My 2022 Investment Thesis

I was initially prompted to write a sector-specific investment thesis that is almost like a report. However, as a believer in diversifying your investments in different software markets, I thought it would be more interesting to talk about how to pick the markets first. This article will explain how I think about picking long-term winners in profitable markets.

There are 4 characteristics that I look for in a company:

In a new, growing market with the potential to monopoly

Going at an existing market is hard. It’s either a perfect competition where you won’t have pricing power or a moat. Or taking on an existing monopoly or duopoly where the probability of success is not only low, but completely dependent on the founder’s unique insights, and not even as replicable as people assume.

As society evolves, new markets for services are appearing faster than ever. Finding a new market and dominating it is much more attainable. What’s important is having the insight that the market will grow so that when you own the market, you can grow with it without having to explore other means of growth.

• Google is the best example that achieved pricing power through monopoly in search.
• Carta is a good example of finding a new market and aiming to dominate. If Carta had tried to become a market maker, it would have been very hard. If Carta had tried to become a public equity brokerage, it will enter a market where the competition drives the margin to zero. (Robinhood did and performed poorly after the 2021 IPO). Disclaimer: Carta didn’t “invent” cap tables. Carta found a highly fragmented and manual industry of transfer agents and built software for it.

Has Network Effect-led-Pricing Power

I like a business with strong pricing power that is reinforced(not created) by network effects.The company must be providing superior experiences that give them customer loyalty, which also means pricing power in the first place. Sometimes, network effects create additional value to customer experience and reinforce their pricing power.

• Apple is a good example with high customer satisfaction and has network effects like Airdrop and iMessage that reenforces custom loyalty and pricing power. As much as some despise the “green bubble” effect, many professionals have near-zero price sensitivity to Apple products. An iPhone is such an integral part of our lives that affluent Americans will buy one whether it is $750 or $1250. It’s not unusual to see “tech bros” spending $4k+ to max out their latest MacBook Pros.

Is a company that I am a customer of

Like Warren Buffet, I only invest in what I understand. I mostly invest in consumer tech, fintech, design/dev tools, and startup SaaS. I care a lot about being a consumer of the company that I invest in and know other users. Albert Wenger once told us in a class that when a startup has Product/Market Fit, even with organizational issues, it likely grows. As an investor, being a customer or super close to customers is a superpower. It gives you a constant pulse check on the demand and the company’s solution. For early-stage companies, I want to be able to imagine being a customer.

• Uber is an example where the market demand is so clear, the expansion was inevitable (ignoring regulatory risks here). It was such a VC darling because every investor understood the business model and can imagine being a customer.

Has a leading employer brand

Like Scott Belsky mentioned, I also only invest in companies that I would work for. The common measure is that you like the founders and the management team. But I believe an under-appreciated long-term asset is a strong employer brand. Executives come and go, but brand equity stays with the company and attracts future talents. During a difficult time, it also means retaining talents.

• Airbnb is a great example of a strong brand that performed a beautiful coming back during Covid. A lesser brand would have suffered way worse in losing employee morale.
• Goldman Sacs doing a few bad deals and having a few bad apples hasn’t prevented job seekers from wanting to work there. The strong brand of Goldman also made Marcus is sexier employer brand than other traditional bank’s tech products.

Case study

A company that has all 4 above is Figma, an interface design tool used to design software user experiences. My below analysis is oversimplified and may only make sense if you are familiar with the business.

Potential to monopoly in a new, but growing market

The interfaces design tech market is estimated to be $40B. Figma was last valued at $10B and commands over 50% of the specific market today in 2022 (averaging a few studies). Figma has clear sight to dominate the market entirely.

Figma charges enterprise a fixed monthly fee per user. As long as there are more software companies, Figma will have more customers. When a company’s software division grows, Figma’s revenue per enterprise custom grows as more seats are added.

So as long as we continue to create more software, Figma will grow.

Network effect-led-pricing power

Figma has built two very strong moats: 1. Stakeholders who rely on the collaborative nature of Figma. 2. A large number of community plugins and resources. Number one prevents design teams or individuals from moving to a design tool of different kind (one lacking collaboration features). Number two prevents design teams or individuals from moving to a direct competitor copy of Figma, in fear of losing the community resources. This combination of network effects gives Figma enormous pricing power over enterprises.

Disclaimer: I’ve heard people describing Figma as an amazing tool for designers but just an okay tool for stakeholders. If a competitor came out with a tool boasting the same designer experience today and significantly better stakeholder experience. The likelihood for the design org to switch to a competitor is still minimal, according to many of my friends, which reinforces Figma’s strong network effect.

Is a company that I am customer of

My unique insights come from being a customer. An additional data point is that many designers I know will not join a company today if the company isn’t using Figma for design.

Has a leading employer brand

Figma built a very strong brand leveraging twitter, where Designers and Product Managers constantly engage with the community and show a high level of craft and care. They’ve demonstrated a high bar for talent and created a halo effect for the employees that work there. The successful community push made Figma a very popular employer.

If you like or dislike my takes, you can find me on Twitter @sjzhang_