Value Investing

The Last Mover Advantage

I was shocked to read in a reputable financial newspaper, in my home country Australia, an article written by a known stock promoter singularly contributing Paypal’s success to the first mover advantage.

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It strikes me as a simple explanation for the success of Paypal, which operates in a complex adaptive system where there are many independent variables that contributed to Paypal’s success in gaining market share.

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The author uses a few strawmen arguments and throws in a red herring for good measure to “strengthen” their argument.

The author argues that the reason they win is that they are already winning with innovative leaders who can bring ideas to life.

Sounds like a compelling idea if you only think about it for 15 seconds.

The first red herring is the sporting analogue which has nothing to do with competitive interactions between firms operating in complex systems.

The author throws in another strawman argument and red herring at the same time, by stating that you cannot you will identify the first mover advantage by simply looking at the reproduction value of balance sheet.

Duh, Sherlock, the reproduction value of a company’s balance sheets purpose is to, help the investor understand the real economic value of the assets and liabilities underpinning the earnings power of the company, as first advised by Benjamin Graham and David Dodd back in 1934 edition of Security Analysis.

The author continues to throw in the cliché words like network effects into the mix to further look like they know what they are talking about.

I wrote the headline last mover advantage to demonstrate that anyone can come to the wrong conclusion based on a simple premise.

For instance, it could be argued (not successfully) that Microsoft in the 70s and 80s came to dominate the PC software industry because it was last to market.

By 1982 it becomes clear that other software companies were developing GUI programs of their own for the IBM computer but Gates wanted to make Microsoft’s Interface Manager (the prelude to Windows) the industry standard for the IBM PC, and only Lotus and VisiCorp stood in his way.

Before Windows become the dominant software system for PCs, Microsoft Dos was had lost ground to Lotus and VisiCorp.

In 1983, VisiCorp started shipping VisiOn and Gates had boasted nine months earlier that Microsoft would be the first to market with a graphical user interface evaporated like so much hot air. Then another company called Quaterdeck, a start-up software publisher announced it too, is building a graphical user interface, named DSQ.

First to market wins right?

Wallace & Erickson described how Microsoft was being outflanked on several fronts by competitors that were further along in the development of their own GUI system. Worse, Gates was having a tough time selling IBM on the product.

More than 20 other computer makers, including Compaq and Radio Shack, had indicated their willingness to endorse. But there was one name conspicuously absent from the Windows alliance -IBM. Gates wanted Big Blue to endorse Windows, but it refused to do so. IBM executives, never particularly happy about sharing revenues with another company, wanted to bring software development in-house. IBM decided to design its own graphical user interface, called TopView.

Gates was furious. This is a technique used by IBM to deflect attention from VisiCorp and Quarterdeck and also people were willing to wait for the market leader’s product to come out. InfoWorld magazine later coined the term for such a product ‘vaporware’.

Sound familiar? Tesla also uses the vaporware technique today, they have missed its production targets consistently, and it been the main reason commentators have recommended investors not invest in Tesla if only understood the underlying reason why it does it.

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The other reason why Gates announced Windows was as a pre-emptive strike against Apple who was secretly working on Macintosh with its graphical user interface and mouse was going to shake up the industry when released in 1984.

Fortune in early 1984, made the astute observation about the trouble with Microsoft’s inexperienced management structure:

“…a lot is riding on Windows. If it fails to become an industry standard, Microsoft may not get another chance to take the consumer market by storm. Momentum is an ephemeral quality in any nosiness, and in an industry evolving as fast as microcomputer software, it can be lost in the blink of an eye…Like other fast-growing companies racing to seize transient opportunities, Microsoft has devoted little time to develop the kind of management depth that will be needed to turn temporary victories into long-term dominance.”

Microsoft missed several deadlines continually pushing back the release date. The first release of Windows 1 was a dud, “it would take two major revisions before Windows was made right. Not till the release of Windows 3 in 1990 would it deliver as promised.

General George S. Patton liked to say, a good plan, violently executed now, is better than a perfect plan next week, and Vern Raburn, former president of Microsoft’s consumer products division, discussed with Fortune magazine this same ethos of Microsoft’s product launches: ‘with a few expectations, they’re never shipped a good product in its first version. But they never give up and eventually get it right. Bill is too willing to compromise just to get going in a business.’

Using the faulty logic of our author, you would argue that being last to market is the single reason for Windows success. Now that might help sales for their stock promotion business but it misleads investors into thinking it’s as simple as identifying a single variable.

I want to draw your attention to a W. Brian Arthur, who over 20 years ago introduce important new concepts to understand how new technologies companies operate within new economic models.

Bill Miller, who beat the S&P 500 every year from 1991-2005, at Legg Mason’s Value Trust fund, contributes his success to Arthur’s work, and it easy to see why.

Arthur wrote to explain why first mover advantage was misleading back in 1996 for Harvard Business Review, titled Increasing Returns and the Two Worlds of Business– read it here.

Identifying the variables that contribute to the success of an organisation is hard. It requires the investor to conduct a multivariable analysis.

That’s why both Warren Buffett and Charlie Munger, plus other billionaire investors recommend you stay within your circle of competence.

Thank you of reading

– Adam

P.S. Don’t rely on reading a financial commentators latest “hack” or tactic used incorrectly – I want you beat them at their own game. If you were my own bother I would say this; you need to learn how to conduct a multi-variable competitive analysis of the company and industry, and let me teach you how! Join the 10-Week Investment Analysis Program to learn how plus much much more. Learn more here.

Article by Searching For Value