Recently, I wrote on optionality. It is one of my favorite concepts to investing, but the article left out one key feature (on purpose). A key accelerant to optionality comes from autocatalysis, which is a biological reaction where “one of the reaction products is also a catalyst for the same or a coupled reaction”. In investing, this means a feedback loop is created where one outcome creates other possibilities. A good example is Disney:
“Disney is an amazing example of autocatalysis … They had those movies in the can. They owned the copyright. And just as Coke could prosper when refrigeration came, when the videocassette was invented, Disney didn’t have to invent anything or do anything except take the thing out of the can and stick it on the cassette.” – Charlie Munger
The beauty of this quote is it is pre-Disney+. Now Disney has leveraged all of their pre-existing content into not only a revenue stream, but a recurring revenue stream. On top of that, they also are able to leverage the popularity of movies into their parks, apparel, etc…
Network effects are a great example of autocatalysis. Once you’ve built a massive network, you can leverage that into new revenue a lot easier. A great example of this is Facebook. Originally, Facebook was just a social network. Then, once that network was built and reached mass network effects, Facebook was able to leverage it into new uses (Marketplace, Jobs, Groups, Events, etc…). Facebook isn’t done yet, with shops, dating, and much more still in the works. When you already have the network, so much of the work has already been done.
In many ways, Autocatalysis is related to flywheels and compounding. Reactions that feed off themselves, create more reactions that feed off themselves… Before you know it, you are compounding. Compounding is really the whole goal of flywheels. All these ideas are related and feed off each other. Knowing one strengthens your understanding of the rest.
Autocatalysis is a simple idea, but I think it is good to think about how autocatalysis relates to your investments. Another mental model to add to your latticework of mental models. Like optionality, you can easily see autocatalysis in many of the largest companies (which makes sense given how optionality and autocatalysis are related).
Some quick thoughts on autocatalysis on a few stocks:
$AAPL: Given the massive userbase on iOS, Apple can quickly enter new markets with great success (health, fitness, iPay, etc…).
$SPOT: Huge userbase, low-ish market cap considering size of userbase. Autocatalysis could lead to optionality and eventually increased margins. Podcasts are the start, but once you have the userbase, so many more options are created.
$SE: Huge optionality is driven by Garena as a cash cow. If they combine their cash cow with a growing user base, scary things could happen.
$SQ: Cashapp is growing it’s userbase. As it does, users will naturally use new features they roll out (stock purchases, bitcoin purchases, payday loans, etc…)