Will It Increase Productivity? A Lens for Investing
I look at most investments through the lens of productivity: if the company succeeds in its mission, will it meaningfully increase productivity in the world?
This tends to be an excellent litmus test for screening whether a business can grow really big. And notably, it works well in both private and public markets.
What is Productivity?
Core to the question is the word “productivity.” I’m using the economic meaning of the word, where productivity refers to how much output can be produced with a given set of inputs. There are two ways to grow productivity:
Grow output while holding the number of inputs constant (or grow output at a faster rate than one increases inputs).
Reduce the number of inputs while maintaining the same level of output.
Both really mean the same thing: each input generates more output. But the framing slightly changes the characteristics one might look for. The former is more oriented toward new-market growth, whereas the latter puts the focus on cost declines.
Applying this Framing
In practice, how does a company actually improve productivity? Keeping with the framing above, there are two heuristics that I’ve found especially valuable:
For growing a market: the company (or the technology it utilizes) expands access to the good or service.
For reducing costs: the company has identified a cost center within an existing market and has found a way to improve upon it (e.g. via less expensive substitutes, better technology, etc.).
These considerations don’t exist in isolation. Sometimes cost reductions make the market available to new participants who were previously priced out. Similarly, market growth can incentivize R&D into new technologies or techniques that, in turn, help drive down costs. Companies that build such flywheels often enjoy compounding competitive advantages.
There are many scenarios where this framework isn’t quite as cut-and-dry as it may sound. Answers often differ based on a function of one’s time horizon. Take re-launchable rocket companies. It took a lot of inputs a long time to generate any output. But if we get reusable rockets and can start to do things like space manufacturing, the size of the resulting market may be huge.
Successful examples are almost always easier to rationalize in hindsight. That’s why I find the framing if it works far more helpful than will it work – at least for earlier-stage, venture-style investments.
Later-Stage / Public Markets Addendum
There are a couple variations of this question applicable in later stage (i.e. more mature) markets.
The initial question – will this meaningfully increase productivity? – points towards growth. But there are some companies that have already achieved this status. So the better question to ask might be If this company disappeared, would productivity fall? A “yes” answer to this question suggests not only that the business provides a valuable good or service (i.e. validation that it has indeed achieved “productive” status), but also that its market position is likely well-solidified.
Early-stage companies tend to be hyper-oriented around growth – which frequently includes a plan for disrupting incumbents. The flipside is that mature, market leaders need to defend their business. There are many ways that a company can defend (or, in the case of regulatory moats, enshrine) its position. I’ve found this focus on productivity to be a good starting point: it’s both a litmus test for defensibility and a structured gateway to more market-specific analysis.