What can we look at from the history of PE to understand the type of firms that will win in this next phase?
What were the phases of PE?
“INNOVATIVE” ACTIVITIES OF LEADING FIRMS
Why Did Some Firms Fail to Dominate? (despite starting out strong)
Bluntly put: They failed to adapt. They kept optimizing today’s levers.
Example: GTCR1
GTCR2, once a promising player in the 1990s, focused heavily on financial leverage but struggled to build sufficient operational expertise, which limited their ability to generate alpha.
Unlike their competitors such as KKR and Carlyle, who were increasingly investing in operational improvement capabilities and sector expertise, GTCR failed to adapt to the growing need for deeper industry-specific strategies.
Claim: GTCR kept playing “today’s game” but failed to see “tomorrow’s game” would be different
I believe many of today’s firms will continue squeezing blood from a rock and will not see PE is about to transition from horse and buggy to internal combustion. The best horse-shoe maker will not necessarily be the best internal combustion maker
“The techniques that worked so extraordinarily well when applied to sustaining technologies, however, clearly failed badly when applied to markets or applications that did not yet exist.” -Clayton M. Christensen, The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail
What is the evidence that today’s levers are reaching a point of diminishing returns?
Premise #1 - The industry is not new. It has been mainstream for 40 years3.
Premise #2 - The top quartile returns are below the past4
What Will the New Firms Do That Will Allow Them to Dominate?
“Truth - more precisely, an accurate understanding of reality - is the essential foundation for producing good outcomes.” - Ray Dalio
First Principles of PEAI5
Bluntly put, I believe intellectual humility is the greatest weapon here6. Every company that has disrupted (Apple with iPhone, Bain with PE, etc.) has a common factor. Each of them were brutally honest about the items that seemed “great today” but they saw as woefully insufficient.
Bain was clear financial engineering alone was not enough. Apple was clear that a mobile player that couldn’t take phone calls or pictures was not enough7.
Hypothesis: Glossy resume firms will struggle to compete with less risk averse / low group think firms
“If you are unwilling to disrupt yourself, there will always be someone willing to disrupt your business for you.” - Marc Randolf, Netflix founder
What Are the Worst Assumptions That a GP Could Make at This Phase?
All I Want To Know Is Where I'm Going To Die So I'll Never Go There - Buffett & Munger, A Study in Simplicity and Uncommon, Common Sense By Peter Bevelin
Marketing to LPs = Reality
I believe leadership that can’t have candid conversations that deal flow + operational improvement levers are commoditized will struggle to seriously “disrupt themselves”
Individual selection: Proxies for Future Results = Legacy Proxies
We have seen organizations repeatedly select the type of thinker or team that created success in the past. I emphatically believe that will lead to ruin here.8
Tesla lapped General Motors by hiring differently.
What are my GP mindset hypotheses?
I’m 41, so I guess you could say I’m mid-career. Here is one framework I apply. Grounded to High Reality vs. Low Reality; Visionary vs. Squeeze Blood from Rock9.
Low Reality vs. High Reality
I am applying this specifically to the GPs views of competitive differentiation of their firms
Low Reality - View deal flow and levers as very unique and proprietary (yet struggle and grind to create returns)
High Reality - See that deal flow and levers if they are really honest are not “order of magnitude” different than peer firms
Visionary vs. Squeeze Blood from Rock
Squeeze Blood from Rock - Focused only on optimizing today. Very focused on activity/inputs and do not measure whether the output is declining relative to the input.
Visionary - Able to plant a flag for where the puck needs to go. This often requires doing so without immediate feedback10.
There are numerous other examples of this playing out
GTCR was founded in 1980. It has invested ~$15B (vs. Bain Capital founded in 1984 ~ $185B)
Overtime advantages get competed away without defensible innovation
This is clear evidence that competitive advantages have been competed away (that is until the next innovative players break rank).
I have a lot written on this which I will be sharing
To that extent - There are a lot of things I don’t know here that I’m in the process of exploring. These include how LPs are going to react, etc.
Even though at the time the iPod was proclaimed one of the most innovative devices.
Future post
The is a derivative view of Peter Thiel’s classic Definite Optimism Framework
That said, there is an important nuance. There are plenty of glossy resume R&D shops that had bright brilliant visions of the future but failed to deliver. I would argue they were often solving for ego over reality. There are several frameworks I will articulate that distinguish the two.