Gorilla Game II
by Al Levit
by Al Levit
Glendale, CA (June 18, 1998) -- At midnight tonight, the voting for the 8th addition to the Cash-King portfolio comes to an end. On Monday, we'll offer the buy report. And next week, we'll put all of our $2000+ cash position into this 8th C-K stock. Here's our last day's link then to the Cash-King Online Poll. Tomorrow, we'll announce the winner in this report.
Ladies and gents, Fools all, this has never been done before -- mass research and a simple democracy to manage money. The Street won't like it. Neither will the media. You bunch of online hypesters.
Thanks for participating.
Today we return to our examination of the work by Moore, Johnson and Kippola entitled The Gorilla Game. This article is the second in a three-part series that began Tuesday, so if you missed that first column, please click here. I will note once again that this review is no substitute for reading the book in its entirety. It's a fine book; you'll get far more from reading it than this Fool can package for you in a few short reports. With that, I begin today by examining how high-tech markets develop and produce "gorillas."
High-tech markets begin with what the authors call a discontinuous innovation. This is a new and unique product or service. Examples of discontinuous innovations are the first PC, the first spreadsheet, the first local area network and the first Web browser. There are loads of new discontinuous innovations invented every year, but relatively few survive through the Four Key Phases of the Technology Adoption Life Cycle. These phases are actually defined as groupings of potential customers who adopt technology in the following order:
1. Technology Enthusiasts -- these are people (sometimes referred to as geeks or nerds) who will try any new whiz-bang techno-gizmo. Getting this group to try out a new product is easy; they'll put up with loads of aggravation in order to be on the cutting edge.
2. Visionaries -- These are highly-placed executives who are looking to get ahead of the herd. They'll adopt the new technology if they can see a break-through competitive advantage from using the product. And they won't be deterred by high adoption costs if they foresee significant advantages for those using the product. In addition, the visionaries' rank in the business world gives them a large enough discretionary budget to use the product.
3. The Chasm -- This is an area in the Technology Adoption Life Cycle that is devoid of customers. Empty. None. Nobody. No door to knock on. No bell to ring. Nobody's home. There isn't even a home. And it is here, in the chasm, where most discontinuous innovations die.
4. Pragmatists -- These customers are the proverbial herd, and easily the largest grouping of the four. They don't believe it's practical to search through hundreds of new products a year to guess at which will become a mass phenomenon... a product that we'll all eventually have to have. So they won't buy a new technology product until they sense that everyone else is. And this creates a giant chicken and egg problem. The largest grouping of people in the Technology Adoption Life Cycle is literally sitting there on the other side of the Chasm, waiting for everyone else to jump in first.
In the business world, the Chasm is crossed when a problem, often on a department level, gets so bad that pragmatists are given a "solve it or else" directive from their bosses. Faced with no other choice, the pragmatists reluctantly seek out and purchase the innovations that had been used by the visionaries before them. They suffer the pain to adopt the technology, but the innovation works and their jobs are saved. Then their competitors down the street, with the same problem in the same department, hear about the success and adopt the technology as well.
Quickly, the word spreads among all the pragmatists that a new solution is out there, AND IT'S WORTH IT. Then, if the innovation is really useful, it will spread beyond the department level to the company level, and the market will undergo hypergrowth. The author's call this initial stage of the pragmatist development -- where departments at competing companies start adopting it -- the bowling alley, as first one pin goes, then two, then three, et cetera. Then, the stage when true hypergrowth sets in -- where entire companies adopt the technology -- is called the tornado.
The authors propose that the truest way to play the gorilla game is to invest in a company just as it enters the tornado (or in riskier cases, when it enters the bowling alley). As I noted on Tuesday, I'll leave the risk assessment to others. I'll even leave the "entering the tornado" decision to others, because I largely believe that Cash-King companies pressing down on monopoly status can frequently have many years or decades of market outperformance ahead of them. Without too much risk. With the reduction in trading, and the reduction in the opportunity costs of tracking for new gorillas, I'm effectively an early pragmatist investor. I like to invest in gorillas. I come from the other side of the chasm, and I'm happy beating the market over twenty-year periods.
In our specific case in C-K land, we really have two technology gorillas on hand: Microsoft (Nasdaq: MSFT) and Intel (Nasdaq: INTC). In my mind, there are three key questions that I want answered about these two companies:
1. How much of a premium, if any, should I receive as a shareholder for their gorilla status?
2. What will happen if they lose their gorilla status?
3. When might they lose their gorilla status?
These questions are answered together by the authors. They explain that, in general, the market will grant extra value to a gorilla based on three factors:
1. A gorilla is expected to have far higher earnings and revenue at the beginning of its history than most other companies.
2. A gorilla is in a hypergrowth market to begin with, and it is likely to have a fatter growth rate for most of its early history than most companies.
3. A gorilla is going to be the PERMANENT leader of its market, making investors much more confident in its earnings than most companies.
The authors submit that gorillas will tend to remain gorillas until a further somewhat-unpredictable discontinuous innovation replaces the gorilla stronghold. Thus, for example, IBM had the gorilla position in computer mainframes, and they only lost their gorilla power when the PC came about and transferred the gorilla power to Intel, Microsoft, and to a certain extent, other box makers.
As for the death of a gorilla, well, it's not pretty. The first to see the new, better, product innovations on the horizon are normally the gorilla's partners, and they bail out at an ever-quickening pace. It may take a while for one to go -- but then the partnering chasm is crossed, and everyone jumps ship. Then the financial community hops off, and the stock of the aging gorilla quickly heads sideways or south. The last to give up are the gorilla's customers, who are reluctant to undergo the switching costs of moving to a new technology. Eventually, they do.
The authors point out that this death spiral has been played out over and over, in similar fashion, as the shareholders of Wang, NBI, Prime, Data General, Four Phase, Control Data, Unisys, Honeywell, Dun & Bradstreet, Knowledgeware, Cullinet, MicroPro, Ashton-Tate, Borland and many others will attest.
Now what about our two companies (and possibly our third, Cisco, via the Online Poll)? We'll cover that tomorrow, along with some notes about my favorite company that's not a Cash-King (that would be Dell (Nasdaq: DELL)). In the meantime, here's a hint -- I haven't sold my personal shares in either Microsoft or Intel. And I also think that tracking the financial statements, quarter by quarter, year by year, (and in particular the balance sheet) will tell us whether our companies are still kings of their jungle.
Day Month Year History C-K +0.38% 2.59% 8.50% 8.50% S&P: -0.07% 1.43% 10.49% 10.49% NASDAQ: -0.21% -0.35% 7.25% 7.25% Cash-King Stocks Rec'd # Security In At Now Change 2/3/98 22 Pfizer 82.30 114.25 38.82% 2/27/98 27 Coca-Cola 69.11 81.38 17.75% 5/1/98 37 Gap Inc. 51.09 59.94 17.32% 2/3/98 24 Microsoft 78.27 91.13 16.43% 2/6/98 56 T. Rowe Pr 33.67 34.56 2.64% 5/26/98 18 American E 104.07 105.38 1.26% 2/13/98 22 Intel 84.67 69.69 -17.70% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 64.34 70.75 9.97% 3/12/98 20 Eastman Ko 63.15 67.75 7.29% 3/12/98 15 Chevron 83.34 81.94 -1.69% 3/12/98 17 General Mo 72.41 69.56 -3.93% Cash-King Stocks Rec'd # Security In At Value Change 2/3/98 22 Pfizer 1810.58 2513.50 $702.92 2/27/98 27 Coca-Cola 1865.89 2197.13 $331.24 5/1/98 37 Gap Inc. 1890.33 2217.69 $327.36 2/3/98 24 Microsoft 1878.45 2187.00 $308.55 2/6/98 56 T. Rowe Pr 1885.70 1935.50 $49.80 5/26/98 18 American E 1873.20 1896.75 $23.55 2/13/98 22 Intel 1862.83 1533.13 -$329.71 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 1286.70 1415.00 $128.30 3/12/98 20 Eastman Ko 1262.95 1355.00 $92.05 3/12/98 15 Chevron 1250.14 1229.06 -$21.08 3/12/98 17 General Mo 1230.89 1182.56 -$48.33 CASH $2037.63 TOTAL $21699.94 *The year for the S&P and Nasdaq will be as of 02/03/98