Natural Science #9: Critical Mass

Imagine a cloud of gas floating in space. Over centuries, the cloud collapses under its own gravity and what happens next depends on how much matter was available. In one case, we might end up with a Jupiter or Saturn like ball of gas floating around. Given a bit more matter, we end up with a brown dwarf – a sort of failed star. But at some point, adding a bit more matter causes a drastically different outcome. A thermonuclear reaction lights up the sky.

The amount of matter needed to form that star is called its critical mass and it’s the subject of today’s post.

Critical mass in physics

Around 1941, the term “critical mass” was coined to describe the minimum amount of a given fissionable material necessary to sustain a nuclear chain reaction at a constant rate. A chain reaction is a sequence of reactions where the product causes additional reactions. There is a self-sustaining feedback loop. For example, a snowball leading to an avalanche or a spark leading to a forest fire.

In a nuclear reactor, a neutron hits an atom causing a larger number of neutrons to be released. Those neutrons continue to hit other atoms, causing a self-sustaining nuclear reaction. In a nuclear weapon, the mass needs to be kept sub-critical until detonation is desired. This is accomplished by either storing the fuel in different chambers or storing the fuel in sub-critical shapes. For detonation, the fuel is slammed together and critical mass is achieved.

Critical mass in sociology

In social dynamics, critical mass is the sufficient number of adopters of an innovation so that the rate of adoption becomes self-sustaining and creates further growth. Malcolm Gladwell popularized this idea in his book The Tipping Point. Gladwell uses the example of a fax machine:

Sharp introduced the first low-priced fax machine in 1984, and sold about 80,000 of those machines in the United States in that first year. For the next three years, business slowly and steadily bought more and more faxes, until, in 1987, enough people had faxes that it made sense for everyone to get a fax. Nineteen eighty-seven was the fax machine Tipping Point. A million machines were sold that year, and by 1989 two million new machines had gone into operation.

How do you sell the first fax machine when no one else has a fax machine? Critical mass plays a significant role in deciding whether an innovation will light up like a star or fade away. Another often cited example is a riot. Everyone has a threshold where they will join a riot. Some people will have a low threshold and riot even if no one else is. Other people will require that the whole city is rioting before they join. A chain reaction occurs where each threshold brings in new rioters, which in turn raises the threshold for even more.

Other social examples are strikes, conformity, voting, migration, when to leave a party, etc.

Critical mass in investing

In business, critical mass refers to the size a company needs to reach in order to sustain growth without further investment. Uber is a recent example of this. The ride share industry is throwing billions of dollars at attracting customers and drivers. Everyone hopes to reach that critical mass where they will be able to cut back on the investment and finally turn a profit. Facebook hit critical mass when it beat Myspace and started selling ads. Sony’s blu-ray format hit critical mass when it beat HD-dvd.

It is important to note that the companies that are able to reach critical mass will be rewarded exponentially. The returns in these situations follow a power law distribution in which many fail and a few get rich. Charlie Munger put it this way:

Adding success factors so that a bigger combination drives success, often in non-linear fashion, as one is reminded by the concept of breakpoint and the concept of critical mass in physics. Often results are not linear. You get a little bit more mass, and you get a lollapalooza result.

We don’t have automatic competitive advantages. We’re seeing some more insurance volume, mainly from General Re, and Cort and Precision Steel have momentum, but we have to find future advantages through our own intellect. We don’t have enough critical mass and momentum in place at Wesco, so investors are betting on management.

Critical mass can also work negatively as is the case in financial panics. One person pulling liquidity from the market can have a negative feedback loop where everyone pulls liquidity. The reaction can become so powerful that markets completely fail. This was seen in the great depression and more recently in the great recession.

As investors, we should keep an eye out for critical mass situations. These are situations where a company has such a strong competitive position that management can be idiots and still succeed. When we can’t find these situations, we have to rely on managements ability to drive out-performance.

Conclusion

Critical mass is a powerful concept from physics. It states that at a certain point, a reaction enters a self-sustaining feedback loop. In social situations, this can refer to the adoption of a new technology. In business, this can refer to the size of a company where economies of scale take over. In investing, this explains the large gap between the winners and the losers in most markets.

References:
https://en.wikipedia.org/wiki/Critical_mass
https://en.wikipedia.org/wiki/Chain_reaction
https://www.amazon.com/Tipping-Point-Little-Things-Difference/dp/0316346624
http://a16z.com/2016/03/07/network-effects_critical-mass/

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Author: David Shahrestani

"I have the strength of a bear, that has the strength of TWO bears."

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