1. Key Takeaways & How Kessler Addressed Them
Take #1: Find and Exploit Your “Edge”
What It Means
Kessler explains that simply saying “We’re based in Silicon Valley” is not enough of a competitive advantage. Hedge fund managers often believe location alone or superficial knowledge is an edge. Instead, Kessler finds that true “edge” comes from:
- Immersing yourself in the workings of companies, verifying claims face-to-face.
- Understanding second- and third-order effects (like cost collapses that create entirely new markets).
- Knowing something others cannot—either through direct scuttlebutt, analyzing margin structure, or reading technological breakthroughs earlier than mainstream investors.
Real Examples in the Book
- Jack Nash Meeting: Kessler pitches the fund’s “tech focus” to legendary hedge fund manager Jack Nash. Nash demands: “What do you know that no one else does?” Kessler initially stumbles, saying “We’re in Silicon Valley,” but realizes that is insufficient. He leaves the meeting determined to develop deeper insight—especially about cost structures, demand triggers, and direct company visits.
- Company Site Visits: He invests days shuttling around from CFO to CFO (the “four-door office”), extracting firsthand knowledge that other big-fund managers, stuck on the East Coast, do not gather. This constant “on foot” approach becomes his real information advantage.
How He Addressed It
- Meeting CFOs in Person: When confronted with contradictory or vague statements, Kessler visits the competitor or calls their major customers. He might notice if a CFO literally closes the door (as with Red Brick) and treat that as a red-flag sign.
- Watching Margins & Growth: Kessler keeps spreadsheets of each firm’s cost declines, new product cycles, R&D pipelines—deciding if those “technical edges” are real or hype.
Take #2: Technology “Waterfalls” & Cost Breakthroughs
What It Means
Kessler loves the metaphor of a “waterfall,” describing situations where a technology’s cost drops so steeply that entire new applications (and mass demand) open up. He compares it to how Watt’s steam engines in 1775 reduced horsepower costs, or how cheap DVD laser chips launched huge consumer markets.
Real Examples in the Book
- Elantec’s Laser Diode Drivers: Kessler discovers Elantec’s low-cost laser drivers, which cost around $1–2 each, yet could be sold at a $5–10 premium. Once CD/DVD burning booms (sparked partly by Napster music swapping), the attach rate surges from near-zero to the majority of PCs. This triggers a “waterfall” in Elantec’s sales and stock. Kessler’s small stake turns into a 50x return.
- Alteon’s Edge & Bandwidth Growth: Alteon built layer-4 to -7 switches for the Internet. As broadband expands (cost of bandwidth dropping each year), companies demand these advanced switches. Alteon’s “waterfall” soared so high that Nortel paid $7.8 billion for it.
How He Addressed It
- Constantly Studying Cost Curves: Kessler calls it “second derivative thinking”—not just whether DVD drives are cheaper this year, but how fast they are cheapening and how that might explode usage (like Napster or home video editing).
- Upside Patience: Once he identifies a “waterfall,” he invests for the big upside, tolerating day-to-day volatility.
Take #3: “Steam Engine” Moments & Historical Parallels
What It Means
Kessler devotes chunks of the book to the Industrial Revolution, analyzing Boulton & Watt’s steam engine breakthroughs. He does this to illustrate how a new engine (power source) cut costs drastically and changed entire global industries. By analogy, microprocessors (Intel), operating systems (Microsoft), and optical networks (Cisco, Alteon) do the same in the late 20th century.
Real Examples in the Book
- Studying Boulton & Watt: Kessler reads about how John Wilkinson’s precise boring tool gave Watt’s steam engine 5 times more power. Boulton didn’t even sell the engine—he rented its horsepower, a new “business model.” Kessler sees parallels in licensing IP for chips or software, where margin is perpetually high if you have the “indispensable” part.
- Margin Surplus vs. Trade Deficits: Kessler then extends the steam engine lesson to U.S. modern economies. Like steam power letting Britain run profitable factories, the U.S. uses chip/software IP to run massive profits, overshadowing the “on paper” trade deficits.
How He Addressed It
- Applied the Lesson to Tech Stocks: He hunts for companies that, like Boulton & Watt, own the essential IP or the “monopoly vantage.” E.g., a crucial DVD chip or advanced network switch.
- Focus on Profit Streams: Boulton’s model was collecting a fraction of a horse’s cost over decades. Similarly, Kessler invests in software or chip companies that sell repeated licenses or high-margin designs.
Take #4: Managing “Mania” & Forced Redemptions
What It Means
Kessler sees short-lived booms and crashes—from dot-com IPO frenzies to currency crises. When mania hits, prices become detached from fundamentals. He protects his fund by systematically sending back capital to investors each month (“forced redemptions”), ensuring they don’t get stuck if the market collapses.
Real Examples in the Book
- Dot-Com Euphoria of 1999: Kessler recounts conferences where random B2B or e-commerce names soared on minimal revenue. People pitched “the next Netscape.” Once Kessler sees a room full of “peach-fuzz” junior analysts endorsing $100+ price targets, he recognizes mania.
- Selling Out of MP3.com: He gets 10,000 IPO shares at $28, flips them for $60+ on day one, and never looks back. Later, the stock crashes near zero due to lawsuits. That’s how he uses mania to his advantage but keeps risk tight.
How He Addressed It
- Proactive Partial Selling: Instead of waiting for a meltdown, he deliberately sells pieces of big winners, month by month. This “slow exit” technique protects him from the bubble bursting in 2000.
- Closes the Fund on Schedule: He ends the fund after 5 years, even though performance is still strong. He believes returning capital ensures that mania won’t devour gains.
Take #5: Building One’s Own Research Process
What It Means
Instead of relying on sell-side analysts, Kessler conducts rigorous, first-person due diligence. He calls these face-to-face visits “soap operas,” because each company’s CFO or CEO drama reveals crucial details about product viability, sales traction, or hype.
Real Examples in the Book
- Versant & Red Brick: Kessler invests in both software companies but quickly spots management red flags (closed-door CFO conversations or “over-rosy” sales pipelines). He learns the hard way to confirm real demand by talking to customers.
- Fidelity to the “Four-Door Office”: Driving daily around Silicon Valley, meeting 6+ companies, collecting “pattern recognition” about CFO behaviors, product demos, and whether “the new version is shipping or delayed.”
How He Addressed It
- Cross-Checking Competitors: If Company A says “Our competitor’s product is worthless,” Kessler visits the competitor to get the story. He forms an independent mosaic.
- Evaluating CFO Body Language: “Door shutting,” “guarded talk,” or repeated deflections signal potential problems. If he senses trouble, he sells swiftly (like Red Brick at $26 before it plunges to $5).
2. Key Opinion
“Stay close to reality, not stock-ticker illusions. If you’re ‘long and wrong,’ find out fast. If you’re ‘long and strong,’ ride the wave but know mania can flip anytime.”
Kessler’s overarching viewpoint is that knowledge from real people—engineers, CFOs, customers—trumps fancy charts or macro rumor-mongering. His secret sauce is that he physically shows up in the CFO’s office or invests time calling customers, while many big funds skip that step.
3. Selected Quotes & Relevance
Quote #1: On Edge
“Just being in the Valley doesn’t cut it. I have to know which chip is on which board in whose product.”
Why It Matters: This is Kessler’s admission that “local advantage” must be turned into factual advantage. He invests hours in scouring product lines to see who truly wins the next generation.
Quote #2: On “Steam Engine” Parallels
“If you could invest in Boulton & Watt’s 25-year steam-engine patent in 1775, you’d ride an empire. We do the same with network routers and DSL chips.”
Why It Matters: Kessler sees the present day “monster markets” (Internet infrastructure) as analogous to 18th-century cheap power. The takeaway: intellectual property is the new horsepower.
Quote #3: On Forced Redemptions
“You can’t wait for the party to end. You must slip out early, or you’ll be picking up shards of broken glass.”
Why It Matters: His monthly forced redemption strategy is how he “slips out early,” securing big gains ahead of the 2000 crash.
4. How This Shaped His Story & Approach
- He Overcame “Impostor Syndrome” by developing deeper knowledge than momentum chasers.
- He Found Real Gems (Elantec, Alteon, Inktomi) by verifying the “waterfall effect” of cheap or pivotal IP.
- He Learned from Failure (Versant, Red Brick) to walk away quickly when management red flags appear.
- He Exited at the Right Time by forcing partial distributions before the market meltdown, saving his fund from major losses.
5. Brief Reflection on “Steam Machines” & Intellectual Property
Bullet Recap
- Watt’s improvement in steam engine design parallels “shattering cost barriers” for Kessler’s DVD or networking picks.
- Patents & IP (like Boulton & Watt’s 25-year exclusive) match high-margin chip and software designs: you can “rent” them repeatedly.
- Vision Over Indecision: Kessler says you must foresee when a cost barrier is about to vanish so you’re in position to invest well before hype sets in.
6. Notes to Self
- Do the Work: Like Kessler, talk to CFOs, customers—don’t rely on hype or quick tips.
- Focus on Tectonic Shifts: If you catch a “steam engine moment” early, the upside can be enormous.
- Manage Risk: Bubbles form fast—adopt or invent strategies (like forced redemption) to preserve gains.
7. Building Goodwill & Connections
- Show Up, Earn Credibility: Kessler is blunt that big returns come from “knocking on doors,” not waiting for phone calls. Over time, CFOs trust him to do repeat visits.
- Skeptical of “fast talkers”: The smarmy “placement agent” who demanded 50% ownership taught him that raising money can turn into losing your firm—Kessler always tries to keep personal control.
8. Dealing with Authority & Institutional Investors
- Let Performance Speak: Kessler’s run-ins with suspicious institutional investors (like Jack Nash, or the big family offices) show that numbers & track record eventually matter most, not glitzy offices.
- Light Touch with Regulators: He’s not a fan of heavy regulation but recognizes the meltdown in 2000 or the fiascos at LTCM, Enron taught him that “someone must watch the watchers.”
Background & Conclusion
Throughout Running Money, Andy Kessler chronicles his pivot from Wall Street analyst to co-founder of a Palo Alto tech-focused hedge fund in the mid-1990s. He systematically pursues:
- Deep “soap opera” research on companies,
- Spotting “steam engine” cost leaps that unleash massive new demand, and
- Protecting gains when mania hits.
The overarching lesson is a combination of thoroughness, imagination about the future, and discipline in managing a portfolio. Just as steam once powered entire revolutions in manufacturing, cheap computing & bandwidth power modern wealth creation, if you position yourself ahead of that shift.
Final Thought: Kessler’s story affirms that the real “edge” is knowing exactly which disruptions and margin surpluses matter—and going in big before the crowd sees it. But also, as he repeats, “Don’t let mania keep you at the casino table.” Sometimes the best edge is stepping away with gains intact.
“Margin is everything. If you find that unstoppable IP, buy early and watch the ‘steam’ carry you—just don’t ride over the falls.”
Jerry Wu Investing and Social Justice 