Cathie Wood, the head of ARK Investment Management, was interviewed on CNBC last week. Ms. Wood is one of the most visible fund managers of this Covid and post-Covid era, and is renowned for taking large positions in firms where emerging but scalable technologies are central to their businesses. Tesla, for instance, is one of her funds’ top positions. Read this NY Times article if you want to learn more about Ms. Wood and where she comes from.
One notion that Ms. Wood addressed during the CNBC interview was Wright’s Law. I knew about Moore’s Law, but not Wright’s Law, so I looked it up. Theodore Wright was an airplane engineer during the 1930’s. Despite his last name and involvement with airplanes, Theodore does not appear to have been related to Wilbur or Orville, as the latter two did not have children. Anyhow, Theodore developed a formula that forecasted by how much the cost of manufacturing airplane components would decline as production increased. The “by how much” is the key. Whereas Moore’s Law posited that the number of transistors on a chip would double every two years, Wright’s Law predicts by how much the cost of components would decrease over time. As the concept of Moore’s Law has been broadened to address many other (mostly high-tech) industries, so too does Wright’s Law apply to industries other than the airplane industry.
ARK’s Usage of Wright’s Law
Ms. Wood and the people at ARK use Wright’s Law to calculate how much costs will come down over time as companies’ production grows. ARK has found that Wright’s Law is remarkably accurate in forecasting these costs. For instance, ARK uses Wright’s Law to calculate the cost of lithium ion batteries, which are central to Tesla. According to this article from 2019 on ARK’s website, ARK forecast that Tesla’s gross margin for the Model 3 would be 30% by the end of 2020. Guess what? According to its latest annual report, Tesla’s “automotive gross margin” as of Q2 2021 was 28.4%. Pretty darn close to the 30% forecast. It has helped also that Tesla has been able to maintain its sales prices, a function to which Wright’s Law does not apply. As a result, while other investors concern themselves with supply and production issues or with Covid and the likelihood that electric car sales would increase, ARK’s focus is mostly on declining production costs as calculated through the application of Wright’s Law.
The more I investigated, the more it appears that ARK’s use of Wright’s Law is really its secret sauce. By using Wright’s Law, ARK has calculated by how much costs should decrease in fields such as autonomous tech and robotics, genomics, FinTech, and Space. ARK looks far into the future but it may not look so hazy to them if they believe the costs of all of these futuristic technologies will decline and by a specific amount. As a result, ARK’s assets under management in its principal Innovation Fund have grown from about $8 Billion a year ago to about $21.6 Billion currently.
I find it interesting that this theorem was devised not from the professorial ranks but from an engineer who worked within the industry. Likewise with Moore’s Law. All of that practical, hands-on experience is invaluable. Also, that Cathie Wood and ARK use the Wright’s Law concept and apply it to all of these other industries is a good way to get a handle and focus on what the future may look like. Let’s keep watch on them.
Y = aX^b
Y = cumulative average time or cost per unit
a = time or cost required to produce the first unit
X= cumulative number of units produced
b = slope of the function