Every contrarian, at some point, feels like an… (source)

How to be contrarian in a bull market

I am fond of a particular interview question that was popularized by Peter Thiel a few years ago:

“What do you believe in strongly that others do not?”

The theory behind this question is that, as an investor, you only achieve outsized returns by opposing conventional wisdom — that is, by being a contrarian. It’s not good enough to be right; you must also be right when others are wrong. Otherwise, even when you’re right, the arbitrage opportunity will have disappeared, leaving you with merely average returns.

Schematically, you might represent this philosophy in a 2x2:

In 2009, when I started in venture capital, it was much easier to be contrarian because, at the heart of the recession, everyone was so negative and the future so uncertain. Collaborative consumption, on-demand economy, software-defined data center, cloud services in the enterprise…all of these trends that almost no one in Silicon Valley would doubt today had serious detractors only 6 years ago. It was a great time for us to invest in companies like thredUP, Handy, VMTurbo, and 2U. I give these teams a ton of credit for seeing around the corner to the present bull market.

Today, it is much harder to maintain that mindset. It feels like technology has the potential to drastically transform every industry, every function, and every geography. Every single product is getting “re-imagined” with software at its core. Social media influencers are reinforcing the trope that this time is actually different — that we are only at the beginning of a monotonically growing revolution being led by the software industry.

Even if this were true, there is a danger in believing it too much. The danger is that every deal looks great because no deal looks bad. Investors can get lazy and fund “me too” companies just to catch a rising tide. All these companies can compete for the same customers and, while that competition should lead to better products in the long-term, it makes the market noisy and less profitable in the short-term.

So, how does one maintain a contrarian perspective amidst this fracas? I try to focus less on what pundits say, and more on what technologists show me in demos. I try to imagine what is possible if that demo could be a product. I then try to imagine what kind of platform that product could turn into. Lastly, I try to imagine what kind of business could be built around that platform.

Along those lines, here are some beliefs I hold strongly about opportunities in technology today, which to others might be contrarian:

1. Virtual reality (VR) will be the next major consumer platform, but the killer app will not be gaming. The only way for VR to reach 100M people will be through mobile devices, and their experiences on those devices will feature immersive content with lightweight interactivity. I’m encouraged by the content produced by our portfolio company Jaunt, but I’ve also seen some great stuff from emerging VR animation studios as well.

2. The business of open source software (OSS) will be far more attractive in the future than it has been in the past. Many CIOs tell us that OSS is now the default solution for building new infrastructure. A classic low-end disruption, OSS is, in some cases, better than the proprietary solutions it has replaced, thanks to decades of community contributions and open testing in real-world environments.

Yet, I know many investors who believe that OSS is a fundamentally bad business to be in. They cite several justifications: (1) it’s too easy to cancel your license when you have scale and can hire developers internally; (2) if the project is successful, Redhat will just add it to the list of projects it supports; (3) the services model creates an disincentive to improve the product, so a better proprietary alternative will always exist.

What these arguments ignore is the value of controlling an ecosystem which consists of multiple open source projects and making all the pieces work well together. Cloudera (Hadoop), CoreOS (LXC), and Elastic (logs) have all gone down this route and will likely be better OSS businesses than those who have come before them.

3. Future business applications will be fueled by software that makes autonomous, machine-driven decisions on behalf of the user. SaaS might be the least contrarian sector today. It went through several stages of evolution, each of which defied conventional logic at the time: (1) horizontal SaaS companies proved that old on-premise systems (CRM, HCM, ERP, etc) could all move to the cloud; (2) small-business SaaS companies proved that inside sales+upsell could create value at relatively low ACVs; (3) vertical SaaS companies proved that focusing on an industry-specific workflow provided enough incentive to switch from legacy systems to the cloud. Today, most SaaS investors I know are still chasing trend #3, especially after the spectacular success of Veeva Systems in the life sciences vertical.

The contrarian bet today is that the horizontal players are ripe for disruption. It is contrarian because most of the incumbents are platforms now, with strong integrations and partnerships. How many people have ever uninstalled Salesforce or Workday, for instance? It’s pretty tough to do.

Yet, I think we’re back to square one. The incumbent products were built in an era where simply digitizing workflow was enough. Today, that is table stakes; the new model should be to view the customer data in your system as the core asset that helps make your SaaS product significantly better. The CRM startup RelateIQ (now part of Salesforce) is a great example of using data to automate many tasks that are time consuming and manual in a traditional CRM. Using machine (and perhaps deep) learning to power core features, these new SaaS products will be beloved by users, not just buyers, and will be pulled into the enterprise in an unstoppable, bottoms-up fashion. Economies of scale and the network effects of data will ensure that these products stick around once they get adopted.

It might be harder than ever before to be contrarian, but I am confident that many opportunities like this exist. We just need to look a bit harder, see through the clutter, focus on product, and welcome the un-intuitive.

I would love to hear your own contrarian theses. Feel free to email them to me at ataussig@hcp.com and, with your permission, I will update this post accordingly.

[Update:] A few friends & colleagues have already submitted a few viewpoints of their own:

Slava Akmechet, CEO/co-founder of RethinkDB:
At the end of the post you asked for contrarian theses, so here are mine. These get progressively crazier:

  • The web will go through a tectonic shift to push architectures, and all of the infrastructure will need to be retooled around that shift.
  • Millennials are interested in experiences much more than in tangible goods. This opens enormous possibilities for experience companies. For example, companies like twitch.tv in verticals other than gaming.
  • More and more traditional businesses are moving online (e.g. education), but we’re still thinking about it in narrow terms. What else can move online that people don’t normally think of? (e.g. How about going to church online?)
  • With the marijuana legalization movement, the moral compass of American society is changing and becoming more liberal. This opens possibilities not just for drug companies, but companies that allow people precise control of people’s own brain chemistry on demand.

Jens Christensen, CEO/co-founder at JauntVR:
One thing I have noticed is that, when a new technology/industry is emerging, it’s often very unclear what the business model should be, or whether there even is one, but that’s also precisely the time to get involved. Once the business model is sorted out, it’s often too late for startups. Here are some examples:

(1) Software: It was very unclear, even as late as the early 90's, how one could monetize software — bits essentially, that could be copied ad infinitum. The whole licensing model we are now used to had to be invented, adopted and accepted.

(2) e-commerce, a la eBay: A few cents on every transaction did not seem like a plausible model; this was the reason eBay had trouble raising funding at first. The business had to grow to a previously unheard of scale, which seemed very unlikely, but of course is exactly what happened.

(3) Search: Extremely useful technology, but again no obvious biz model initially, until Google latched onto advertising.

(4) Open source: Giving away software? How can you make money doing that?

There not being an obvious business model initially is actually a boon to entrepreneurs in that it gives them time and room to maneuver. If the business model is already in place, existing players will pursue the same opportunity vigorously making it harder for startups.

Special thanks to @spakhm, @jensbch, @jamesreinhart, @peteskomoroch, and @cj_reim for your suggestions on this post.