Any questions for Geoffrey Moore? He's doing a Schwab "Investors Forum" tomorrow night from 6-9 pm, and one can submit potential questions at the website (www.schwab.com). Not that they'll use it, but I asked whether he followed the discussions of online GG disciples, and what he had learned from them! Wonder if he'll have the guts to say, Q! <VBG> His first interview was on May 25, and ran as follows:
When you talk about the gorilla game, who are the gorillas?
The gorillas are companies like Microsoft, Intel, Cisco, Oracle or SAP -- all of
which are high-tech product companies that came to prominence in rapidly
growing markets. One of the characteristics of high-tech, hypergrowth markets
is that industry power often corrects into a single company's control. When
that happens, the stock price of those companies can appreciate dramatically.
Those are the companies we call gorillas.
If those are the gorillas, what is the gorilla game?
The gorilla game is an investment strategy that tries to buy positions in
hypergrowth markets and over time, consolidate those positions into holdings
only in gorillas. Briefly, the process is to wait until the category has
demonstrated an annual growth rate of 100 percent, and buy the basket of
companies that are the potential leaders in the category.
So you aren't trying to pick a winner yet?
Not at this time. Over the next few quarters we expect one company to emerge
as the dominant player in the various high tech categories. Once that
company's No. 1 position has become clear, we sell all the other companies
in the category and put the money into the gorilla. Our goal then is to hold the
gorillas for a long period of time.
You referred to a hypergrowth market. What do you mean by that term?
In technology markets, there is something called the technology adoption life
cycle. In that cycle, pragmatic customers play a wait-and-see game to
determine, first, if this is a category of product that everyone is going to buy;
and if so, which company will be the safe buy, or market leader. Because
pragmatists wait and watch each other, they end up buying into the market
roughly at the same time. That's what creates the hypergrowth. It's a little bit
like a junior high-school dance where the evening starts with boys and girls
on either side of the gym floor, and at some point everyone's out on the dance
floor all at once. High-tech markets work the same way.
Playing with gorillas
Could you describe how one actually goes about playing the gorilla game?
Step one in the gorilla game is to identify markets that have gone into
hypergrowth, or where the pragmatists have stampeded. When a market goes
into hypergrowth, everyone -- The Wall Street Journal, the technical press --
will talk about it. For instance, when the Internet went into hypergrowth,
everyone was talking about it. This is a key idea with the gorilla game. It's not
about getting secrets; it's about reacting to the obvious.
Step two comes when the market has already taken off. At that point, you buy
stock in the companies that have the most purchased offers in the category.
You may buy three or four stocks. Again, do not try to buy the winner --
because in hypergrowth markets, the pecking order among the leading
companies can change overnight. Our models predict that sooner or later,
one company will emerge as the established leader in the category and over
time, its lead will increase, not decrease.
Once that company emerges, you've identified the gorilla and you now want to
concentrate your investments in that one company by selling off the other
stocks and putting the money into the gorilla.
What's the time frame for seeing a leader emerge?
Given that different categories might evolve at different paces, we would
expect it to be over a period of several quarters, maybe as long as a year or
more. It's definitely not a matter of days or weeks.
When do average investors jump in and out? What signs should be
considered?
The goal of gorilla game investing is to buy and hold. It is specifically not to
buy and sell. So investors should jump in when they are confident the market
is in hypergrowth and not before. Don't worry about getting in too late. These
markets can go on for several years in hypergrowth, according to our models.
So the gorilla game's philosophy leans to buy and hold, and you wouldn't
see the current dip as an opportunity to accumulate on selected holdings?
The gorilla game takes a very long-term view of the market. In that view, buying
on dips is not part of the primary strategy. There is -- over time -- little to be
gained from trying to capture the last dollar advantage in a market we hope to
see grow several hundred percent over a number of years.
When would you sell a gorilla stock?
In our model, the only time you sell a gorilla stock is when the category itself
has come under serious attack. For example, Novell was the gorilla in local
area network systems, but when the category was attacked by Windows NT
and Novell did not provide a definitive, competitive response, investors rightly
sold off their holdings in Novell. A similar thing happened when Netscape's
gorilla position in browsers was attacked by Microsoft. Microsoft attacked the
browser category, threatening to simply make it part of the operating system,
and investors sold their stock in Netscape.
Does the regulatory environment have any impact on the game?
Regulation, corruption, tax policy and other environmental factors all could
dampen the effects of the gorilla game.
Since most companies have a number of products, how can we determine
what phase the products are in?
This is what makes any form of investing challenging, because few
companies are truly "pure plays." By that, I mean a company whose earnings
are based almost exclusively on a single category or offer. When companies
become more successful, they accumulate many offers, and the investment
opportunity they provide becomes blurred. We call this diversification. Most
investors today seek diversification through creating a portfolio of stocks or
through buying mutual funds, and they do not look to a single stock to provide
diversification for them. So right now, pure-play stocks get more favorable
treatment from investors than diversified portfolio companies, such as IBM,
HP or Compaq.
But since gorilla companies need to be able to dictate standards for their
markets, don't larger organizations have an advantage, in spite of their
multiple products?
That's an interesting idea. However, it turns out that the innovator in the new
category may have the advantage. History suggests that large companies
become threatened by innovations -- even their own innovations -- and often
do not pursue opportunities aggressively enough to win the day.
Do you apply your principles mainly to companies operating in the United
States?
In theory, there should be no distinction between these principles in the
United States or elsewhere. For example, SAP is a German company that is a
worldwide gorilla in enterprise resource planning systems (ERP). I have to
confess, however, that I tend to be more aware of U.S. markets and U.S.
companies, which probably biases my point of view.
How has the Internet changed the rules of the gorilla game?
That's a big question with many dimensions. The Internet market is a
dramatic example of a hypergrowth market, so in a sense, we're playing the
same game. But the sector is different in a couple of ways.
Internet stocks are based on selling services, whereas traditional gorilla
game stocks have been based on selling products. Because service
innovations are much easier to adopt, they diffuse through a market faster
than products. That means leaders may emerge much faster and much
earlier in the game.
Also, the switching costs of changing from one company to another in a
service market are generally much lower. That makes these leadership
positions more precarious, which in turn makes Internet stocks and the stock
market much more volatile.
Given that Internet services are more volatile, would you agree with the
idea that companies focused on products related to the Internet -- Cisco,
Lucent or Sun, for example -- would be a better option in the
gorilla-identification process?
The short answer is yes. Cisco is considered one of the classic gorilla
investments that benefited from the Internet. Lucent gives every sign of being
one, too. Sun is a more interesting question because the switching costs of
moving between Sun computers and other UNIX computers are much lower
than the switching cost of moving away from a Cisco router or a Lucent switch.
Will awareness rather than product similarities continue as a definition of
Internet gorilla markets?
I think that going forward, the top tier may have some characteristics in
common, namely high brand awareness or first mover advantage. I just read
a report from Mary Meeker -- an analyst with Morgan Stanley which stated that
there are five Internet stocks that have high brand awareness among adults in
the United States -- America Online, Amazon.com, Yahoo, eBay, and
Priceline.com. There are other companies, but staying with brand for the
moment, these five stocks exemplify high brand awareness, which is one
criteria to consider when evaluating stocks using the gorilla game approach.
But I also think we will continue to see differentiation, as companies choose
between a portal, retail-commerce, or auction strategy, or an exchange-model
strategy vs. the community-hosting strategy.
If traditional financial valuation models show that many Internet
investments -- such as eToys or Yahoo -- are overvalued, how can sound
investors be buying these companies at their current valuations?
In very high growth markets that are in their early stages, the projections of the
current business flow could be a small proportion of the future potential
performance. When you add to that the idea that there are future business
models that this company has first option to invoke, you begin to understand
the high-flying Internet stock. For example, Amazon.com started off as a
bookstore. It then added a music store to its business model. Later it added
auctions, and invested in a drugstore site and, just recently, a grocery store
site.
Because Amazon is a dominant brand, consumers are giving it permission to
become a leader in an industry the day it announces its entrance. That sort of
brand power and ability to enter markets as a leader has rarely, if ever, been
seen before. But it's something that the leading Internet stocks all share to
some degree. And that is where these "beyond the financials" valuations are
coming form.
So do you think it's a good idea to invest in Internet stocks based on
"beyond the financials" valuations?
For investors who can put capital at high risk, this may be an acceptable form
of investing. However, in my view it is not suitable for investors who really
cannot afford to lose their capital. Remember, this is not the gorilla game. The
gorilla game is a much more conservative form of investing focused on
product-oriented companies with high switching costs. Internet investing is
much riskier -- and may have potential higher rewards. I encourage people to
segment their investment capital into higher- and lower-risk portfolios and
follow the traditional gorilla game for the lower-risk portion, while tackling the
Internet market only with the higher-risk portion of their capital.
There has been talk about the Internet bubble bursting. When that happens,
what impact do you think it will have on technology stocks?
I think "bubble bursting" is the wrong metaphor. I think a better metaphor is
"souffl‚ starting to sink." By that I mean that the Internet market might divide
into a first tier of stocks that will sustain high valuations, and then multiple
tiers of stocks that will be significantly downgraded once the market
understands competitive advantage on the Internet better. So when the market
matures in this way, I do expect a short-term flurry of anxiety and a big sell-off,
particularly among daytraders who may never have seen a downturn before.
But I genuinely believe in the fundamentals of value creation in the Internet.
Although individual stocks may be overvalued, the category as a whole --
which has a market cap of between $250 billion and $500 billion, roughly
about Microsoft's market cap -- may still be undervalued.
What updates to your strategy do you see now, and what new categories
do you see emerging with gorillas of their own?
We are actually going to release a revised edition of "The Gorilla Game" this
summer, primarily to give additional guidance on Internet investing. As I
mentioned, it's not part of the traditional gorilla game, but it's on everybody's
mind.
First, the most interesting emerging category in the traditional,
product-oriented gorilla game is front-office applications or enterprises --
often called the customer relationship management sector. We talked about
this sector in the book and it continues to demonstrate hypergrowth and the
emergence of a gorilla.
Second, with respect to the Internet, we built a model to describe types of
competitive advantages that different Internet companies have, with the goal of
comparing that kind of power to traditional, high-switching cost power. Some
of the types of advantage we discuss are brand power, stickiness, first-mover
advantage, scale and community. As sites have one or more of these
characteristics, their competitive advantage increases and thus, we expect
their stock price to continue to be high.
Do you think it's too late to buy winners like Microsoft, Intel and Cisco?
Certainly they must still be on the cutting edge of the tech revolution.
Without endorsing any particular stock, as long as gorillas have the power to
enter new markets with competitive advantage, the gorilla game suggests
investors hold or add to those types of stocks.
Do you see gorillas disappearing from the computer manufacturing area?
Particularly companies such as Dell and Compaq?
In PC manufacturing, we make a distinction in the book between gorillas and
kings. Kings are market-share leaders that have low switching costs. To
change out a Compaq computer for an IBM, or a Dell for a Hewlett-Packard, is
not a painful process. Therefore, their hold on market leadership is weak
compared to a Microsoft, where switching out its product would be very painful
indeed.
For gorilla stocks to remain gorilla stocks, they must redefine themselves.
Given this, what do you see as the next technology boom?
I think for the foreseeable future, all booms are variations or extensions of the
Internet boom. My expectation is that we may have perhaps five or ten new
waves of innovation, each with new hypergrowth markets and new leaders.
That will be necessary just to work out all the implications of the Internet and
its impact on commerce.
What are some good resources that would help me research and find
these gorillas?
The Internet is a great source of information about high-tech stocks. In the
book, we reference the Web sites at The Red Herring, Upside magazine and
The Industry Standard. All three provide great coverage. The online discussion
forums at techstocks.com and other investing sites are also good resources.
Lastly, we have a Web site called gorillagame.com, where investors can
subscribe to a discussion group with other readers of the book. But to be perfectly honest, the best single place to hash out all this stuff is Uncle Franq's friendly forum on Silicon Investor, the "Gorilla & King Portfolio Candidates" thread. They are the ones who taught me about the Mighty Q, and I hear they've discovered another young one--Jimmystar, or something like that--recently. I'd go there if I were you, although you'll probably increase the number of posts to an even more unmanageable level... <sigh>
1. "Internet Overview Update", by Mary Meeker, Morgan Stanley Dean Witter, May 6, 1999. |
