which is every great company either has unique product or unique distribution. The best companies in the world have both. The best companies in the world have such unique product that it leads to unique distribution, but if you don't have either of those... [00:00:00] S0: What's your favorite example of that?