Nassim Taleb’s anti-fragility concept in private equity situations

Private equity investors and lending banks are fond of subscription businesses because they provide more “stable and predictable” cash flow.

I once worked on a buyout deal where the target company had two revenue streams. One stream was unit sales and theĀ other stream was subscription sales with average one year duration. The subscription revenues where “obviously” of higher quality than the unit sales. And hence a higher valuation multiple would be assigned to subscription revenues.

But if you think about it, the thing that should ultimately matter here is the customer satisfaction with the product, and hence the likelihood for repeat purchase. A subscription contract can lock-in the customer, but it can not make the customer more satisfied. So the subscription only delays any customer feedback to the company. Unit sales, on the other hand, may be less predictable and hence less comfortable short term, but creates more potential for anti-fragility due to real time feedback of customer satisfaction.

So there you have a real life example of “fragility disguised as robustness” as per Nassim Taleb’s new book.

P.S.: admittedly, the predicability of subscription revenues is hugely beneficial, especially for smaller companies where small downward shocks can have severe impact, but with that benefit comes a drawback (delayed feedback which can lead to even bigger unexpected negative shocks).