Henry Ellenbogen - Man Versus Machine - [Invest Like the Best, EP.452]

Second-time founders (“Act II teams”) possess a unique advantage. They can solve the same core problem but with complete clarity from the start, knowing the edge cases and organizational structure required. This allows them to leverage modern technology while avoiding the mistakes of their first venture, as seen with the founders of Workday and Affirm.

Durable Capital founder Henry Ellenbogen's research shows that over any 10-year period, only about 40 of 4,000 public companies compound at 20%+ annually. Critically, 80% of these “valedictorians” begin their compounding journey as small-cap stocks, highlighting this market segment's importance for long-term growth investors.

Just as Kaizen and “China cost” revolutionized physical product businesses over 40 years, AI is initiating a similar, decades-long optimization cycle for intellectual property and human-centric processes. Companies that apply this “digital Kaizen” to lean out workflows will gain a compounding cost and efficiency advantage, similar to what Danaher achieved in manufacturing.

An estimated 80-90% of institutional trading is driven by quant funds and multi-manager platforms with one-to-three-month incentive cycles. This structure forces a short-term view, creating massive earnings volatility. This presents a structural advantage for long-term investors who can underwrite through the noise and exploit the resulting mispricings caused by career-risk-averse managers.

The public markets offer a unique advantage over staying private indefinitely: discipline during transitions. Daily stock prices and investor scrutiny force management to confront hard truths and balance growth, profitability, and innovation. As seen with Netflix's pivot to streaming, this pressure is crucial for realigning employee incentives and making tough capital decisions during strategic shifts.

For early-stage growth companies, an investment memo must prove a dual thesis: not only will the initial capital generate a fair return, but the company's progress will make it *more* attractive to buy additional shares at higher prices as it de-risks. If you wouldn't dollar-cost-average up, you shouldn't make the initial investment.

Investor Henry Ellenbogen favors two types of competitive advantages. First, hard-to-replicate physical assets like distribution networks, which are messy and time-consuming to build. Second, “soft” moats built on elite human systems for talent development, operational excellence (like the Danaher Business System), and sharp capital allocation. These are harder to see but just as powerful as physical scale.

A durable competitive advantage, as defined by lessons from Amazon's Jeff Bezos, is an edge that persists even if a competitor woke up tomorrow and perfectly copied your strategy with equally talented people. Amazon used its early cost advantage to build physical fulfillment centers, creating an infrastructure lead that became impossible to close, even once the strategy was obvious.

Durable Capital's process includes a mandatory three-year look-back for every investment, comparing the original thesis to reality. This is crucial because while small deviations can be excused quarterly, compounding them over 12 quarters reveals significant thesis drift. The formal review forces an intellectually honest assessment of whether a slow-moving problem has become critical.