Latticework of Mental Models: Surfing

In spite of having a coastline of more than 7,500 km with warm oceans and favourable conditions, surfing is not a familiar sport to Indians. It seems we are more fascinated with the swing of a cricket ball than the twists and turns of water waves.

In many western countries including the US and Australia, surfing is a popular sport as well as a recreational activity. Surfing is a surface water sport in which the wave rider, referred to as a surfer, rides on the forward or deep face of a moving wave, which is usually carrying the surfer towards the shore.

A surfer not only is carried by the wave, but it gives an exceptional forward speed to its rider, provided the surfer can get on to the wave at the right time and not get thrown off in between. The second most important thing required to ride a wave is to recognize that the a wave is approaching. Which means 90 percent of the times you would find a surfer lying on his surfing board and paddling slowly, waiting for the right wave.

So why are we talking about waves and surfers in a place reserved for discussing mental models?

That’s because “surfing” isn’t just a sport. There are brilliant insights that can be used to analyse a business opportunity through the lens of a mental model with the same name i.e., Surfing.

Charlie Munger used the surfing metaphor in his lecture on Elementary Worldly Wisdom to represent the idea of some large business force that developed, which a company was able to ride to grow itself much bigger.

As the saying goes – A rising tide lifts all the boats. But it’s important that one keeps his or her boat ready and identifies the tide on time. Many a times the same rising tide finds some people off guard and instead of lifting, it drowns them. That’s competitive destruction.

Charlie Munger says –

When technology moves as fast as it does in a civilization like ours, you get a phenomenon which I call competitive destruction. You know, you have the finest buggy whip factory and all of a sudden in comes this little horseless carriage. And before too many years go by, your buggy whip business is dead. You either get into a different business or you’re dead—you’re destroyed. It happens again and again and again.

And when these new businesses come in, there are huge advantages for the early birds. And when you’re an early bird, there’s a model that I call “surfing” – when a surfer gets up and catches the wave and just stays there, he can go a long, long time. But if he gets off the wave, he becomes mired in shallows….

But people get long runs when they’re right on the edge of the wave – whether it’s Microsoft or Intel or all kinds of people.

Microsoft was a result of a 16 year old catching a wave right on the edge. Bill Gates and his friend Paul Allen were just 16 years and 18 years old respectively when the PC wave hit. Gates recounts his experience –

As early as 1971, Paul and I had talked about the microprocessor. And it was really his insight that because of semi-conductor improvements, things would just keep getting better. I said to him, “Oh, an exponential phenomenon is pretty rare, pretty dramatic. Are you serious about this? Because this means, in effect, we can think of computing as free.” It is a gross exaggeration, but it is probably the easiest way to understand what it means to cut cost like that. And Paul was quite convinced of that. So I would sort of say to Paul, “Well, you know what that means?” And he’d say, “Yeah, that is what it means.” It is kind of fun to know this, and think, gosh, how are companies going to react, how are they going to respond to something that phenomenal? The early days were very slow moving, though. By the time I went to Harvard, all there was the 8008 chip. And the 8080 was just coming out, which was the first good general purpose microprocessor chip that Intel was coming out with.

Do these waves hit only selected people? Obviously no. But only few people see them coming. Why?

Two people can see the same thing, but have a very different understanding of the implications. When Internet was in its early phase, a lot of people said, “What’s the big deal about the Web?”

But when Jeff Bezos, who was working in a Wall Street firm until then, saw the Internet, he had different thoughts. He started looking for things that could be done with this strange technology called world wide web. He said this in one of his interviews –

I started working at the intersection of computers and finance, and stayed on Wall Street for a long time, ultimately worked for a company that did this thing called quantitative hedge fund trading. What we did was we programmed the computers and then the computers made stock trades, and that was very interesting too.

The wake up call was finding this startling statistics that web usage in the spring of 1994 was growing at 2,300 percent a year. You know, things just don’t grow that fast. It’s highly unusual, and that started me about thinking, “What kind of business plan might make sense in the context of that growth?

For him the moment of recognition happened when he saw the unusual growth numbers associated with internet. Jeff Bezos recognized the potential of the wave called Internet. And then he didn’t sit there paddling, he climbed onto his surfing board called Amazon, and got on the wave. Needless to say, the wave lifted this surfer to such heights that he changed the way things are bought and sold.

After 20 years, Bezos is still riding the wave.

As an aside, do you know who is the greatest surfer of all time? And I am not talking about riding a business wave. I mean the real wave in the ocean. His name is Laird Hamilton. He infamously surfed the most dangerous wave in the world. It was as tall as a seven-story building.

Talking about catching the next wave in technology, Steve Jobs, in an exclusive interview with Fortune, said –

These waves of technology, you can see them way before they happen, and you just have to choose wisely which ones you’re going to surf. If you choose unwisely, then you can waste a lot of energy, but if you choose wisely, it actually unfolds fairly slowly. It takes years. One of our biggest insights [year ago] was that we didn’t want to get into any business where we didn’t own or control the primary technology, because you’ll get your head handed to you. We realized that for almost all future consumer electronics, the primary technology was going to be software. And we were pretty good at software.

This reminds me of Malcolm Gladwell’s book Outliers where he explains how these Silicon Valley tech entrepreneurs, who were born within a couple of years of each other, like Bill Gates, Steve Jobs and Bill Joy, recognized and caught the same wave.

And then you have Indian tech czars like Narayan Murthy, Azim Premji, and Shiv Nadar who were also born within a space of few years and ended up riding the same software services wave in India. Sunil Mittal was another guy who rode the GSM wave and became one of India’s richest men.

All the examples above tend to suggest that surfing a wave phenomenon is only relevant in technology related businesses. But that’s not entirely true. Charlie tells the story of John Patterson and his company National Cash Registers –

The cash register was one of the great contributions to civilization. It’s a wonderful story. Patterson was a small retail merchant who didn’t make any money. One day, somebody sold him a crude cash register which he put into his retail operation. And it instantly changed from losing money to earning a profit because it made it so much harder for the employees to steal….

Image Source: Poor Charlie’s Almanack
But Patterson, having the kind of mind that he did, didn’t think, “Oh, good for my retail business.” He thought, “I’m going into the cash register business.” And, of course, he created National Cash Register. And he “surfed”. He got the best distribution system, the biggest collection of patents and the best of everything. He was a fanatic about everything important as the technology developed. I have in my files an early National Cash Register Company report in which Patterson described his methods and objectives. And a well-educated orangutan could see that buying into partnership with Patterson in those early days, given his notions about the cash register business, was a total 100% cinch.

Another great example that Munger talks about is of Les Schwab who rode the Japanese tire invasion wave, because of which he grew his tire store chain into multi million dollar sales.

When it comes to investing, Surfing is an important mental model that every investor should be thinking about for picking stocks.

“That’s exactly what an investor should be looking for,” says Charlie, “In a long life, you can expect to profit heavily from at least a few of those opportunities if you develop the wisdom and will to seize them. At any rate, surfing is a very powerful model.”

Now an important question is – how easy or difficult it is to catch a wave? Or for that matter, do you really need to surf every wave coming?

When the PC wave and the Internet wave hit, Warren Buffett was not just a spectator. Especially in the case of Intel and Microsoft, Buffett was right there, rubbing shoulders with the people who are considered pioneers in getting onto those waves.

As part of the finance committee of Grinnell College, he signed off the decision to make an initial investment in a company called Integrated Electronics. However, Buffett never put his own money into the company which later became Intel. Similarly, Buffett met Bill Gates in 1991 and they became good friends. But in spite of Gates’ suggestions to invest in Microsoft, Buffett passed the opportunity.

So why did Buffett choose to be a mere bystander to both PC wave and the Internet wave? Charlie Munger explains –

Berkshire Hathaway, by and large, does not invest in these people that are “surfing” on complicated technology. After all, we’re cranky and idiosyncratic—as you may have noticed. And Warren and I don’t feel like we have any great advantage in the high-tech sector. In fact, we feel like we’re at a big disadvantage in trying to understand the nature of technical developments in software, computer chips or what have you. So we tend to avoid that stuff, based on our personal inadequacies.

Again, that is a very, very powerful idea. Every person is going to have a circle of competence. And it’s going to be very hard to advance that circle…So you have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make. You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence.

Some of you may find opportunities “surfing” along in the new high-tech fields—the Intels, the Microsofts and so on. The fact that we don’t think we’re very good at it and have pretty well stayed out of it doesn’t mean that it’s irrational for you to do it.

The fact that Buffett and Munger don’t invest in technology (though Buffett has invested in IBM of late) doesn’t mean that it’s irrational for you to do it. What’s irrational is to try to catch on a wave which is outside of your circle of competence. You have to figure out where you’ve got an edge and then wait for a wave in that area.

Conclusion

A lot of business fortunes are made because someone happened to be in the right place at the right time – i.e., luck. Luck does play a large role for someone who surfs a wave. Luck, fortunately or unfortunately, is not sufficient.

Charles Darwin wrote –

It’s not the strongest of the species who survive, nor the most intelligent, but the ones most responsive to change.

I think that sums up the idea of surfing a wave perfectly well, because waves favour the prepared mind.

I hope that this post gives you information that you can apply practically, or use as a springboard for further useful discovery. That would be my aim.

Take care and keep learning.