Mental Model: Bottlenecks

by | Oct 21, 2020 | Episodes, Mental Model | 0 comments

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Basic Definition

Bottlenecks are parts of a process where the result of the overall system is entirely dependent on it.  It is the limiting factor.

Explanation of the Concept

  • This is also known as the Law of the Minimum, or Liebig’s law of the minimum.  German scientist Justus von Liebig helped popularize this idea in agricultural science.
  • It is not the total amount of resources available that makes crops grow, but the availability of the scarcest resource.
  • Think of a literal bottleneck – imagine a bottle of Coca-Cola.  When you pour the soda out into your glass, the liquid is forced into the small throat of the bottle at the top (side note: this actually increases the velocity of the liquid flowing out).
  • A common application of this principle is a manufacturing floor.  Imagine a Coca-Cola factory, and there are different sections where different aspects of production are happening.  One one end you have a station filling up empty bottles with Coke, at another you have a labeling station, another is for sorting, packaging, etc.

    The Mental Model in an Investing Context

     

    • The first thing that comes to mind when discussing bottlenecks in the investing world is how there are certain minimums required to even have a shot at being a successful company, and ultimately a successful investment.
    • Going back to our Coke example, but looking at it from a different angle, imagine you and I wanted to start a beverage company that would compete with Coca-Cola.  Well, we could come up with a formula for a new soda flavor, figure out the packaging, etc.
    • In order to have any shot of success, we’d have to at least penetrate a single local market and win over the market share in that market.  But doing that at a reasonable cost where we could compete would mean that we’d need a certain level of scale in our organization to get economies of scale (another related mental model) to keep our costs and therefore our prices down.
    • So the entire bottleneck of our investment process as a new entrant into the beverage industry is being able to compete at scale from the very beginning.  This would be quite difficult, and would require very good distribution systems, excellent pricing from suppliers, etc.
    • Let’s also look at it from a portfolio management perspective as an individual investor.  I’d be willing to postulate that the bottleneck in most people’s investment process is not the ability to buy or sell companies in a liquid marketplace, or the presence of good opportunities, or even the amount of research required to reasonably select a security (though that is admittedly a huge factor).
    • I think the biggest bottleneck is simply liquidity.  If people had money in their accounts ready to invest, they would be able to move to all of the other steps of the process.  But, without money to invest, one simply cannot multiply what is not there.
    • I was bit by this principle a bit during the recent market correction back in March.  I was able to invest in a few shares here and there, but found myself needing more cash precisely at the time when prices were cheapest.

      Want to listen to another episode or check out another company?  Check out the full archive here.

      Alex Mason

      Hi, I'm Alex and I'm an individual investor and podcaster who's curious about the world, especially when it comes to long term investing in the stock market. I'm always looking for better ways to analyze businesses and add more mental models to my brain's tool belt.

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