In the book “The Black Swan”, Nassim Taleb spoke of the idea of Extremistan and Mediocristan. I remember reading it for the first time in 2007 and being blown away by it. 

What is Extremistan? Extremistan is a place of extreme results. In fact it is so extreme that 1 or 2 winners would tower over everybody else. It’s place where you can apply the power law: 1-99. That is 1% of the population has 99% of the wealth. Or 1 of the business accounting for 99% of the market share or profit share while all others have fight for table scraps. 

To understand this better, think of a football field with 1000 people seated in it. Say the average net worth of the 1000 individuals is $100,000. And in walks Jeff Bezos with a net worth of $ 200 B. And suddenly the average net worth goes up from $100 K to $ 200 M. That is a 2,000 time jump because of 1 individual! Another way to say it:  0.1% of the stadium population accounts for 99.9% of the stadium’s wealth!

And what is Mediocristan? It’s place where the difference between the winners and others is not as dramatic. It’s a place where Pareto principle works: 30-70. Where 30% of the population accounts for 70% of the wealth and 70% of the population for the remaining 30% of the wealth.

Returning to the same football field example. Say the average weight of the 1000 individuals is 70 Kgs. And in walks the world’s heaviest person at 400 Kgs. The new average would now be 70.32 Kgs. Or an increase of 0.4% only! If you lined up all of them from heaviest to lightest, the heaviest 30% would account for 70% of the weight. That’s Pareto principle.

In Extremistan, the difference between the winner and the mean was of the order of 2 Million times ($200 B vs $100k). In Mediocristan, it is 6 times (400 Kgs vs 70 Kgs)! Truly a world of difference in the magnitude of what one winner can make to the group!

We are living in a world where the shift is happening from Mediocristan to Extremistan, driven by technology. In the same book, Taleb shares the example of several artists who had a following of their own. The bigger artists had bigger followings but the smaller guys could also survive. Just as in Mediocristan. But the invention of the gramophone meant that people could now enjoy music performed by artists from distant lands far away or  some who were dead. And therefore 1 or 2 noted musicians could now have most of the market leaving nothing for others. Like Extremistan.

So why pay attention to Extremistan and Mediocristan?

1. In Extremistan there are only 1 or 2 winners. They enjoy a combination of scale, exit barriers, network effects etc and hence are very hard to dislodge. And therefore they become virtual monopolies. Hence your investment universe is limited to the winner.
2. In Extremistan, because of dominant characteristics, the winners can operate their business on other people’s money. And therefore their return on shareholders’ equity tends to be fantastic. 
3. In Extremistan, the big are likely to get bigger. 
4. In Mediocristan, all your investment options are open. You can find that the #2 is more profitable than the #1 (like Infosys and TCS). Or you can find a profitable niche operator. Since it is Mediocristan, more than one business model can exist and more than one player can be investment worthy.
5. Business models are changing and businesses are leveraging technology to bring in Extremistan-like qualities to a Mediocristan business. For example, coaching classes were traditionally a Mediocristan business as they are limited by space and capacity. But now, even they provide recorded classes online and therefore can deliver the same product (lecture) without constraints of space or capacity.

Extremistan is fascinating and emerging in India as well. Remember, Extremistan is a place of extreme results and therefore we must make some room in our portfolio for these businesses. 

Will share more thoughts on Extremistan in the next post.

Thanks for reading!

Featured Photo by Ashley Knedler on Unsplash