In the world of tech, founders, management and investors are all trying to solve for one thing – to accurately and precisely forecast the trajectory of future growth. In a mature market with known parameters, this is arguably simpler to do. But in a new market with high growth rates, unknown adoption rates and an undefined total addressable market (TAM), it becomes very easy for insiders to fall into a trap of undue optimism and for investors to be swept along for the ride. As tech analyst Eugene Wei notes in his excellent blog on invisible asymptotes, too much focus on the first inflection point of the S-curve can lead one to miss the second inflection point in the curve.
Wei’s conceptualisation of the invisible asymptote is exactly as it sounds – an invisible ceiling to a company’s growth that often goes unnoticed until it is too late. In his exposition, Wei makes a distinction between two types of businesses – one in which the TAM can be estimated with a reasonable degree of accuracy, and the other in which the TAM is unknown. This is an important distinction to bear in mind, as it requires different management responses to drive sustainable growth, and it is ultimately up to the investor to determine if management is taking the right approach.
Chart 1: Invisible asymptotes
Invisible asymptotes cause growth to taper off sooner than expected as, by definition, they are invisible and thus unexpected.
Wei uses Amazon as an example of a new business (back in the day) with a quantifiable TAM – initially, the size of the global printed book market. As Amazon entered new retail markets, one could tack on the TAMs of each market and arrive at reasonably sensible upper limits to growth. What was unknown, however, was the adoption rate. Amazon quickly figured out that shipping fees were the barrier to greater adoption, notwithstanding the fact that its offer, plus shipping fees, was still cheaper than buying the same items in stores. What they also figured out was that the same customers that griped at shipping fees were more than happy to pay for an entire year’s worth of shipping upfront, along with a few freebies, and thus came the advent of Prime (customers can be irrational like that). The rest, as they say, is history.
Another example given is that of Snap, the parent of the Snapchat messaging app, as a business for which the TAM is not easily quantifiable. That Snap has hit an invisible asymptote is hard to dispute given the company’s lacklustre performance since its IPO. What should have investors worried, however, is not Snap’s decelerating growth trajectory, but rather that management is bumping heads against an asymptote they still don’t realise (and/or admit) is there, and thus adopting the wrong response to the problem. The product itself has been widely criticised for being inscrutable to use, yet the redesign of the user interface in 2018 not only alienated Snapchat’s core userbase, it also failed to attract new users.
Wei posits that Snap’s invisible asymptote is not one of feature set, but more of a generational divide – that is, management and shareholders believe Snap’s TAM to be much larger than it actually is. Snap bulls once touted the app as the “Facebook killer”. Such a categorisation would imply that Snap’s TAM is in the billions of users, and it is likely that the IPO and initial trading was priced on that basis. However, a rational assessment of the product could have suggested otherwise. Firstly, older generations did not grow up with a forward-facing camera within reach all hours of the day, and thus text communication is more natural to them; Snap is a camera-based communication tool embraced by the selfie-taking younger generation(s). Secondly, while the ephemeral nature of Snapchat is a selling point for teenagers and young adults, as people age, their desire for lasting memories increases (and hopefully their messaging indiscretion decreases), so a disappearing messages app is not only less appealing, but also unnecessary. All of this is to say that tweaks and revamps of the feature set is unlikely to solve Snap’s problems; at 191 million active users, Snap might already be approaching saturation of a more realistic TAM. To inflect upwards again, Snapchat would need to…not be Snapchat but something else entirely, which would destroy the appeal of the original product.
This “invisible asymptote” concept is an important addition to any investor’s mental framework, particularly when it comes to analysing companies with historically strong growth trajectories that could be tempting to extrapolate forward. In these instances, investors can often spend too much time agonizing over the gradient of the middle part of the S-curve and fail to notice the company bumping into the shoulder of the curve. The concept is equally applicable when analysing value stocks, for an investor that misdiagnoses an invisible asymptote as a bargain opportunity can quickly find themselves stuck in a value trap.