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Home My Column

Tail Engine: By Tanvi Mehta, Ramaswamy Ranganthan and Sudaarshan R

by Editorial
June 20, 2020
in My Column
5 min read
Tail Engine: Tanvi Mehta, Ramaswamy Ranganthan and Sudaarshan R
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Black Swan has become extremely popular since Taleb coined it and wrote about it with great detail, the whole world has started to use this, and this has in every check become the most abused word in the business fraternity.

All sorts of Bank failures are being called Black Swan events. Rightly irritated by the abuse of it, Taleb described Black Swan as it is unpredictable, the “Unknown Unknown” which in simple means no one can see it coming.

We are very sure that Bank Failure, Currency Crisis, Economic Recession, and other notable things which keep happening in the economy are predictable, but most of them are TAIL EVENTS.

In a “normal” distribution the outliers, or “tails” – the lines tapering off to the left and right of the bell curve – are thin, meaning that the probability of outlier events is low. When the tails get “fat” it means the chance of something crazy happening is higher than one might expect.

In the Business World, majority of the success is hugely driven by Tail Events. The most critical to note is that companies innovate, minority succeed and the same minority drive majority of the earnings within a company or within the industry. Tail Events guide the future of the industry and Tail events drive the earnings barometer within a firm too.

Let’s dig the long tail in the world. A key point here is that the probability of a move alone doesn’t matter, it should always be considered in the context of magnitude. Robust likelihood of a small, modest move is not as powerful as lower likelihood of a large, powerful move that infuses power of deadly compound changing the Business Landscape.

The advent of Internet became a driving force in creation of Tail Events and drilling this down few companies further will make you realise that TAIL EVENTS not only drive the firms into glory, but it also cements the foundation.

Google itself due to internet is a great Tail Event, combine that with Search, YouTube and Android, all the three are Tail Events, which drive majority of the earnings for Google. Search alone contributes close to 100 Billion Dollars in Revenue, Android dominates the smartphone system, and YT dominates the user-generated content on Video.

The advent of JIO is a classic case of Tail Event, this is where the likelihood of a large powerful move, infused with the power of dynamite shook the landscape, in India.

Jio today dominates the telecom business, progressed excellently into a technological platform, and led the industry to a shakeout. New entrant entering a market, cannot be a termed a Tail Event, but free services of data for a year is a massive tail event, which not only shifted the consumers but also penetrated the rural market of India with great aggression.

Vodafone is virtually bankrupt, Airtel was bleeding till recently, the damage unleashed by JIO is unmatched globally. The Telecom Industry in India today is practically a duopoly.

Today JIO has raised over 1 lakh CR from global investors, which itself is a Tail Event considering the situation in which we are now in and within the timespan.

Stanford, Harvard, Brown , Cornell, Columbia, MIT, Princeton, Yale, Dartmouth, University of Pennsylvania, have something in common which is Tail Event, apart from being Ivy League ( MIT and Stanford are not Ivy but are stupendous in academics) they all have low acceptance rates, they all get the brightest students in the world, and these brightest students go on to have the brightest career in their chosen field of profession, pick any fortune 500 company, most of the top positions are filled up by alumni of these universities.

These students have extraordinary careers which is nothing but a Tail Event.

Getting into an Ivy itself can alter your ordinary career into a Tail driving career.

Think Facebook and Google, where do the founders come from. Think where does Sundar Pichai comes from. Think Where does Amazon founder come from …. Princeton.

Warren Buffett has admitted that buying Berkshire itself was mistake, that time it was a textile business struggling to find its feet. Berkshire itself is a Tail Event, it has the largest net worth (shareholder’s equity) amongst all the companies in the world.

In Dec 2019, the Shareholders Equity is $428563 million, this is probably the fattest tail possible, to quote Charlie Munger he said, if you take out our 15 great decisions, our record would be pretty average.

This clearly explains the relevance and importance of Tail Events.  Berkshire’s Float has grown from $84 Billion in 2014 to $129 Billion in 2019, this itself is a miraculous Tail Event, considering that the cost of float for Berkshire has been negative.

Apple was in tatters when Jobs returned and the company struggled for 6 years, the birth of iPod started the tail engine, the launch of iPhone changed the face of the company forever, granting Steve Jobs an immortal place in the pantheons.

The Market cap of Apple was $1 Billion in Dec 1980, dial forward to 2020 its above $1 Trillion. iPhone is the biggest Tail Event in the history of Apple so far, resulting in Professor Damodaran calling it the Greatest Cash Machine in the history. These accolades don’t accrue without Tail Events.

Amazon was virtually Bankrupt in the Dotcom bubble, and it had a hard task to survive, in 1997 September Amazon had a $1 Billion Market-cap, 1999 -Market cap of $30 Billion come 2001, Market cap drops back to $2.25 Billion. Amazon was $100 Billion in 2012, and in 2020, Jeff is the richest man in the world with Amazon at over $1Trillion in Market cap.

Amazon launched Prime in 2005 with consumers paying $79 for free 2-day shipping, this consumer-focussed obsession started the Tail Engine. This Tail engine started when Jeff had a meeting with the founder of Costco Jim Sinegal in a coffee shop, where he learnt about Costco’s loyalty membership and their obsession with customers.

Amazon quickly adopted the strategy and the Tail started to wag with Prime and then came the bigger Tail of AWS. Today most of the value of Amazon is driven by Prime and AWS which is one of the most sublime Tail Engines in the world.

The story of Medallion fund is the mother of all Tail Events, At the age of 14, Jim Simons worked at a garden supply store as a floor sweeper after being demoted from a stock boy position due to his lack of memory of inventory location.

However, he had the ambitious plan of becoming a mathematician at MIT.

In 1955, Simons was accepted into MIT and majored in mathematics. Upon graduating, Simons studied at the University of California at Berkeley for his doctorate in mathematics. After just one year, he received his doctorate at the age of 23 in 1961. (so much for demotion from a stock boy to floor sweeper)

Thereafter, he went on to teach mathematics at MIT and Harvard. The Institute for Defence Analyses (IDA) recruited Simons in 1964, where he played a key role as a code breaker during the Vietnam War.

In 1978, he started a hedge fund named Monomeric, now called Renaissance Technologies. The fund has an outlandish track record.

As Greg Zuckerman noted in The Man Who Solved the Market, Renaissance’s flagship Medallion Fund generated 66% annualised returns (before fees) and 39% annualised returns (net of fees) from 1988-2018.

To put this performance in perspective, $1 invested in the Medallion Fund from 1988-2018 would have grown to over $20,000 (net of fees) while $1 invested in the S&P 500 would have only grown to $20 over the same time period.

Even a $1 investment in Warren Buffett’s Berkshire Hathaway would have only grown to $100 during this time. This means that the Medallion Fund outperformed one of the best asset classes of the last few decades by 1,000x and one of the best investors of all time by 200x.

The world out there is made up of Luck, Skill, and Risk (LSR). The Tail outcomes in business or life in general is the interaction of LSR.

The beauty in life and business lies in recognising that minority of events will drive majority of business earnings and majority of happiness in life will also mandatorily come from minority of moments.

By Value  Investors – Tanvi Mehta, Ramaswamy Ranganthan and Sudaarshan R .

Tags: Ramaswamy RanganthanSudaarshan RTail EngineTanvi Mehta

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