The Wooden Nickel is a collection of roughly a handful of recent topics that have caught our attention. Here you’ll find current, open-ended thoughts. We wish to use this piece as a way to think out loud in public rather than make formal proclamations or projections.
1. Reports of Software’s Death Have Been Greatly Exaggerated (For Now)
There’s been an entertaining and illuminating debate transpiring this summer about whether we’re on the cusp of the demise of how we have come to know the software industry, primarily in its “as a service” form. It’s not a new debate; a version of it surfaced last summer after a particularly ugly quarter from Salesforce, a poster child of the SaaS era. The debate then, and to a lesser extent now, revolved around the fear of AI’s disruptive force, specifically companies being able to do the same amount of work with fewer employees. Less labor means fewer subscriptions, or “seats”, needed for software.
Today, the debate has evolved along with the rapid gains in large-language model capabilities. As the argument goes, as the barriers to entry and cost to create software have collapsed, it has become all the easier to find a software solution to meet a business’s needs. Software creation has gotten so much easier that a business can even spin up its own software solution for whatever task it needs: inventory management, website development, customer relations, marketing automation, etc.
Elements of the argument engender sympathy. A massive boom in supply in any industry tends to be followed by mediocre returns at best in the following years; this is the classic capital cycle framework. We’ve also been through a bit of a golden age of software in the last 15 years, starting with Software Eating the World in an era of zero capital costs, flush VC pockets, and ending with the digitization boom of the Covid pandemic. This has brought us to a new phase where peak growth rates are probably behind us; where it used to be common to see software companies growing north of 30% it’s now difficult to find one that grows north of 25%; markets have been penetrated, and the playbooks for scaling a software business are better understood. To put it simply, whatever challenges face much of software, especially at the enterprise level, most of them would still be present whether or not ChatGPT had ever been created in the first place.
Figure 1: The Capital Cycle
But companies don’t exist to build software; they exist to deliver goods and services. Every hour spent building, debugging, maintaining, updating, iterating, securing, and integrating software is an hour that isn’t spent building up your core business. Yes, code is getting much cheaper to develop, but cost was not the barrier to begin with. The burden isn’t in developing code; it’s in owning it. Over a system’s life, maintenance, integration, enhancement, and security typically absorb the majority of total cost (often 60–70%), long after the initial build is done. That burden doesn’t disappear.
Companies build software solutions and tools out of necessity, not out of hobby or to pinch pennies. The odds of that changing feel slim. And yet, golden eras can’t exist in perpetuity; if they did, it would defy the very definition of a “golden era”. A more likely set of hurdles, though indemonstrable, is to think of the ramifications on the current software landscape being disrupted by AI native applications (much like the winners in the era of the internet were not the on premises winners of the dot-com bubble) for the same end task or even more consequentially what happens to the nature of work brought about by the AI paradigm. To borrow Benedict Evans’ concept, platform shifts unlock new use cases. They don’t become features in existing methods; rather, they’re the building blocks upon which brand new, unimagined use cases are built upon.
2. The Smartest Guys in the Room
It’s commonly said that there’s more than one way to make money investing in equities; not everyone investing is playing the same game. Across different time horizons, the source of what accounts for investment results changes. It’s why markets are said to be “voting machines in the short run and weighing machines in the long run.”
Figure 2: What Drives Investment Results Over Time
The image in Figure 2 is frequently shared and well known, but it came back to mind recently with the news that Kraft Heinz would be splitting back apart, less than 10 years after getting together in the first place.
The deal saw a unique, although not unprecedented, arrangement between 3G Capital (known for its efficiency drives and emphasis on zero-based budgeting) and Warren Buffett. At the time of the deal, 3G had an aura about them; almost a glow or halo, as though the firm knew how to run consumer businesses far better than anyone, that they were doing a service to the industry by buying an anchor asset and using it as a platform upon which to roll up the packaged foods industry. Build scale, cut costs, hold more leverage over customers, strategically raise prices, lever it up and buy another asset. Rinse and repeat. Speculation on who the behemoth would buy next was prime finance gossip among analysts and investors.
The deal has been an unmitigated disaster, however you slice it. The share price is down 69% since the merger closed. The air of optimism and benefit of the doubt the company, its managers, and owners held evaporated; the only thing surprising is just how quickly it unraveled.
Figure 3: Merging Kraft and Heinz Has Been a Financial Disaster
The lessons of the Kraft Heinz debacle are two-fold. The first is that you cannot cut yourself to growth or prosperity. To starve an entity of investment is akin to cutting off oxygen; there is only so long you can last. Austerity doesn’t work out for anyone. While efficiency is a necessity, it is not sufficient to unlock value.
The second is to know the makeup and judgment of those you partner with. The inclusion of Buffett in the Kraft Heinz deal gave a specific type of stamp of approval to the deal. That while cost cuts would be a part of it, there would be more to the story in order to generate success. And further to it, this wasn’t the type of smash-and-grab private equity job that gets stereotyped in the press or common lore. That there were engines of value creation being brought to the table. And yet all that proved to be nonexistent.
Knowing people who worked for 3G companies or advised 3G companies, the feedback was consistent and unanimous. Terms like “cold”, “soulless”, “barren”, “empty”, “exhausting”, and dozens more littered the reviews; it was genuinely difficult to find a single positive adjective associated with the company. It makes you wonder, “How can a company delight its consumers without a soul?” Did they really know how to build brands and consumer affection? Did they know how to win hearts and minds? Or did they confuse their genius for a bull market that eventually evaporated?
The longer the investment horizon, the factors of manager alignment with the engines of value creation become all the more paramount.
3. Recommended Reads and Listens
