{"id":19208,"date":"2024-01-02T15:33:55","date_gmt":"2024-01-02T15:33:55","guid":{"rendered":"https:\/\/www.michaeldempsey.me\/blog\/?p=19208"},"modified":"2024-01-02T23:21:47","modified_gmt":"2024-01-02T23:21:47","slug":"category-creation-capital-in-technology","status":"publish","type":"post","link":"https:\/\/www.michaeldempsey.me\/blog\/2024\/01\/02\/category-creation-capital-in-technology\/","title":{"rendered":"Category Creation & Capital in technology"},"content":{"rendered":"\n

I believe one of the most damaging pieces of advice to proliferate in the tech world over the past few years has been \u201cbeing early is indistinguishable from being wrong\u201d<\/em>. <\/p>\n\n\n\n

There are many reasons why this is true in theory<\/em> but as I\u2019ve talked about for years, at this stage of technology development and penetration, whether you\u2019re a technologist or capital allocator, if you\u2019re not too early, you\u2019re too late.<\/a><\/p>\n\n\n\n

As venture markets continue to institutionalize, this becomes more true with consensus startups getting rampantly bid up in price. This leads to a compressing of returns and forces growth-stage investors to have asymmetrically upside-skewed beliefs on terminal outcomes in order to capture meaningful alpha.<\/p>\n\n\n\n

Concurrently, technology as an asset class has continued to evolve and is now going through a next major wave that could lead to market cap dislocation at a far faster pace and grander scale than this past decade.<\/p>\n\n\n\n

Put simply, if the prior decade of technology as an asset class was about incumbent industries being swallowed up by tech, leading to an expansion of the market cap of \u201ctech\u201d as a category, than the next may be about disruption and market cap destruction within<\/em> tech itself.<\/strong><\/p>\n\n\n\n

What this means is that there will be parallels of businesses that are \u201ctech\u201d versus \u201cnon-tech\u201d versions as well as \u201cnew tech\u201d versus \u201cold tech\u201d versions. With this dynamic comes a necessity to create legibility in order to properly (or improperly) analyze and value these new types of technology businesses. People do this by changing the terminology and descriptors surrounding these companies, a cycle that continues to happen over and over again.<\/p>\n\n\n\n

How Capital Flows Through Assets<\/h2>\n\n\n\n

At a high level, category creation occurs as an exercise to draw in capital, create legibility, and then create novel re-rating or \u201cmultiple expansion\u201d of an opportunity.<\/p>\n\n\n\n

The chart below details this entire dynamic.<\/p>\n\n\n\n

\"\"\n\t\t\t\n\t\t\t\t\n\t\t\t<\/svg>\n\t\t<\/button><\/figure>\n\n\n\n

Capital needs structure<\/em> in order to properly flow through the system. <\/p>\n\n\n\n

We look at this at an Asset Class<\/strong> level. An asset class has a few high level properties like timeline, risk, and business dynamics that allow large sums of money to be bucketed. The examples in my chart above are Equities, Fixed Income, Commodities, and many others.<\/p>\n\n\n\n

Let\u2019s now follow the equity-like instrument component down the rabbit hole further to get a better grasp of how we get from there to a novel category.1<\/a><\/sup>Yes, I know this chart doesn\u2019t only look at equities<\/span><\/p>\n\n\n\n

Assets then progress into Sectors<\/strong> that are based on the area of focus (Technology, Telecom, Healthcare, Financials) or higher level properties of the asset from a risk or metrics perspective (Growth, Value, ex-US). <\/p>\n\n\n\n

Sectors enable people to then begin to allocate a relatively finite amount of capital across entities in a zero-sum way (people will make explicit decisions of wanting to be in equities, and then within that deploy into sectors like technology or telecom or growth, etc.).<\/p>\n\n\n\n

As Sectors become more well-understood, market participants look for ways to further differentiate a basket of companies or investible assets in order to capture flows, or theoretically to increase the flow into the broader Sector. This is where Categories<\/strong> are created and perhaps is the key thing to understand about why capital creation happens.<\/p>\n\n\n\n

Novel categories are created in order to differentiate a sea of companies with market-wide illegible properties, in an effort to create multiple expansion or a re-rating dynamic within the given sector. <\/p>\n\n\n\n

Put more simply, people name things something novel so that they can tell other people that Company A<\/em> in Category X<\/em> is a better company than similar incumbent Company B<\/em> in Category Y<\/em>. Alternatively, they give a name to Category X<\/em> because the technology itself or the companies within them were too difficult to understand or not marketable enough. <\/p>\n\n\n\n

Not machine learning, but AI. Not digital worlds but The Metaverse. Not Blockchain but Crypto…well actually, Web3.<\/p>\n\n\n\n

These categories are built around narratives that people hope will come true across a variety of fundamental property types. These properties can include but are not limited to:<\/p>\n\n\n\n