Non-zero sumness
Non-zero sumness – A key evaluation criterion for early-stage investments
We wrote about how we think about investing in a world of easy VC money in the week before last. Our primary objective is to make a series of high-conviction bets on businesses and founders whilst ignoring the noise in the ecosystem as well as rejecting the ‘spray & pray’ approach.
This is similar to Warren Buffett’s ‘20 – Slot punch card’ approach that he often taught to business school graduates.
“I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches - representing all the investments that you got to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at all. Under those rules, you'd really think carefully about what you did, and you'd be forced to load up on what you'd really thought about. So you'd do so much better.”
However, this is easier said than done – How do we develop conviction in our investments?
Especially in the case of early-stage businesses where there is no developed business model, several experiments in marketing/ sales strategy, (usually) negative unit economics, and in some cases not even in fully developed business. This makes the case of evaluating such opportunities fairly difficult.
We recently read a great whitepaper on investing - ‘Complexity Investing’ published by NZS Capital, which speaks about the concept of ‘Non-zero sumness’ at length. We strongly encourage our readers to give it a mindful read.
Essentially non-zero sumness refers to the creation of value in which all participants gain more than what they shell out for a transaction (non-zero-sum transaction). In the traditional (and rational) business sense, a buyer pays the price of a product/ service which is offered by a seller for exactly the perceived value he derives - this results in the seller gaining an ‘X’ amount whilst the buyer paying the same – this nets off to a zero-sum transaction. In the bygone era of information asymmetry and production/distribution-related moats, businesses benefited as long as they had willing buyers. However, in today’s information era, these points cannot sustain indefinitely. Today, the businesses which add more value than what they partake in are the best bet for large sustained growth. Think about the likes of Microsoft – which provides Office at a cost that is far lower than the value we derive from it, or Google whose ‘Search’ or ‘Maps’ service has become ubiquitous. Closer to home, Reliance deployed its Jio platform across mobile & web at scale for a reasonable cost creating enormous value to end-users. A more minimal example will be D-Mart stores which provide the promise of being a one-stop-shop for quality products at a reasonable price thereby adding value in terms of savings as well time for its customers.
It should be noted that non-zero sumness does not prerequisite a business to charge less – take the case of Amazon’s marketplace – it charges a hefty marketplace commission and controls the customer but the wide reach and distribution of its audience it provides is unparalleled and is value additive to businesses despite the cut.
This brings us back to the evaluation of startups – we believe that founders who focus on creating a business based on non-zero sumness – adding more value than they partake are best placed to disrupt or create a market. This is also reflected in some of the best-run startups in India and globally. Zerodha started by offering a flat brokerage fee trading account, but has built on it continuously to add value to investors and traders alike. Stripe, the famous payments company perhaps best sums up creating ‘non-zero sumness’ in its mission ‘Our mission is to increase the GDP of the internet!’. Starting off as a payments platform, Stripe has built and bought applications/ software that puts the mission of facilitating/ increasing customers' online collection at the heart of their operations.
Companies that focus on ‘non-zero sumness’ automatically tend to create a competitive moat around them through one or a combination of quality of product/ service, pricing, constant innovation + experiments whilst singularly focusing on adding value to the customer. One simple way to identify such potential value-additive early-stage companies is to ask – How affected would potential customers be if this business shut down? Would they go back to operating in the same manner as they were before the startup launched? Would they seek other alternatives? Answers to these questions will give an indication of the real value delivered by the opportunity! Detailed research and due diligence should ideally further strengthen the initial conviction.
Of course, as early-stage investors, we do focus on the quality of the management, potential competition and the business edge, growth runway, and the context (headwinds/ tailwinds) for the opportunity, however, we also consider the non-zero sumness as a critical parameter of our evaluation.
We aim to work with founders who are focussed on delivering GDP to their customers – Please do reach out to Siddharth or Dhruv if your idea fits this thesis.
Critique and views welcome
Image credits:
https://medium.com/eclectic-spacewalk/eclectic-spacewalk-4-non-zero-sum-78e4ef0d450