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Geoffrey Moore, Paul Johnson and Tom Kippola

The Gorilla Game: Picking Winners in High Technology

Summary

Moore, Johnson and Kippola outline what the gorilla game entails and how to go about being a successful investor in the high-tech space

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Key Takeaways
  1. The basic framework of the gorilla game includes
    1. Find a hypergrowth market (~100% revenue growth year over year). Hypergrowth begins after the 'herd' (general consumers) adopt the tech
    2. Buy a basket of potential gorillas (2-4)
    3. Consolidate these holdings into one stock once it is likely it will become the gorilla
    4. Hold for the long-term
    5. Sell only when a new category, based on an alternative technology, threatens to eradicate the gorilla's power
  2. High tech markets develop in unique ways and this leads to more gorillas (companies with almost impenetrable moats, think Microsoft, Cisco, Intel)
    1. Chasm - time between early adopters and mass adoption
    2. Bowling alley - earliest signs of potential gorilla game, niche customers adopting tech
    3. Tornado - chaotic period where mass market begins adopting. A handful of companies are battling to become the gorilla. Goal is to identify recognizable milestones in the development of a high-tech market that the private investor can use as signals for buying and selling
    4. Main St. - after 3-5 years of tornado, main st. begins recognizing the power of the gorilla and gorilla gains even more power through variation and assimilation. Gains market share, margin share. Often loses over half its value first time its earnings miss but if a true gorilla, prudent investors use this fall to accumulate more
  3. Criteria for the gorilla game are very strict and limits potential holdings to a small universe. Must have proprietary architecture and high switching costs
  4. Discontinuous innovation is what makes the gorilla game different. These new innovations are not compatible with existing systems and therefore creates a whole new environment around it
    1. Boom because of technology adoptoin life cycle and punctuated equilibrium - change does not happen linearly which leads to hypergrowth
    2. "Hypergrowth markets, in order to scale up quickly, will often spontaneously standardize on the products from a single vendor. This simplifies the issue of creating new standards, building compatible systems, and getting a whole new set of product and service providers up to speed quickly on the new solution set. In short, it makes it much easier for the new value chain to form. The vendor on the receiving end of this spontaneous standardization enjoys an extraordinary burst in demand. Everyone wants its products because they are setting the new standard. Its competitors by contrast, must fight an uphill battle just to get considered. It makes for a huge competitive advantage."
  5. What makes the gorillas so potent and valuable is that they also increase their competitive advantage over time - law of increasing returns
  6. Important to differentiate between the early market, tornado and chasm. Before you invest, the companies have to cross the chasm and be in the tornado phase
  7. Market share tends to get set during the tornado as switching costs become too high after standards have been set
  8. Competitive Advantage Period (CAP) = power = higher returns (get more customers, keep more customers, push prices down while increasing profits)
    1. Gorillas are the ultimate value chain leaders
    2. Gorillas have the influence to outsource low-value, high cost parts of the value chain
  9. Architecture of software very important - proprietary (gorillas) vs. open
  10. Monkeys vs. Chimps - Monkeys are clones of the gorilla and chimps are gorillas without the market share or CAP but can occupy small niches
  11. Kings, princes and serfs - Kings are leaders, princes are challengers and serfs followers of the gorilla but don't have proprietary architecture
  12. Power of gorilla corresponds to number of purchases it influences, power in own market and industry
    1. Enabling technology (capability to drive radical change in the capabilities of a user or culture) crucial in gorilla game and much more powerful than application technology
  13. Potential gorilla collisions are important to follow
  14. Barriers to entry help short term and scalability helps long-term advantage
  15. Any disruptive tech shifts leads to potential vacuums where new gorillas can emerge
  16. Gorilla stock almost always appears extremely expensive but in fact the market is almost always undervaluing a true gorilla. Therefore, this gorilla game framework is vital to know when a stock is just hot and expensive vs. when you're dealing with an up and coming gorilla
  17. Investing is all about understanding a company's competitive advantage
  18. Great execution which doesn't raise competitive advantage is relatively useless
  19. P/S is a better metric than P/E for hypergrowth stocks as tracking revenues is a better indicator
  20. Market undervalues true gorillas for two reasons - true returns and the CAP are under appreciated
  21. End of tornado correction - market will over penalize gorilla if it misses earnings expectations because expectations run too high and/or the company didn't communicate effectively
    1. Use this opportunity to add to position
    2. Protect and lower risk by selling chimps before the end of the tornado
  22. 4 mega sectors in high tech - semiconductors, services, computer systems, vertical market system. Gorilla game focuses on computer systems
  23. Can outperform market by outthinking and out reacting but out thinking is much safer, more consistent and profitable over the long-term
    1. Consistent business model and research practices to spot tornadoes
  24. Tornadoes only form when a new value chain comes into existence
  25. Questions to ask regarding value chain
    1. Can this value chain develop into a tornado mass market?
    2. If so, what conditions are currently holding it back?
    3. Are these constraining conditions likely to be removed, and by whom?
    4. If so, when is the last remaining constraint likely to be removed, and by whom?
  26. Deal with obstacles first and then enablers
  27. Adoption complexity and implementation (producer) complexity are two barriers. Must be able to produce mass quantities to meet demand and help supply hypergrowth
  28. Need killer app to provide consumers continuity and value but discontinuity in supply chain (producer's end)
  29. 10 Rules
    1. If the category is application software, begin buying in the bowling alley
    2. If the category is enabling hardware or software, begin buying after the tornado has formed
    3. Buy a basket comprising all the gorilla candidates - usually at least two, sometimes three and normally no more than four
    4. Hold gorilla stocks for the long term. Sell only on proven substitution threat
    5. Hold application software chimp stocks as long as they exhibit potential for further market expansion. Do not hold enabling technology chimps
    6. Hold kings and princes lightly, selling individual stocks on a marketplace stumble and the category upon deceleration of hypergrowth
    7. Once it becomes clear to you that a company will never become a gorilla, sell it
    8. Money taken out of non-gorilla stocks should immediately be reinvested in the remaining gorilla candidates
    9. In a gorilla collision, hold your gorilla candidates until there has been a definitive outcome
    10. Most news has nothing to do with the gorilla game. Learn to ignore it
  30. Filters
    1. If it is not about a tornado, you don't want to know
    2. If it is about a tornado, you want either bad news or facts (see questions above)
    3. New value chain, niche market, killer app, third party partners doing, proprietary architecture, switching costs, new tech to shorten gorilla CAP?
  31. Selling worries - focus on process and whether it was good or bad and the decision if it was good or bad, not the outcome
  32. A lot of press a great sign of gorilla status
  33. Gorilla can leverage high stock price for accretive M&A
  34. Gorilla process = SHARES
    1. Scan for trends, new categories, confirmations, exceptions, irrelevancies
    2. Hypothesize through tech magazines, website
    3. Analyze to gain sense of CAP
      1. "The focus of all these interactions should be on refining the model of the market place, drawing the maps of power, understanding the sources of competitive advantage, and anticipating how competitive dynamics might change, occasionally within categories, but more commonly because of categories colliding."
    4. Respond - no paralysis by analysis
    5. Evaluate - invest only 4x per year
      1. Spreadsheet - revenue and earnings history going back at least 6 quarters (if available), stock price chart, current market cap, P/S, P/E, estimated market share in category
    6. Strengthen by putting additional funds into potential gorillas
  35. Don't predict, respond
What I got out of it
  1. Awesome investing framework for investing in "gorillas" in the high-tech space. Argues that by following this framework, you can remove a lot of uncertainty and produce incredible returns by investing in companies that will have the fattest competitive advantage period

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