"Any sufficiently advanced technology is indistinguishable from magic."
That aphorism, attributed to Arthur C. Clarke, came to mind as I was reflecting on a vision for the future an entrepreneur shared with me, so I looked it up.
Turns out it’s from a fascinating essay Clarke wrote in 1962, “Hazards of Prophecy.” It’s a biting essay on how bad “experts” are at forecasting the future. It’s similar to some of Nassim Taleb’s writing. You can find the essay here.
Clarke starts off:
With monotonous regularity, apparently competent men have laid down the law about what is technically possible or impossible—and have been proved utterly wrong, sometimes while the ink was scarcely dry from their pens. On careful analysis, it appears that these debacles fall into two classes, which I will call “failure of nerve” and “failure of imagination.”
Failure of nerve
Failure of nerve is the more common failure, which occurs “when even given all the relevant facts the would-be prophet cannot see that they point to an inescapable conclusion” (emphasis Clarke’s).
He goes on to list a series of developments and the common misgivings of naysayers: locomotives—suffocation at thirty miles per hour; electric light bulb—impractical; flying—physically impossible; space travel—fuel would be too heavy; etc.
He makes an interesting point that many of the naysayers were credible, competent people:
The lesson to be learned from these examples is one that can never be repeated too often, and is one that is seldom understood by laymen—who have an almost superstitious awe of mathematics. But mathematics is only a tool, though an immensely powerful one. No equations, however impressive and complex, can arrive at the truth if the initial assumptions are incorrect.
Failure of imagination
The second part of the essay focuses on what he calls the less blameworthy, and more interesting, failure—the failure of imagination:
It arises when all the available facts are appreciated and marshaled correctly—but when the really vital facts are still undiscovered, and the possibility of their existence is not admitted.
Clarke gives the example of Lord Rutherford, who discovered a great deal about the structure of the atom and yet frequently mocked those who believe that one day the energy locked up in the atom could be harnessed.
Clarke points out that it was only five years after Lord Rutherford’s death that the first nuclear chain reaction was started and warns:
The example of Lord Rutherford demonstrates that it is not the man who knows most about a subject, and is the acknowledged master of his field, who can give the most reliable pointers to its future. Too great a burden of knowledge can clog the wheels of imagination…
He embodies that idea in what he calls Clarke’s Law:
When a distinguished but elderly scientist states that something is possible, he is almost certainly right. When he states that something is impossible, he is very probably wrong.
Clarke gives some advice on how to prevent this second failure:
One can only prepare for the unthinkable by trying to keep an open and unprejudiced mind—a feat which is extremely difficult to achieve, even with the best will in the world. Indeed, a completely open mind would be an empty one, and freedom from all prejudices and preconceptions is an unattainable ideal. Yet there is one form of mental exercise that can provide good basic training for would-be prophets: Anyone who wishes to cope with the future should travel back in imagination a single lifetime—say to 1900—and ask himself just how much of today’s technology would be, not merely incredible, but incomprehensible to the keenest scientific brains of that time.
The thought experiment Clarke suggests is pretty neat. Since I’m an investor in technology, I’m more interested in the five to fifteen year window so I’ll modify that thought experiment slightly:
To understand the sort of technology companies that will win in the next ten years, go back ten years and ask yourself which of the winners of today would be completely unforeseeable by the keenest investing minds of that time.
Markets are nice because expectations are baked into prices. Valuations reflect beliefs about the future so if the value of a company increases (or decreases) dramatically in the intervening time, it’s obvious that something unexpected happened.
You can’t predict everything, but to Clarke’s point, much that could be predicted wasn’t because there was either a failure of nerves (failing to take the facts to their logical conclusion) or a failure of imagination (failing to accept that there were possible—in some cases, likely—significant events in the future).
Ten years ago was 2003. Some brief anecdotes of what was happening then and what happened since:
- VMWare was five years old. In 2004, it would be acquired by EMC for $625 million. In 2007, it would IPO at an $11 billion market cap. And by 2013 it would have a $30 billion market cap.
- Salesforce was four years old. In 2003, it would have close to $100 million of revenue, having grown revenue 90 percent that year. It would go public in 2004 and be valued at about $1.3 billion. Analysts valued the company using multiples of revenue from “comparable” companies and by projecting its future cash flows. For a sense of expectations at the time, Credit Suisse was neutral, believing the $13 per share price would increase to $15 in 12 months. It valued the company on projected cash flows and projected FY ‘13 (ending 1/31/13) revenue of $812 million. Actual FYE 1/31/13 revenue: $3.1 billion. Enterprise value: $29 billion. That’s a 22x appreciation, 41 percent CAGR—through the worst economic downturn since the Great Depression.
- SuccessFactors was two years old. Revenue in 2002 was $2.5 million, and it would be $4.1 million in 2003. Good, not great. I don’t have the financing details directly but backed into them from the S-1 (happy to share details): it looks like the Series B it raised in 2002 of $5 million had an $11 million post-money. That was certainly a deal given the outcome, but it was a deal even on those revenue figures.
- Amazon was nine years old and had been a public company for six years. The stock was trading around $35 at mid-year for a $14.6 billion market cap on projections for 2003 and 2004 of revenue increasing from $5.1 billion to about $6.2 billion. All of the public analyst discussion was centered around merchandising categories, fulfillment costs, free shipping promotions, and margins. The stock crested at $91 just prior to the 2008 housing/banking crisis, shrinking to $38 at the low. Today, it’s at $272 for a market cap of $127 billion and projected 2013 revenue of $74 billion. That’s a 23 percent CAGR on the share price and a 31 percent CAGR on revenue. All of the discussion was focused on AWS, digital offerings, Kindle, Amazon Prime, original content, and China.
- Facebook hadn’t launched yet. That would be January 2004. The seeds were sown, though. Zuckerberg had created Face Mash and gotten in trouble for it. Friendster was one year old, and Myspace would launch that year and be acquired two years later for $580 million.
Just some quick observations. I’m going to write about each of these in more detail later. But they give you a flavor of what the technology world looked like ten years ago.
The reverse thought experiment—who were the high flyers of the time that eventually stumbled—is informative as well. I’d love to dig in to Yahoo, RIM, and others.